What to Buy Now
Marilyn Cohen, Forbes Magazine, 10.19.98

DID THE SUMMER PANIC make you sell your shakier bonds? I hope not. The spreads between bid and ask have been wider than a mile. Brokers have been taking advantage of the illiquid market -- taking advantage of you, that is, if you insisted on selling.

Outside of Treasurys, the global meltdown touched almost every kind of bond. Domestic junk bonds posted their worst losses in eight years.

Investment-grade corporates had their worst month of the decade as they widened more than 50 basis points versus Treasurys, according to Salomon Smith Barney. Even triple-A Ginnie Maes and other mortgage issues suffered, as falling interest rates spurred homeowners to prepay. The prices of staid munis held steady, largely because they're just about invisible to hedge funds.

Though an international effort to rescue Brazil might help emerging- market bonds, don't look for a fast run-up in U.S. corporate, mortgage or muni prices. Your brokerage and fund statements for October probably won't look much better than August's.

Now, to sift through the rubble. The best buys: muni bonds.

Individual investors have shunned tax-free yields for wild-and-woolly stock market gains; now they may be willing to settle for some boredom and safety. No single state is particularly cheap, so focus on your home-state exemption. (A majority of states tax interest from out-of-state munis but exempt local munis.)

As a percentage of Treasury yields, the yields of general obligation bonds, the safest municipal issues, are at their highest levels since 1986. Example: the Allegany County, Md. G.O. 4.65% due August 2013. It gets an AAA rating by dint of insurance from AMBAC and is priced at 100.7 for a 4.6% yield to worst call. That yield is 98.8% of the yield on the comparable-maturity Treasury. Another buy is the New York State G.O. 5% due October 2013. It's rated A and trades at 102.3 for a 4.7% yield to worst call -- that's 102% of comparable Treasury yield.

Somewhat riskier revenue muni bonds are paying even more. Here are two tempting issues: Allentown, Pa. Water Revenue 4.75% due July 2013, multiple calls, rated AAA by Moodys and MBIA insured, priced at par. The 4.75% yield comes to 104% of the comparable Treasury. And consider the Clear Lake City, Tex. Water & Sewer 4.8% due March 2013, rated AAA based on MBIA insurance, priced at 100.35 for 4.8% yield to worst call.

If you are not reasonably confident of holding to maturity, buy a mutual fund. Two that I like are Scudder Managed Municipal Bonds and Vanguard Municipal Bond Long-Term, both no-load and both rated Best Buys by FORBES. The Best Buy ranking means that the funds combine good risk- adjusted performance with low expense ratios.

If you have more nerve -- and especially if you are investing through a tax-deferred account -- try some high-yield bonds; they're trading as if bankruptcy is around the corner. Consider Chattem Inc., a maker and distributor of beauty products and toiletries. Even if the economy falters, folks will buy deodorant. The 8.875% bond due April 2008, rated B, is priced at 94.5 for a 9.8% yield to worst call. And look at the Integrated Health Services 9.5% due September 2007, rated B and trading at 96.5 for a 10.1% yield to worst call. This provider of nursing and rehabilitation services has been deleveraging and reducing debt, but in this pessimistic market, no one seems to care.

As with munis, so with junk: If you need liquidity, go for a fund.
Northeast Investors Trust and Vanguard High Yield Corporate are both Forbes Best Buys.

Two more categories to consider. Put up to 10% of your fixed-income money in an emerging-market debt fund, but average in slowly, over several months. They could drop another 20%, and you won't know the bottom until after the fact. As for Treasurys: If you think the long bond will drop to near 4% -- I think it will, as global volatility keeps investors on edge -- then trade the trend by buying zero coupon Treasurys or a no-load, target-term trust like American Century-Benham Target Maturity 2020.

Marilyn Cohen is president of Envision Capital Management®, Inc., a Los Angeles fixed income money manager. Visit her home page at http://www.forbes.com/search/results.jhtml?RD=DM&MT=marilyn%2Bcohen&date=&author=&sort=.