The Dow Jones is down 12 percent. The S&P 500 is down 12 percent. Think that going outside the US is the key to profits? Think again.

US investors are down over 9 percent on Toronto stocks. European markets don’t provide much of a haven, either: London, Frankfurt and other key markets are down 15 to over 20 percent for US investors. The same story holds in Asia. Tokyo is down more than 12 percent, and the market in Shanghai has hemorrhaged 45 percent.

This carnage has transpired in just eight months; who knows how much conditions will worsen through the year’s end.

And the usual suspects in any equity market are unlikely to pay out more than a percent or two along the way, so any dividends are unlikely to cover these losses and will do little to reimburse us for our patience along the way.

The same logic applies to the main street of the bond market. Put your money here if you want to gain some 4 percent so far this year from intermediate US Treasuries rather than suffering even greater losses in the equity markets. Of course, if you factor in inflation, hat 4 percent just won’t cut it.

We advocate a better approach to investing in bonds, a strategy designed not just to earn a profit, but to overcome inflation and return enough to help you pay your bills.

Buy & Own

Few to any of the funds, individual bonds and preferreds in the Taxable and Non-Taxable Portfolios have ever continued to rise on a straight and true line, instead exhibiting their fair share of ups and downs. The ups naturally make us a whole lot happier, but it’s perhaps the downs that often represent the best opportunities.

Investing in bonds isn’t about flipping them willy-nilly; the key to success in this arena is tracking the value of cash flows and shifting your holdings only when metric changes to create better opportunities.

Cash flows from bonds amount to the coupon payments throughout the year as well as the final payment of the balance of the principal. When analyzing the relative strengths of your current holdings, the ideal decision process boils down to maximizing cash flows–the extent to which interest and principal that can reasonably be expected to be paid given credit risks. This largely depends on the credit and credibility of the issuer.

The market isn’t perfect. If it were, little movement would occur and every bond would be fully priced at all times. And, in turn, why bother?

Instead, bonds will sometimes move in erratic fashion; for example, prices might suddenly dive lower without any reference to the performance of bonds from the same issuer or those that are in a similar industry or market sector.

A lack of liquidity and transparency in bond markets is the reason behind these swings. A single trade can move one issue up or down, even as related bonds remain stable or swing in the opposite direction.

This is especially the case when it comes to the collection of mini-bonds in our Taxable Portfolio.

Take, for example, the telephone companies. Prices and yields vary dramatically between some of our recommendations. Qwest Communications 7.75 Percent Note of 02/15/31 (NYSE: PKH) is trading at around 22.44 for a yield of 8.63, while US Cellular 7.5 Percent Note of 06/15/34 (NYSE: UZV) is priced at 21.55 for a yield over 8.7 percent. At the same time, Verizon Communications 7.625 Percent Note of 12/01/30 (NYSE: PJL) is priced at a much more expensive 24.80 and yields only 7.69 percent.

Risk considerations of course are part of this, but given the steady revenues and assets of each of these companies the ideal trade boils down to cash flows; right now the best bet would be to either buy more of the Qwest and US Cellular or sell Verizon to increase your position in the two high-yielders.

It’s important to note that a few quarters or a dollar can exert a considerable affect on the percentage movements in the month to month returns for each of these issues. And if you’re paying attention, a few sell trades in some of these mini-bonds can set you up for great buys.

That doesn’t mean you should worry about moving from one mini-bond to another, month by month; by buying into a greater number of these mini-bonds and simply locking them up in your own portfolio, you can ride out the up and down and bank the high yield flows from the dividend/coupon payments.

Let’s look at a few key mini-bonds that showcase their steady performance over time. Unum Group 7.4 Percent Note of 12/15/28 (NYSE: PJR) is currently trading around 24.30 with a yield of 7.6 percent-plus.

Thus far it’s been a solid performer, returning over 1.6 percent for the quarter in excess of 25 percent for the year.

But let’s look at the price movements over the past 12 months.

Source: Bloomberg

If you were to take a peek at this bond at the wrong time of the year, a sell call could transform this long-term gain into a short term loss. But those who either bought at down times–or simply bought and held it–have indeed done very well.

This is the key with mini-bonds. You can certainly trade these as one moves up towards a higher price, swapping for another that’s been pushed lower. And you can do this back and forth throughout the year.

But for most investors the buy and hold approach should suffice, providing reliable cash distributions and a foundation for your portfolio.

Either way, we continue to recommend owning a greater number of mini-bonds, rather than a smaller assortment. Trading at 25 or less, a hundred shares of each issue can be bought and owned with a modest portfolio sum.

The Exceptions

There are two mini-bonds in our portfolios that are exceptions to this advice: AMR Corp 7.875 Percent Note of 11/13/39 (NYSE: AAR) and Tribune Company 7 Percent Note of 11/15/96 (NYSE: HJS), both of which are too speculative to serve as a foundation of our portfolio.

We continue to recommend both, though the perceived credit risk of the issuing companies is somewhat elevated.

AMR Corp (NYSE: AMR), an airline holding company, remains well-focused on controlling losses and maintaining credit. Unlike its peers, AMR has balked at bankruptcy deals to retain control of the company and its assets for the long haul.

In addition, with the respite in petrol, every dollar saved right now is a dollar that can flow back to the company in higher margins.

It’s been hit hard, but has rallied of late and makes for a great trade and speculation against oil’s further fall.

Source: Bloomberg

As for Tribune Company, plenty of folks would love to see Sam Zell fail in his efforts to return the media company to profitability.

But thus far Sam’s been doing exactly what he set out to do. On the operations side, Zell’s management team has instituted content changes rather than simply laying off productive employees.

And by selling assets that aren’t part of the long term plan, Tribune has reaped mountains of cash that should enable the company to service its debt for at least the next year. And with the pending sales of the Chicago Cubs and Wrigley Stadium, even more cash is on the way.

Source: Bloomberg

Much more speculative than AMR Corp 7.875 Percent Note of 11/13/39, Tribune Company 7 Percent Note of 11/15/96 nevertheless continues to be worth a punt.