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Cramer Offers The Argument For Bonds

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(Ed.'s note: This column appears in this month's issue of


magazine, a Philadelphia-focused publication. While Cramer has written about the goodness of bonds before, this column captures many of his bond thoughts in the same piece. We hope you enjoy it.)

Psst. You want a good tip for a possible giant capital gain -- and an investment that lets you sleep at night?



General Electric

perhaps? Could it be


? Nah, way too risky given the outlook I see for the coming months. Look no farther than the U.S. government's own paper, particularly those notes that expire ten years hence.

Many people know me as a stock picker, someone who tries to come up with ideas that will beat the market-and everybody else in this game. At times, though, it doesn't pay to try to play those odds. At times the risks outweigh the rewards. Better yet, there are times when the Purloined Letter of investments, U. S. Treasuries, shine not just with safety, but with a possibility of a big payoff.

This is one of those times.

I know what you are thinking. You don't often expect a bond lecture from me. You don't want to hear about the safest of all investments from a hedge fund manager like me. But there's nothing cleaner, more exciting and more right than bonds at this time.

Let's look at the U.S. for a second. In many ways Philadelphia has turned into a microcosm for the nation. Job growth is off the charts. Inflation remains subdued -- but more on that later. The economy, once hamstrung by the domestic market and a barrage of imports, is now free to prey on any market in the world, with superior goods for reasonable prices.

Now let's look around the globe. Europe, long perceived as a place for growth, has slowed markedly over the last few years, a function of fiscal discipline and brutal marketplace pressures. Yet, at the same time, inflation flares worse in Europe than here. In fact, if you look at Germany you will see America 20 years ago. No growth, unstoppable inflation, nasty unemployment and a workforce that is in charge of management. And Germany used to be the paragon of financial virtue!! Now, it's Italy that looks restrained. That would be fine if Italy could be the locomotive, but alas, because of its size, it will never be more than the little engine that could.

France, hmmm, go invest there, please. Britain? Currency is way too strong. Spain's unemployment dropped only during the two weeks that were the Barcelona Olympics.

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Russia. Hey great that they are no longer falling off a cliff, but invest there? I'd rather go to



Asia is such a wild card at this time that I don't believe we can even make a judgment. But I know it's not safe. Too many imbalances, from trade to government debt. Too much willy-nilly spending, too much confidence.

Latin America is no better. I love some of the higher risk investments in Brazil and Argentina, two amazing growth nations. But safe? I wouldn't invest the money I save to go to the movies in those places. Mexico and Canada? Well, they are swell if we are swell. And if we are swell I'd rather be with us.

But how do you play this economy? If we do it with stocks, oddly we now find ourselves hostage to the same forces that are plaguing the Asians, Europeans and Latins. We sell into those markets and none of them is healthy enough to make me feel comfortable. Because of their problems -- and a lack of our own -- the dollar, something we tend not to think about as Americans, is a powerhouse. That's terrible if you invest overseas, as your investment in local currency loses value and it costs too much to hedge all but the largest investments. It's worse if you make product here and intend to sell it over there. You can't compete as aggressively as you would like.

So, that rules out many of the so-called classic growth names, the consumer staples like Coke and Gillette and the tech stocks who, short and intermediate term, at least, depend on orders from other countries. Domestic stocks? Could be great, but require an awful lot of homework. The smallest may be the best ones, as we are in the midst of a pretty powerful small cap rally. But what happens if you make a mistake? Can you get out of it without losing some of your capital? And how about those taxes if you don't make one? No thanks.

Hmmm, so what does that leave us? How about that dowager of investments, U.S. bonds.

For the longest of times I dreaded U.S. paper. Periodically, when I felt the economy was about to nosedive, I would make a big leveraged bet on bonds, only to feel helpless if I were wrong, as nothing feels worse than when a bond market moves inexorably against you. But when I was right, the power of the bond market to make you money is subtle but tantalizingly delicious as you rack up daily interest and capital gains. There's a terrific twosome.

Now, here's the secret, inner sanctum/handshake stuff I promised up top. When you go to buy bonds, your broker is going to try to steer you away from the plain vanilla variety. U.S. treasuries, he will say? "Too boring. Not exotic enough. Not enough pizzazz."

No, he's got something better. He has some homegrown brew, a bond backed by the full faith and credit of Fredonia that guarantees a return twice that of treasuries for the same amount of risk. Or, in inventory, he has a dynamite piece of LTV preferred that has withstood the test of seven years of prosperity! Better yet, he will ask if you've ever considered buying collateralized mortgage obligations issued by some select entities in the Southwest trying to boost their own balance sheets to take advantage of spectacular desert land prices?

Think I am kidding? Think that stuff doesn't go on? I know it does. Heck, I did it myself. And I did it for the reason that you would expect but could never see: the gross credits.

People think that brokers take a cut in stocks that is unconscionable. Wake up and smell the bond market. When someone wants to buy a bond, and you can find one in inventory, bells go off. Bond commissions are all hidden within the yield to maturity. Unsuspecting clients who deal with only one broker can be fleeced to the tune of thousands in commissions and never even know it when they buy these doggy pieces of paper out of inventory. And then be happy about it!

How do you prevent a broker from knocking down your rate of return and taking advantage of your innocence in the bond buying process? Simple: buy U.S. Treasuries and buy them "in competition." Avoid exotics. Take a pass on corporates. Fire her if she wants you to buy any security that has tranches or other noxious bells and whistles.

When accounts used to come to me and ask if I would bid on Treasury bonds, I would always try to get my sixteenth or 32nd if I could. Heck, there has to be some compensation. But around me I saw others taking 8ths! On millions of dollars that's a windfall.

But when someone told me I was in competition, I would gladly do the trade for only a 1/64th credit, as small as it comes. Sometimes I would do it flat -- no money to me -- just to please and to keep the customer happy. I regarded treasuries as a loss leader.

Treasuries aren't just a great deal from the commission side. Let's say you spot some main chance during the next five years, or you need the money to buy that house, any other investment and you will get clipped on the go out. But Treasuries? Just tell the broker he is "in competition" and you will get what you want, the way you want it, with no vig. The next day, replete with interest! It doesn't get better or cleaner than that.

We're not done yet. The most difficult decision facing a bond buyer is not which security -- we have solved that already -- but how far out to go. Few questions bedevil professionals like this one. Some firms have spent literally millions of dollars trying to figure out the optimum place to be on the yield curve. Others just think it is all guess work and it can't be determined.

I've got my favorite places. When the economy seems like it could heat up, as it does right now, I don't want to go out too far. Go out 30 years, to the so-called long bond, and you run the risk of getting hit upside the head by a wave of inflation none of us can see right now. Go out too short and you won't get the bang for the buck that I envision from the global deflation.

That's why I like ten-year paper. Oddly, because of our own government's new frugal behavior and because of the incredible budget surplus that is developing, these pieces of paper could become endangered species. The idea of a ten-year in short supply would have made people cackle during the derelict Bush administration -- did I mention that I am a capitalist-roading Democrat? -- but under Treasury Secretary Rubin, it's no laughing matter. They just don't print these in the quantities they used to.

If I am right and the trend toward worldwide deflation, the likes of which we have seen in Japan, Thailand and Malaysia most recently, really takes hold, this piece of paper could shoot up in value. If I am wrong, you are still being paid a handsome check, 6.65% -- virtually the same as out 30 years -- while you wait around for your money back. That's a risk/reward that let's me sleep at night -- and be a player in the daytime.

James J. Cramer is manager of a hedge fund and co-chairman of Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Mr. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he welcomes your feedback, emailed to