One Good Idea: A safe play in a dangerous market

By Dianne Maley
Globeinvestor Magazine Online, Sept. 19, 2008

Source: Bob Hoye, editor and chief investment strategist, Institutional Advisors newsletter, Vancouver.

The idea: Buy five-year government bonds. If you are one of the Canadians with a collective $72-billion stashed away in money-market funds, you may be feeling relieved, even a little smug, after the recent panic selling on world stock markets.

But "cash in a crash" is not the best strategy either, says Mr. Hoye. That's because short-term rates fall when a big financial bubble goes bust as central bankers scramble to prop up the economy and stave off deflation. At the same time, long-term rates rise as investors lose all tolerance for risk and dump long-term bonds for the safety of shorter maturities.

With money market yields at a scant 2 per cent or so and falling fast, people who huddle for safety in T-bill funds will slide deeper into the hole after subtracting inflation.

"If you're in three-month treasury bills, with every rollover you're going to get a lower interest rate," Mr. Hoye said.

The payoff: Safety, income and potential gain. The advantage of five-year bonds, which currently yield about 3.2 per cent, is an extra percentage point or so in yield and perhaps some capital appreciation, too.

The big risk: Interest rates could rise across the board, eroding the value of bonds of every term. Investors would face the choice of selling at a loss or holding their bonds to maturity in five or so years. As well, inflation could gobble up some or all of your yield over time.

Why listen to Bob Hoye? Because of his track record. In July, 2007, Mr. Hoye warned that a "financial train wreck" of historic proportions was looming that would take down some major financial institutions and take years to work out. In August, 2007, the asset-backed commercial paper disaster struck, followed by the collapse of some of the largest investment dealers in the United States, Bear Stearns and Lehman Brothers. Mr. Hoye and his associates have a knack for calling turns in financial and commodity markets, including the peak in oil prices in early July.

Mr. Hoye, who studies market cycles going back to the 1700s, believes we are in a financial crisis so serious it will be beyond the ability of central bankers to stop. A "very severe liquidation" is under way that will culminate in late October, he warned in an interview Monday. By the time it's over, major stock indexes will have tumbled nearly 50 per cent from their peak.

Special to The Globe and Mail