Archive for the ‘Interest Rates’ Category

Fundamentally Flawed

Friday, March 14th, 2014

Imagine if the outcome of a football game depended more on the weather than on the talent of the players.

Weather, indeed, can have an impact and should, but its role is usually to test the talents of the players, not to be the primary factor in the outcome.  When it is the primary factor, anything can happen.  In such cases, would you put money on the game?

The weather is not the number one factor affecting the performance of the stock market these days, but neither is the talent of the players – that is, the fundamental performance of publicly held companies.

In recent years, The Federal Reserve Board has held sway over the market’s performance via quantitative easing, although under former Chair Ben Bernanke, it was somewhat more predictable than the weather.AUDJPY

Now, with tapering under way, that may change (we’ll see, as many expect plenty of bond buying ahead).  Yet other world events may replace QE in determining the performance of the market.  That means potentially greater volatility than we’ve experienced in the easy money era.

It doesn’t take much to affect today’s global economy, especially when the impact of events is amplified by high-frequency trading.  Consider, for example, the impact of the falling yen and Australian dollar on the S&P 500.

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Getting Your Bond Portfolio in Shape for 2014

Friday, December 13th, 2013

It’s time to start thinking about New Year’s resolutions.  It’s an American tradition to resolve to lose weight, exercise regularly, be nicer, work harder and give up everything you enjoy.

But who are we kidding?  Such resolutions are made to be broken.  So this year, why not make a resolution and keep it?  This year, resolve to pay attention to bonds.

That’s right.  Boring old bonds.  They don’t have the flash that stocks do, they lack the immediate thrill that cash can provide because of its liquidity and they’re not as mysterious as alternatives.  Yet, if you give them a chance, bonds can play a major role in ensuring that your retirement will be secure.Cost of zero interest rate

Bonds are not without risk – especially in a rising interest rate environment – but they can help you protect your principal, produce income and add to your total return.

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The Beat Goes On

Friday, September 20th, 2013


From a future article in The New York Times:

Janet Yellen, retiring chair of the Federal Reserve Board, announced that The Fed’s quantitative easing program, aka QE12, is close to meeting its goal of achieving a 6.5% unemployment rate. Yellen

With The Fed’s bond portfolio exceeding $10 trillion, The Fed is running out of government bonds to buy, but Chairwoman Yellen said she’s confident the U.S. Treasury will pick up the pace at which it issues new bonds.

Chairwoman Yellen praised the quantitative easing program, which she said has managed to bring the unemployment rate down to 6.8% from a peak of nearly 10% in just 12 years.  QE has also helped the economy grow at a rate of nearly 2% a year.

During a brief press conference, for the first time since the quantitative easing program began, she was asked, “How does buying bonds create jobs?”

She explained that QE obviously decreased unemployment, since the unemployment rate exceeded 9% when QE began and is now approaching 6.5%.

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America – The New Europe?

Friday, September 13th, 2013

Defaulting on bond payments isn’t just for Europe anymore.  Detroit and several cities in California have defaulted on bond payments.  Now Puerto Rico may be in trouble, as its bonds are trading as if they are going to default.

This week, the yield on Puerto Rico’s general obligation bonds (PR G.O.) pushed up over 10%.  That led the Government Development Bank on Tuesday to announce that it would scale back bond sales for the rest of 2013.

Puerto Rico’s bonds offer a double tax advantage, which should help hold their yield down.  Yet when considered on a tax-equivalent basis, PR G.O. yields this week exceeded CCC corporate yields, based on the Merrill CCC Index YTW.

Puerto Rico’s junk bond status reflects a weak economy, but it also signals that the island is in deep financial trouble.  And the problems extend beyond Puerto Rico, given that it is part of a growing list of state and local governments with financial troubles.

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At The Fed, Saying Trumps Doing

Tuesday, September 3rd, 2013

President Obama’s campaign slogan for last year’s election was “Forward.”  The Federal Reserve Board’s slogan in the coming months may be “forward guidance.”

According to Goldman Sachs, The Fed is expected to begin tapering its bond buying in September, but will place more of an emphasis on “forward guidance.”

So what exactly is “forward guidance?”  Here’s how The Fed defines it:Goldman 1

“Through ‘forward guidance,’ the Federal Open Market Committee provides an indication to households, businesses, and investors about the stance of monetary policy expected to prevail in the future.  By providing information about how long the Committee expects to keep the target for the federal funds rate exceptionally low, the forward guidance language can put downward pressure on longer-term interest rates and thereby lower the cost of credit for households and businesses, and also help improve broader financial conditions.”

In other words, it’s pontificating and predicting.

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Take Advantage of Rising Interest Rates by Understanding Duration

Friday, June 7th, 2013

Recently, there has been a lot of news about rising interest rates ending the bond rally.

Investors who have a significant percentage of their investments in bonds may be getting nervous, but there’s a simple strategy for protecting principal and taking advantage of increasing interest rates.

Bonds generally make up a significant portion of a diversified portfolio, so if the bond rally is over, it is important to be positioned in bonds that will maintain their value in a rising interest rate environment.

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This Is Progress?

Friday, September 28th, 2012

Economic growth for the second quarter of 2012 officially has been revised down to 1.25%, which is below the lowest previous estimate.

In an effort to stimulate the economy, the Obama Administration and the U.S. Congress have added $6 trillion to the federal debt, with annual deficits exceeding $1 trillion.  The Federal Reserve Board meanwhile has announced its third round of quantitative easing, on top of Operation Twist.

Yet the unemployment rate remains over 8% and, as we stated earlier this month, could be as high as 19% if you take a true and accurate count of everyone who is not working.

Since the current “recovery” began, real income for the average American has dropped 5.7%, and while inflation as a whole remains in check, the price of essentials such as oil and food has soared.  At least we can credit quantitative easing with taming deflation!

This all sounds pretty gloomy, but cheer up.  Alan Krueger, who chairs the President’s Council of Economic Advisors, says “we’re making progress.”

It’s All Relative

Progress, of course, is relative.  It’s true that the free fall that began in 2008 created the worst economic conditions we’ve encountered since The Great Depression, but in the past the rule has been the greater the recession, the greater the recovery.

Not so this time.  Cumulative growth for the past three years has been just 6.7%, according to the Congressional Joint Economic Committee.  In comparison, the average for all 10 post-World War II recoveries is 15.2%.

In other words, the economic growth we’re experiencing is well under half of what it has been historically after past recessions, even though it should have been among the best periods of growth ever, given the severity of the recession.

Worse still, we can look forward to the long-term impact of today’s failed economic programs.  Someday, the debt we’ve accumulated will have to be paid back.  And quantitative easing may keep the country’s debt payments manageable today, but it weakens the dollar and boosts inflation.

And sooner or later interest rates could rise to the point where our current tax revenues will not be enough to pay the interest on our debt, let alone support government programs.

So what do we do when the current economic programs produce the same results as they have in the past?  Prepare for a multi-trillion dollar stimulus package?  QE3, the third quantitative easing program is open ended and can last as long as The Fed wants it to last, so at least we don’t have to worry about QE4.

Over Fed

Friday, July 20th, 2012

To QE3 or not to QE3?  That is the question the Federal Reserve Board has been pondering for months … or at least Fed observers think it’s being pondered.

But, as we’ve said before, if the first two rounds of quantitative easing did little to boost the economy, why would a third round help?  In fact, each successive round of Fed action has had less of an impact than the one before it.

Quantitative easing is the printing of money by the government to buy bonds, which is supposed to stimulate consumer spending.  It hasn’t worked, because consumers are still broke and many have maxed out their credit cards.

The Fed also tried Operation Twist, which involved selling short-term bonds and using the funds to buy longer-term bonds, also had little impact.  Operation Twist, which might have been called QE 2½, was supposed to lower long-term interest rates to stimulate borrowing and investment, but it also has had little impact.

As Frank Barbera of Sierra Investment Management put it in his white paper, “Reflections on Slowing Global Growth,” “most of the liquidity created by QE1 and 2 did not find its way into the real economy, but instead ended up right back on the books of banks as excess reserves, with banks actually contracting their loan portfolios.”

Helping banks build excess reserves was, of course, not the goal of QE 1 and 2.

The one positive aspect of quantitative easing is that each round gives the stock market a temporary boost, but the impact is like that of chocolate, which creates a temporary boost, but makes the consumer more lethargic afterward.

Ray Dalio of Bridgewater Securities expressed concern that “there are no more tools in the tool kit of fiscal and monetary policy to help kick the can down the road.”

The problem with kicking the can down the road is that, at some point, the road ends.

Dancing With A Cow

Tuesday, July 17th, 2012

While Europe’s sovereign debt crisis has beaten down the U.S. stock market, it has helped the bond market.

Because the European bond market is in such poor shape, U.S. bonds are a relatively healthy investment.  Investors have been buying U.S. bonds, because they look good relative to European debt.  But that’s like dancing with a cow because your only other option is a pig.

U.S. yields are at record lows, even though U.S. debt has now reached $15.9 trillion, up from $9 trillion in 2007.  The 10-year Treasury yield, which has averaged 4.88% over the past two decades, hit a record low of 1.44% on June 1, down from its high for the year of 2.4% percent on March 20.

Regardless, the cow may be turning into a pig.  Robert Auwaerter, head of Vanguard Group’s fixed-income group, predicted that unless the U.S. gets its debt under control within the next four years, U.S. bonds will become about as popular as the bonds of the five European countries that have seen borrowing costs soar as investors boycotted their bonds.

What Bloomberg called a Treasuries Doomsday isn’t on the Mayan calendar, but it could be as grim as those end-of-days predictions, at least from a financial perspective.  If yields were to rise back to 3.8% by December 2014, which is their average for the past decade, investors would realize loses of 10.8%.

Demand for U.S. bonds has enabled the Federal Reserve Board to keep borrowing costs low, and President Obama and Congress to fund a budget deficit that’s forecast to exceed $1 trillion for the fourth straight year.

However, Auwaerter said, “In the absence of a long-term credible plan, we are somewhere around four years away on where the markets are going to say ‘enough is enough.’ ”

Bad News Boosts the Market

Tuesday, June 12th, 2012

In the strange world of investment management, bad news is often good news.

That was the case last week, as the S&P 500 gained a hefty 3.7%, more than reversing its 3% loss from the previous week.

The market rose 2.3% on Wednesday alone – its largest single-session percentage gain so far this year – amid signs that the already tepid economic recovery is slowing further.

So why did the market rally?  Because traders speculated that the Federal Reserve will react to the slowing economy with additional stimulus.

Fed Chairman Ben Bernanke didn’t even hint at any immediate plans for a third round of quantitative easing or any other steps to stimulate the economy.  The European Central Bank (ECB), likewise, left its benchmark interest rate at 1.00%.  However, ECB President Mario Draghi said that actions would be taken if needed.

So the chance that another round of stimulus may take place is enough to boost the market 3%.

S&P 500 Chart

Given that economic growth remains anemic and the unemployment rate is at 8.3% and is generally creeping up, not down, previous rounds of stimulus have had virtually no long-term impact.

Short-term, though, markets love quantitative easing, which makes investments in stocks appear desirable by making investments in other assets undesirable.

So if quantitative easing doesn’t help the economy and provides only a short-term boost to stock prices, maybe the Fed should just float a few rumors … plan a faux round of quantitative easing to give the markets a boost without any cost or harm to the economy.

The Pain in Spain, Part 2

 Spain added to the good-bad news last week, as Fitch downgraded Spain’s debt rating from A to BBB after the country held a successful debt auction.

A teleconference last week between G-7 finance ministers to discuss Spain’s banking system, along with other Eurozone problems, failed to yield any specific plan for addressing the crises, and Fitch followed up yesterday by dropping ratings on two major Spanish banks, Banco Santander S.A. (STD, SAN.MC) and Banco Bilbao Vizcaya Argentaria S.A. (BBVA, BBVA.MC).

The downgrades, from A to BBB, came in spite of a weekend agreement by the Spanish government to a European Union bailout of up to EUR100 billion, or about $125 billion.

Spain joins Greece, Portugal and Ireland in the growing list of bailees.  Soccer anyone?