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More on “A Forward Strategy for the Inverted Yield Curve” cont’d #2

Q

Long-term rates can always go lower, but can’t they also go higher? Are all the sophisticated investors on the buy side of long bonds and all the dummies on the sell side? And if all the smart people are buying long bonds, does that mean it’s the right thing to do? Last year Berkshire Hathaway lost $1 billion on its bet on the dollar. Can we really be comfortable with the thought that the probability of rates going to 2% is greater than them going back to 15% plus, like they were under Reagan? Threats from abroad have a financial and economic effect that the Fed and other institutions can’t necessarily control and we, as a country, are doing everything that increases the threats facing us from abroad. Doesn’t being long in bonds tend to increase these risks beyond what is appropriate for most muni investors who are in them for the safety and security of their principal?

S.F., Connecticut

A

James A. Klotz responds:

Not all sophisticated investors are buying long-term bonds, but many are. It really boils down to what you are trying to accomplish. For the most part our investors are focused on income, not capital gains.

We certainly recognize the possibility that long-term rates can rise as well as decline. My point, however, is that if rates rise, long-term investors like you will not sell their bonds. They will utilize the additional tax-free income they are receiving from purchases made over the last four or five years when the “experts” were calling for higher long-term rates and recommended moving bond money into cash. This is income that will never be recaptured regardless of where interest rates go.

Mar 17, 2006

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