Thursday, January 19, 2017

Short Term Bond Ladder: Clustering Maturities Near FED Meetings Where Increase in FF Currently Expected

I was asked about a reader about whether a gradual and persistent rise in the federal funds rate would deter me from adding to my short term bond ladder.  

I am hopefully near or at a completion point. I started building the ladder about thirty days ago in anticipation that the FED will hike the FF rate on or before the July 2017 meeting and again in December 2017. I have now allocated slightly more than $200K to the short term bond/CD ladder.  

I have clustered maturities in December 2017 and January 2018 that can be reinvested into higher yielding short term bonds and CDs assuming my future predictions prove prescient including the prediction that there will be a .25% FF increase in December 2017. Another cluster is in the June 2017 through August 2017 period when the FED may increase by .25%.  

This clustering approach is one way to address interest rate risk issues related to a rising rate environment.   

The FED is scheduled to meet on December 12-13, 2017: 

This is a list of maturities in December through January 2018: FRB: Meeting calendars, statements, and minutes (2012-2017)

Principal Value $1K per Bond or CD
4  4 Week Treasury Bills Maturing Per Month
2 AT & T 1.4% (YTM at 1.491%) Senior Unsecured Maturing Due 12/1/17
2 Disney 1.1% (1.043% YTM) Senior Unsecured Maturing 12/1/17
2 Ecolab 1.45% (1.389% YTM) Senior Unsecured Maturing 12/8/17
2 Chevron 1.104% (YTM 1.224%) Senior Unsecured Maturing 12/8/17
2 ConocoPhillips 1.05% (1.203% YTM) Senior Unsecured Maturing 12/15/17
2 Sherwin Williams  1.35% (YTM 1.294%) Senior Unsecured Maturing 12/15/17
1 U.S. Treasury .75% (YTM .95%) Maturing 12/31/17  
1 U.S. Treasury Bill .888% (1 YR. Bought at Auction) Due 1/4/18 (scheduled 1 Yr reinvestment) 
2 Everbank CDs 1.05% Due 1/11/18
2 BBT 1.45% (YTM at 1.394%)  Senior Unsecured Bonds Due 1/12/18 
2 C.R. Bard 1.375% (YTM at 1.363%) Senior Unsecured Bonds Due 1/15/18 
2 Dominion Resources 1.2% (YTM at 1.507%) Senior Unsecured Due 1/15/2018
2 Brown Forman 1% (YTM at 1.303%) Senior Unsecured Due 1/15/18
1 Deere 1.35% (YTM at 1.35%) Senior Unsecured Due 1/16/18
1 WFC 1.5% (YTM at 1.499%) Senior Unsecured Due 1/16/18
2 Royal Bank of Canada 1.5% (YTM at 1.457%) Senior Unsecured Due 1/16/18 
3 Anheuser Busch 1.25% (YTM at 1.342%) Senior Unsecured Due 1/17/18
1 Statoil 1.2% (YTM at 1.325%) Senior Unsecured Due 1/17/18 
2 Merck 1.1% (YTM 1.192%) Senior Unsecured Due 1/31/18
1 U.S. Treasury .75% (YTM .946%) Maturing on 1/31/18
1  6 Month Treasury Bill Scheduled for Reinvestment at Auction January 2018 

Total Principal Amounts Maturing 12/1/17 through 1/31/18 = $40,000 (about 1/5th of the total allocation). 

A significant number of securities will mature prior to 12/1/17 and in February and March 2018.  

If short term rates rise over the next several months, and bonds maturing in this time frame decline some, I may buy more. 

When the YTM is above the coupon rate, I was able to buy the bond at below par value with the commission. Sometimes, the purchase was made below par but the $1 per bond commission reduced the YTM a slither below the coupon rate. 

Generally, several senior unsecured bonds that I now own may be called at par value within one month prior to maturity. An optional redemption prior to then would trigger the make whole provision that would penalize the issuer for exercising its optional redemption right. 

In the event an issuer sees rates going up higher, there is a possibility that it will elect to call a bond maturing on 12/15/17 on 11/15/17 for example. 

An optional redemption is fine with me when interest rates are rising and I will be able to invest the proceeds in a higher yielding security a month early.     

Since I expect short term rates to rise, a short term bond ladder that extends out three years will lose some income simply by having the longer dated maturities. I am dealing with this form of interest rate risk, which I label the risk of lost opportunity, by weighting maturities within the first 18 months compared to the last 18 months.  

The risk of lost opportunity can also arise in that weighting when short term interest rates remain stable or decline. In those scenarios, I would have been better off weighting the 18 to 36 month time period since I would receive more income for longer. 

The ladder approach is basically designed to mitigate interest rate risk and is based on a recognition that the future is ultimately unpredictable. Something may happen within the next 12 months that will cause rates to plummet or to rise higher than I currently expect.    

The short term bond ladder is also a response to four co-existing events: (1) totally inadequate MM fund yields, (2) an abundance of cash in those MM funds; (3) a strong emphasis on capital preservation with no financial need to take risks; and (4) an unwillingness to commit idle cash to stock purchases given the current high valuations. Conditions (2) and (3) are relevant to me and may not be applicable to others. Some investors may believe that stocks are not overvalued. I view the U.S. stock market as clearly overvalued based on any rational short to intermediate term forecast for real earnings growth.  

I am also dealing with interest rate risk issues in a variety of ways. I have been selling several exchange traded bonds that were recently bought during the last price correction that have rallied in price. I would then look for opportunities to buy buy at lower prices. 

I have a number of bonds and preferred stocks that are floaters and could benefit from rising interest rates when that scenario results in coupon increases. 

And, I still have a substantial cash reserve that can be drained without selling something in the event that particular stocks provide a more attractive entry point than now. 


  1. To deploy some of the idle cash, why not use also online money market accounts paying around 1% as an alternative to short term bonds paying ~1%? e.g. american express or gs bank? $ is liquid, and the risk of say a.e. to go bust is slight

  2. The GS Bank currently has a 1.05% APY for its saving account.

    That is an acceptable alternative to what I am doing.

    I have funds invested in an online savings bank.

    I am investing in short term bonds/CDs the idle cash that I keep in my brokerage accounts which are used to buy risk assets. I could transfer some of that cash to my bank and then transfer cash to the GS online bank, but the income amounts are just not worth the trouble.

    Overall, I am picking up more in a YTM yield for bonds, even for those with maturities this year and maybe another .5% on average for 2018.

    The potential drawback for an online savings account is that rates could go down or up whereas my yields are locked. There is also an issue about teaser saving accounts rates that start out higher to attract money and then settle down some. That is particularly the case for banks that have just started an online presence.

    "Goldman Sachs Online Bank - How Does It Stack Up"

    "Should you open Goldman Sachs savings account now that they’ll take our plebian deposits?"

    The American Express savings account rate is currently .9%:

    Their CD rates have much lower yields than the ones that I have been buying through Schwab and Fidelity at no cost.

    There is a risk to the bank and the depositor when offering a fixed term CD as opposed to the savings account rate which can change on any day.

    1. Thanks for your reply, and also thanks for doing this. I had been a follower of this site, then of your s.a. entries and I am happy you came back to your own site!

      I agree that you can pick a bit more yield in most bonds, but I was thinking more on those you mentioned in your post that are close to the 1%, like the ones listed below. ANd did not mean to use their CD's, they seem to me kind of ridiculously low.

      Also true, you have no guarantee of the rate, although gsbank, capital one, a.e. have not dropped their rates for a long time, and I expect that if anything, they may even increase them when rates continue to go higher.

      As for the trouble, for me, buying a bond or electronically transferring funds is practically the same trouble (in fact, the latter is easier for me). I get the advantage of liquidity with the risk of the bank or of a variable rate. This, in combination with some higher paying bonds in my broker acct, works for me. Obviously, if catastrophes happen, nothing is better than treasuries.

      Finally, Given the lack of confidence in stocks and the historical low rates on bonds, it is hard to deploy 0% paying cash, but it seems to me inconceivable at times that we are spending time on how to make just a few bucks! $1000 @ 1% or 1.5% is only $10 or $15 a year before taxes!!!! But we know: $10 > zero, right?

      2 Disney 1.1% (1.043% YTN) Senior Unsecured Maturing 12/1/17
      1 U.S. Treasury .75% (YTM .95%) Maturing 12/31/17
      1 U.S. Treasury Bill .888% (1 YR. Bought at Auction) Due 1/4/18 (scheduled 1 Yr reinvestment)
      2 Everbank CDs 1.05% Due 1/11/18
      1 U.S. Treasury .75% (YTM .946%) Maturing on 1/31/18

  3. When I started the short term bond/CD basket a month ago, I said than that it was hardly worth the effort and hopefully it will gradually become somewhat rewarding for idle cash waiting for a better risk/reward balance in risk assets.

    The treasury bills are lower. I am in part mimicking the safety part of a MM fund at a much lower cost. I am trading safety for an insignificant difference in yields but limiting my exposure to mostly short term bills and keeping the amounts light hoping for higher rates upon their maturities.

    The rates that you cited are abnormally low by historical standards, but they are an improvement over what has been available for most of the past 8 years. I am willing to spend some effort, since I am retired, to secure another $3K in income per year for assets that would likely remain in a brokerage sweep account for awhile given the alternatives and risk/reward balances for those alternatives.

    The Everbank CD is competitive with most of the one year CDs that are available. The Disney bond is one of the lower yielding ones but it matures in less than 1 year, a few days prior to the December 2017 FED meeting when I expect a rate increase. So the funds will be available to reinvest at a higher rate then. The best nine month CD rates are about .85% according to Fidelity's table. The American Express 1 year CD is at .6% which would be close to the national average.

    GS has a 9 month at .7% and a one year CD at 1.19%. The one year is a tad above other high yield one year CDs and I am using that term "high yield" in a relative sense now and with the perspective of knowing what the rates have been on similar instruments for the past 8 years.

    I do view an increase in short term rates, including savings account rates, to be more likely than a decline, but I have been wrong on the past making that same prediction. The savings account rate is always at risk of being reduced when conditions warrant.

    The Capital One savings accounts and CDs are not that good compared to GS or a few other online banks.

    The Capital One savings account rate is currently .75% which was not raised in response to the last FED increase.

    The 9 month CD rate is .4%; 1.35% for 18 months and 1.45% for 24 months.

    Fidelity is currently offering a Capital One CD maturing on 1/25/19 at a 1.55%, higher than what that firm is offering to its own customers, with semi-annual interest payments.
    I also have a variety of risk assets that pay significantly more in yield than what is available currently in the bond market with higher quality investment grade bonds.

    There are trade offs in assuming more interest rate risk with higher yielding securities while attempting to cope with a rising rate scenario as well.

    I still have some original 3 month bank CDs that matured in the early 1980s that paid over 15% as a reminder of what can happen.

  4. EMERSON ELECTRIC (EMR)(OWNED): EMR has bucked the downdraft in the stock market over the past two trading days, rising $1.21 or 2.11% today and $.91 per share yesterday. The stock went ex dividend for its $.48 per share quarterly distribution on 11/8/16. I am reinvesting the dividend.

    The shares have been depressed for over two years due to EMR's exposure to the oil and gas industry.

    The company increased its energy exposure to about 50% during the downturn through the divestiture of its Network Power business and the $3.2B purchase of Pentair's Valves and Controls business.

    I have not seen anything in particular to justify this spurt. There was a press release on the 18th but I do not see that to be a reason though the timing does suggest otherwise.

    "Emerson Selected to Help Convert UK Coal-Fired Plant to Biomass"

    In the back of my mind, I have at least considered the possibility that EMR may be a takeover candidate for an entity in the energy equipment business such as the GE/Baker Hughes assuming they are successful in merging their energy businesses.

    That deal has yet to clear all of the hurdles necessary for consummation.

    EMR's market cap at $58.43 is about $37.66B and an acquirer could sell of the non-energy part of the portfolio.

    I currently own 190+ EMR shares.

    My last purchases, which I did not discuss, was a 30 share lot at $54.14 (7/11/16). There were two small lot purchases during 2015 at slightly below the current price. The last purchases of EMR have not been optimal selections, but I do not mind holding either long term. I have traded shares successfully in the past as well.

    An example was that I sold a 50 share lot at $55.42 in 2010, just under the current price.

    6. Sold Remaining Shares of Emerson Electric at $55.42
    11/2/2010 Post

    Some may wrongly conclude that EMR is a dog being so close now to its November 2010 price, and I would differ. It is more of a victim of circumstances.

    EMR is after all one of the stocks whose dividend has been raised for more than 50 consecutive years, one of the few remaining Dividend Kings:

  5. hello South Gent,

    I own a small amount of Target and I see it's been down again today big time. It looks like it is at a two year low.

    Looking at all the articles, it appears that online sales are eating into the physical stores. Also, electronics and food I think were bad.

    I personally don't shop much at Target, but when I do go in there, the food area is really poor. I was not impressed by brand choice or prices.

    Jim Cramer thinks that target is cannibalizing itself with online sales growth at the expense of bricks.

    Its previous free cash flow certainly covers its present dividend. I am not sure that the rate of dividend growth will be anything like before, but it sports a dividend of around 3.6 .

    There is a lot of talk that target owns most of its stores and it has valuable real estate. It's unclear to me how valuable this real estate would be if target has to close stores.

    I wondered if you'd ever looked at Target and if so what price you would think would be a margin of safety?

    Any thoughts you had would be appreciated.


  6. Sam: I do not own Target and my general opinion is that box retailers will have increasing difficulties growing earnings due to online competition.

    Wal-Mart may end being a better total return vehicle and has the financial heft to take on Amazon. It is moving in that direction now, but still has a lot of catch up to do.

    Dividend growth is ultimately tied to earnings growth, so I would anticipate that Target's dividend increases will slow down and could conceivably stop or slow to a trickle measured in fractions of a cent.

    I am aware that GS cut the stock to sell after Target recently released disappointing sales number for November and December.

    I would view the stock now as a potential trading vehicle only. I am not sure how I would set a potential entry point.

    Generally, the selling pressure may subside in 4 to 6 trading days after bad news, as investors focus on all of the negatives and see no end of sight in their stock losses or at best dead money until the end of days. The natural reaction is to assume all sorts of bad things lie in the future after a waterfall decline, including a Sears type scenario or Target unable to post positive comps ever again.

    I understand that Target does own a large number of its stores. Hard for you or I to know their worth. One analyst speculates that the real estate is worth more the market cap now.

    "the company’s ownership of nearly all its real estate (we estimate this is worth more than the equity value)"

    I do not see any near term hope looking at a 3 year chart. The five year chart looks like long term support at $55.

  7. MRK (own): Merck shares are likely to rise today as BMY announced it would not seek accelerated approval of its combination of Opdivo and Yervoy for first-line treatment of lung cancer.

    MRK's rival drub Keytrud a has already been approved as a first-line treatment for "metastatic non-small cell lung cancer (NSCLC) whose tumors express PD-L1 as determined by an FDA-approved test."

    Overall, the possibility of restraints on drug prices from PBMs and/or the government is wagging the dog in drug stock prices now.

    Before the Bell 1/20/17:

    $62.50 +2.17 +3.60%
    Jan 20, 2017 8:09 a.m

    $51.05 -$4.45 -8.02%
    Jan 20, 2017 8:11 a.m.