How did I become a contrarian? Back in 2009, fear was in the air that the U.S. economy was about to enter a depression. The financial press and news media were so negative that the contrarian in me believed it was time to buy fixed income investments. I bought AIG investment grade bonds at 39%, UnumProvident bonds at 12%, plus Odyssey Re Preferred Stock at 11%, and many others. AIG common stock (AIG) is down in excess of 90% from its high but my AIG bond was called at par thanks to a U.S. government bailout, resulting in a healthy profit for me. My UnumProvident bonds (UNM) have more than doubled including interest received. Odyssey Re (FFH), which was largely owned by Fairfax Financial at the time of my purchase, is now a Fairfax Financial subsidiary and was called at a large profit to me. Prem Watsa is chairman of Fairfax Financial. I consider him the Warren Buffett of Canada based on his love for investing in insurance companies, his calculated risk taking, and his excellent long-term performance. Prem Watsa's Fairfax Financial increased its book value by almost 25% annually since 1985.
Earlier this year even after a tremendous move up in fixed income investment values, the same media gave the world the impression it was Armageddon time again but this time for Spain. As a result, I was able to pick up investment grade Banco Santander (SAN), BBVA (BBVA), Telefonica (TEF), and Telecom Italia (TI) bonds for a song with yields up to 10%. I bought many of these as the Spain IBEX 35 stock index was flirting with a 10 year low. Banco Santander and BBVA bonds cratered because they are Spanish banks and all I was reading about in the financial press was about how bad things are in Spain with 25% unemployment. Fortunately, these banks are in good shape financially and much of their business is derived from countries outside of Spain. Even Telefonica does a lot of business outside of Spain. These bonds have had returns of up to 30% for me not even counting interest and many are yielding in the 6.40% to 7.25% range today. The rally has taken place thanks to the European Central Bank's pledge to buy the country's bonds if it requests a bailout and the IBEX 35 has also had a healthy bounce.
Not too long ago with the British Petroleum (BP) oil spill and all the negative sentiment, you could get its investment grade bonds at a nearly 10% yield to maturity. I wish I had capitalized on that opportunity.
Fast forward to today. The 7.25% of 2039 Arcelormittal SA Luxembourg (MT) corporate bond has a current yield to maturity of 7.66% despite being rated investment grade by 2 of the 3 major bond rating services, Moody's and Fitch. This works out to nearly double the current investment grade index yield in the 4% range. They are the world's leading integrated steel and mining company, based in Luxembourg. The steel industry is currently going through a severe downturn as a result of weak steel demand, especially from construction end markets. I believe this has created a buying opportunity in the Arcelormittal bond, especially with construction activity beginning to pick up.
How can you profit from these kinds of opportunities?
1) Pay special attention to the financial news in print and online. If you see investment grade companies slammed and it appears to be a short-term phenomenon, it can create buying opportunities. Even a debt downgrade such as one in BBVA can create opportunities (it remained investment grade with the majority of bond rating services and resulted in buying opportunity #2 for 2012).
2) Don't put all your eggs in one basket. What looks like the opportunity of a lifetime may not be if your bonds are called, if the company's financials are in decline, or if the company is acquired by some highly leveraged company such as a private equity fund and the bond ratings suffer, resulting in a lower bond price.
3) Check out recent performance of the common stock of any bond you are considering buying. If the stock market is flirting with new highs yet the common stock of the bond you are considering is near a new low substantially above the high, this is a bad sign. Also watch for downgrades in the bond you are watching, especially from investment grade to junk which will likely result in lots of short-term selling, especially by the bond index funds, etc.
4) Find a financial professional who can navigate you through the often treacherous financial waters.
5) Most importantly, invest like the great Prem Watsa and Warren Buffett and think against the grain.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long Banco Santander, BBVA, Telecom Italia, and Telefonica bonds.