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No. of Recommendations: 4
" I've had a few pop in and out of investment grade, but (knock on wood) none have been at a serious default risk (yet).


If any of your holdings were notched down below 'invest-grade', you aren't a 'vanilla' bond investor. You're screwing around with junk, pretending it's invest-grade. Yes, "technically", any bond rated Baa3/BBB- is "invest-grade". But if you believe that is always the case and reliably so, I've got a friend, who has a friend, who has a cousin, who would be happy to sell you some swamp land or a bridge or two. Seriously, think the matter through.

Most institutionals --pension funds, insurance companies, etc.-- can't own spec-grade debt. If the rating agencies downgrade an issue to spec-grade, those institutionals are required by their charter to dump it. Everyone knows that. The issuer, the rating agencies, and the bond owners. They all know the rules. Therefore, an issuer whose financials are shaky --even more so than usual-- will fudge their financials, and the rating agencies will close a blind eye to accommodate the deception, because they (1) they don't want to lose the issuer's business, and (2) they want to avoid the sh*t storm would happen if they started rating all debt honestly.

If you've read a couple hundred Moody's reports, you'll be surprised by two things: how useful those reports are and how preceptive they are. The guys and gals writing them deserve kudos, because they make our job as investors a lot easier. Where problems arise --as always-- is at the interfaces. When is a triple-AAA rated credit really a double-AA, or maybe even a triple-BBB?

"Can't happen", you say? Bullsh*t. Happens all the time, with the most egregious case being GE's debt. Back in the day, GE was a triple-AAA credit. But it offered YTM's that paralleled those of Mexico's sovereign debt, then rated triple-BBB. Clearly, one or both of those ratings were wrong. As subsequent events revealed, GE was cooking their books, and these days it is rated as the traders back then were saying it should be rated, namely, triple-BBB.

Lesson: "Trust, but verify". If the agency-implied rating differs from the market-implied rating, trust the traders to have gotten it right.

Ques: How does one figure out what a bond's 'market-implied' rating is?
Ans: Comparative shopping, which is the essence of the bond investing. "How much am I being paid to accept how much risk?" In other words, if the reward is there, so is the risk *unless* the debt is truly mispriced, which the "average" bond investor hasn't the skills to determine.

In Ben Graham's words, the question needing to be answered is this: "Is this bond really a bargain?" I'd argue the whole of the bond market is so over-bought as to be risky beyond what a prudent investor should attempt, as is most of the current stock market. For traders in either market, there are still opportunities. But not for defensive --Graham's term-- investors. They need to sit on their hands, or do something more productive, like take a walk. Soon enough, The Big Crash will come, and then, not only will there be bargains aplenty, but debt will again offer gains comparable to equity, as happened in '09-10, which were fabulous years for us coupon clippers.

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