Over the last few weeks and for much of this year, stock and bond markets were in a tug-of-war. When the second quarter closed, stocks won the battle being pulled higher by better-than-expected corporate earnings, stepped-up mergers & acquisitions and the benefits of low interest rates.
Most stock market categories climbed to new highs in spite of geopolitical instability, high oil prices, slow growth in the U.S. economy and hints of inflation. Each of these issues are counterweights that could drag the fragile U.S. and European economies (and stock markets) into the mud.
The battle between stocks and investments that are more conservative will likely continue throughout the summer. The bulls believe that the economy is still growing and that interest rates will remain low. The stock market supporters also suggest that the bond market is overvalued and corporate earnings can continue to improve with the help of financial engineering.
This cautious scenario is causing a number of professional analysts to recommend that investors gradually pivot away from targeting double-digit equity market returns for 2014 as they install more moderate equity allocation models.
My view is that when there are no clear indications of market direction, sometimes the best thing to do is step away from the day-to-day events and wait for the fog to lift. Now is not the time to jack up the wheels of a portfolio and take unnecessary risk. In a moderate-return environment, it is more important to find interesting opportunities and create a watch list without making heroic bets.
Penney reported quarterly results late Thursday, and on Friday's its shares soared 16%. In part, that reflected a performance that was much better than analysts were looking for.
But Penney also announced it had obtained a new credit facility that will increase its borrowing capacity by $500 million. That offers breathing room for the beleaguered retailer to continue turnaround efforts, which matter a great deal for a stock that has become something of an option on survival.
But one quarter doesn't a complete recovery make. So rather than Penney's shares, its short-dated bonds may now offer a better bet.
While Penney's final destination in a retail environment in which shoppers have been gravitating away from malls remains uncertain, its cash position and evidence of some stabilization in its business suggest it should have little problem paying off debt falling due in the next couple of years. Liquidity is expected to be north of $2 billion by the end of this fiscal year, and consensus forecasts indicate Penney's cash burn through 2016 will be $1.2 billion.
Penney's bonds coming due in August 2016 rose sharply Friday. That cut their yield to maturity of about 10%. But at 7.9%, it still compares very well with two-year Treasury notes yielding 0.36%.
The one drawback with the bonds is something Penney itself doesn't often suffer from: a relative lack of inventory. There are only $200 million of them outstanding.
Still, besides paying a decent coupon, the bonds offer a decent hedge against one of the risks around Penney's stock rally. Namely, that management take advantage of this to issue more shares to shore up the balance sheet. Investors were blindsided in this way last September. Such a move, of course, would suit bondholders just fine.