Auto Bonds Drive in the Fast Lane

09/17/2007 12:00 am EST

Focus: BONDS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, publisher of the Forbes/Lehmann Income Securities Advisor, says as this summer's financial panic subsides, debt securities of the two big pubic US auto companies are a good buy.

Last month we saw the beginning of a real-life financial panic and the start of a meltdown of debt and stock markets. The Federal Reserve intervened with talk and well-timed, though modest, actions. The month actually finished with stocks up and interest rates coming back down.

So, having come through all this, can we now expect a continued turnaround? Well, no, not really. I say this because major questions have not been answered, such as: was this event a correction or the warning of a recession, or who was hurt and how badly?  In short, uncertainty is likely to stay with us through year end-at the least.

I do believe the panic stage of the current crisis has been overcome, so the worst I expect is volatility, not another price free-fall. This looks like a good entry point for buying closed-end income-oriented funds selling at sizable discounts to net asset value and yielding over 8%. Also, bonds and preferreds yielding 8% or more.

These securities are still priced to reflect the panic mood that is dissipating. Also, if the economy does tank early next year, interest rates will only come down further. Aside from this, the Fed will likely be easing interest rates shortly.

One area investors should look at closely is the debt issues of General Motors (NYSE: GM) and Ford (NYSE: F). Their debt got hit hard in August because of [their] low credit ratings, but that is not what makes them of interest. The United Auto Workers contract negotiations are scheduled to be finished in September, and the outcome will likely redefine the domestic auto industry. (The negotiations continued late Sunday night, in advance of a strike deadline-Editor.) There is reason for optimism that these companies will come out as more competitive, making their debt and equity more appealing.

The safest plays here are the bonds and preferreds of GMAC and Ford Credit, which yield over 9.5%. Assume a little more risk and you buy the corporate debt of GM and Ford and get returns of 10.5% to 12%.

But if you want to maximize your capital gains based on the short-term labor talk outcome, buy the convertible issues for GM's debentures and Ford. They yield 7.4% and 9.1% and offer sizeable gains if the stocks react strongly to an improvement in the prospects for these two crippled giants.

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