Posts Tagged ‘Interest Rates’

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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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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Why Gold Soared

Thursday, August 1st, 2013

Gold prices are no longer setting records.  Special parties are no longer being held where people can sell their gold jewelry at spectacular prices.  The Midas touch for gold has faded.

Gold was selling for as little as $256 an ounce in 2002 and soared to nearly $2,000 an ounce in 2011.  An investment of $1,000 in 2002 would have been worth about $7,800 in 2011.  In May 2013, though, gold was back down to $1,343 an ounce.

The Federal Reserve Board’s quantitative easing program not only distorted the prices of stocks and bonds, it also sent gold prices soaring for several reasons:

Record-low interest rates.  As an investment, gold earns no interest, so when interest rates rise, gold typically drops in value.  Conversely, when interest rates fall, the price of gold typically increases, although there have been times when gold prices hit record highs while interest rates were rising.

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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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Housing Market Needs Rehab

Friday, May 27th, 2011

It wasn’t long ago that housing seemed like the best possible investment.  Housing prices just kept going up, up, up.

Now 2011 is on track to become the sixth consecutive year of declines in new home sales and, as a consequence, prices are going down, down, down.  Unless the housing market rebounds, which appears unlikely, 2011 will see the fewest homes sold on record (records have been kept since 1963).

The Wall Street Journal notes that “The 323,000 new homes sold in 2010 was less than 60% of the number of new homes sold in 1963, even though the
population today is nearly two-thirds bigger.”

Even with interest rates at historically low rates for the past couple of years, the market has continued to decline.

Even more discouraging, The Journal notes that housing has increasingly been tied to economic cycles.

Pick One: High Risk or Low Returns

Monday, May 2nd, 2011

Here’s your choice: Take on lots of risk and hope for the best or watch your standard of living erode.

The stock market has been soaring, thanks to the Federal Reserve Board’s quantitative easing program, which has continued to hold interest rates at or near record lows for several years now.

Investors came back into the market, not because the market was showing signs of strength, but because it became the least objectionable place for investors to put their money.

A 12-month certificate of deposit (CD) is yielding 1.25% interest today.  The U.S. inflation rate rose to 2.7% in March and is continuing to rise – a deliberate outcome of Fed policy.  So the real rate of return, in exchange for tying up your money for a year, is negative 1.45% (2.7% – 1.25%).

Conversely, The Russell 2000 Index of small-cap stocks recently hit a new high, having jumped 150% since March 2009, including a 9.5% gain so far for 2011.

Small-cap stocks are, of course, the riskiest stocks, representing companies with market capitalizations of $2 billion or less.  And the higher small-cap prices soar, the riskier they become and the more likely it will be that we will see a market correction.

What will happen when quantitative easing ends?  What will happen when market conditions, rather than Fed programs, dictate returns?

Fixed-Income Investors Weather Sovereign Debt Crisis

Monday, May 10th, 2010

Because of our focus on managing risk, fixed-income clients of Wenning Investments generally fared well during last week’s sovereign debt crisis, even though it created widespread panic in global markets around the world. 

Clients who hold a short bond position (TBT, PST) saw an unfavorable drop in prices, but we believe that the drop is temporary.  The position is held to provide a hedge against rising interest rates.  Interest rates fell last Thursday, but the overall trend is for interest rates to rise.

Other bond holders benefited from a decline in yields, which made the bonds they hold more attractive, since bond prices moved higher during the flight to safety.

During times of uncertainty, investors buy bonds to add protection to their portfolios and to avoid losses from falling stock prices.  When that happens, bond yields are driven lower, because the demand for bonds outweighs the supply.

Thursday, during the flight to safety, the 10-Year Treasury yield fell to 3.24%, down from 4% last month.  Today, though, the yield is inching back and is at 3.56%.

According to The Wall Street Journal, “The European Union agreed on an audacious $955 billion bailout plan in an effort to stanch a burgeoning sovereign debt crisis that began in Greece.”

This agreement has calmed fears around the globe and global stock markets are trending higher on the news.

A Sign of Rising Interest Rates?

Tuesday, February 23rd, 2010

The U.S. Federal Reserve surprised the market last week by raising the U.S. discount rate by a quarter of a point (0.25%).

Fed Chairman Ben Bernanke insists the rate hike should not be considered to be monetary tightening, but the bond market doesn’t answer to the Fed Chairman and recognizes that the interest-rate cycle has reached the point where tightening has begun.

There are other signs that a trend of interest rates moving higher has begun.

Generally, when the stock market sells off, the bond market moves in the opposite direction.  When news about Greece’s debt problems hit the market and stock prices declined, typically we would have seen a significant flight to safety, resulting in a significant rally in the bond market.  We saw some shifting of assets to safer investments, but the shift quickly faded.

To identify a trend, investment managers typically look at the long end of the curve, and the 30-year bond showed signs of weakness, in spite of Greece’s debt problems.

Whether rising interest rates is indeed a trend should be determined during the week ahead, with new Treasury Inflation-Protected Securities (TIPS) offerings.  Up for auction will be:

  • $44 billion in two-year Treasuries
  • $42 billion in five-year notes
  • $32 billion in seven-year notes
  • $8 billion in 30-year TIPS

 The 30-year TIPS offering is the first offering of that duration since 2001, as some have considered a 30-year maturity as being unnecessarily long.  Whether the 30-year TIPS will stimulate investor interest remains to be seen.  If the auction is poorly received, higher rates will most likely be on the horizon.  Stay tuned.