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Author: globalist2013 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35365  
Subject: The Stock vs. the Bond? Date: 1/11/2013 12:57 PM
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“When (or whether) to buy the stock versus the bond?”

That's an interesting question, right? So let’s use Nokia as an example and look at charts. Their 5.375’s of ’19 are currently offered at 98 x 322 (10). The stock is at $4.53. http://cxa.gtm.idmanagedsolutions.com/finra/BondCenter/BondD... http://finance.yahoo.com/echarts?s=NOK+Interactive#symbol=no... As you can see (if you’re running a multi-monitor setup, as you should be, so you can put each chart on its own screen), prices for the debt and the common parallel each other. The bottom for the stock, and the bottom for the bond-- which was a good time to be buying either-- were the same time.

Now comes the” narrative fallacy”. In retrospect, everything looks obvious. So, of course, it’s easy to look back and said what shoulda/coulda been done. But is there some way someone could have done reasonable entries into either? Yeah, “averaging in” could have put you into a favorable position. Last year, when the news hit, the stock price fell, as did the bond price. As the news spread and got worse, prices went lower. But at some point, any one following markets should have said to themselves, “The selling is overdone. Maybe it’s become time to put on a position. Not a big position, but an opening position, no more than I’d be willing to lose if I’m wrong about the direction of prices."

So, that’s what I did. My preference would have been to go a single. But the min was two. So, 04/24/12, I went two of the 5.375’s of ’19 at 85.875. Predictable, I was early, and the selling continued, creating a loss for me. So I had a choice. I could review and determine if I was wrong. If so, I should cut my losses and get out. OTOH, if a review suggested the trade still had merit, I should add. MY DD suggested that the situation was grim, but not hopeless. So I filled out my position to a marketable lot by adding three more bonds on 06/15/12 at 77.208. Now I had five, and my exposure was roughly 1/2 of 1% of AUM, or about the right size for a speculative position.

NB: ‘Exposure’ becomes ‘risk’ only when a workout goes to zero. So, in the case of Nokia, though my exposure was 1/2 of 1%, my risk was probably closer 1/8th of 1%, assuming a workout of two-bits on the dollar. That’s the kind of tiny, tiny, tiny risks I take and the reason I can survive in this game. Also, why didn’t I buy the common? Not my game. I don’t do stocks. I make less money than those that bet on the common. But stock betting isn’t a game I enjoy. But let’s run the numbers. Had I bought the common instead of (or in addition to) the debt on the days I did my two entries, what would be my present results?

On 04/24/12, NOK closed at $3.63. On 06/15/12, at $2.48. Had equivalent dollar amounts of the stock been bought as were bought of the bond, what would present profits be? 24.8% on the first position and 82.72% on the second, compared to much, much lower 11.4% and 24.0% gains on the bonds (ignoring in both cases the dividends or coupons paid or accrued). In other words, in this case, buying the common would have offered 2.2x to 3.5x what buying the debt did, and that difference is mostly mostly to a single factor. Stocks are NOT superior investment vehicles to bonds. They are merely multiples more risky. And I’ve found from doing this exercise many times with stock-bond pairs, that 3.5x is a good rule of thumb to describe the expected differences in rewards.

If one is comfortable with the risks of stocks, then superior absolute money can be made. If one wants less risk, then one buys the put (which is what a bond is), and he/she makes less absolute money. That’s the choice. Ironically, over the past decade, choosing less risk has been the superior choice, and it has offered better absolute money. In the prior decade --the raging bull market of the ‘90s-- it wasn’t the best choice *except* on a risk-adjusted basis. What looks good going forward from here is anyone’s guess. But I’m sticking with bonds. It’s a game I know I can do, because I built every detail of my own game myself.

If I try to break into stock investing/trading, then I'd have to do another three to four year apprenticeship, which is about what it takes to get up to speed if one intends to become a journeyman investor in a specific market. Stocks, bonds, currencies, or commodities. It don't matter. Expect to put in about 800 hours of classroom instruction and 8,000 hours of practice in the field before you can pull wages out of a market that's new to you. Obviously, the "average investor" never makes sufficient effort, and that's why the average investor fails, as the Dalbar 20-year studies of investor results so clearly document. "If you want the wages, do the work." Achieving investment success really is that simple.

Charlie
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