Duration…

October 7, 2014

Given the abrupt and recent departure of Bill “The Bond King” Gross from Pimco, the topic of fixed income has dominated the front pages of every financial news outlet over the last week. In keeping with that theme, many investors have been lulled to sleep about the risks associated with fixed income securities due to the 30 year downward trend in rates (see chart below). When looking at a fixed income investment (i.e CD, Government Bond, T-Bill, Corporate Bond, to name a few…), investors need to be aware of two main risks; credit risk (default) and interest rate risk (rate fluctuations) which will be the focus of today’s commentary.

Duration is the most commonly used measure of interest rate risk on a bond or portfolio of bonds. Duration incorporates a bond’s yield, coupon, final maturity and any call provisions into a number expressed in years, which indicates how price-sensitive a bond or portfolio is to a fluctuation in interest rates. This relationship is pretty straightforward; the longer (shorter) the duration, the more (less) sensitive the bond or portfolio is to a shift in rates. For example, a portfolio with a duration of 3 years would be expected to lose 3% of principle if there was a 1% rise in interest rates, or gain 3% if interest rates were to decrease 1%.

Of course the most pressing question is where rates go from here. Inflation continues to be muted and shows no near term risk. Fed chair Yellen most recently mentioned she expects to keep rates down well into 2015. As Gross mentioned in this week’s Barron’s interview, rates are not only low in the U.S., but also around the world. Nevertheless, we recommend a diversified bond portfolio with an emphasis on short-to-intermediate duration and mostly higher quality credit. Be on the lookout for our 3rd quarter newsletter – The New Gulag

10.7.14 Rate Chart

“The main dangers in this life are the people who want to change everything… or nothing.” –  Nancy Astor

Volatility Returns

September 29, 2014

Last week saw a return of volatility in equity prices as the DJIA ended a week with triple digit moves every day. For the week, the DJIA declined 1% and the S&P500 had a loss of 1.4%. Investors are increasingly concerned about the possibility of slowdowns in China and Europe, Middle East tensions and when the Fed will raise interest rates.

In economic news the third reading for 2nd quarter GDP came in at 4.6% and consumer spending rose 0.5% in August. Growth in the third quarter appears poised to come in at more than 3%. Growth will have exceeded 3% for three of the past four quarters if that happens. This week look for the monthly jobs report on Friday. Current estimates are for an increase of 215,000.

09.29.14advanced

“Excuses change nothing but make everyone feel better.”
-Mason Cooley

A Feeding Frenzy

September 23, 2014

The 2014 Bull Market at least partially recovered its sea-legs last week, with the S&P rising 1.3% [producing an 8.8% year to date advance]. The Nasdaq recovered a more modest 0.3% [9.7% YTD], while the smaller-cap Russell 2000 declined a further 1.2% [-1.4% YTD].

Last week’s ND&S Update presented a list of potentially damaging upcoming events. So far at least, these developments have been collectively constructive. The Scottish independence campaign was rejected by 10%, which produced a collective sigh of relief. The Fed’s QE3 purchases were reduced to $15B/month [was $25B . . . and $85B two years ago] as promised, and the Fed continued to be vague about when the Fed Funds rate will be raised [this was better than recent pessimistic market speculation]. Note that the consumer prices report of a 0.2% monthly decline in consumer prices, “only” up 1.7% year/year, is consistent with the Fed’s stated game plan.

Finally, Alibaba came thru with the largest IPO of all time, raising $25B. This has produced a long list of wealthy early investors and many more private companies eager to take advantage of the wide-open IPO window.

Laissez les bons temps rouler.

The Fed, Scotland, ISIS, Russian Sanctions, and more … oh my!

September 16, 2014

Another volatile week as tensions around the world tempered investors’ appetite for risk.

All major market averages lost ground for the week – the first weekly loss in the last five weeks. For the week, the Dow Jones Industrial Average finished at 16,987.51 to close the week lower by 0.87%. The broader-based S&P 500 closed at 1,985.54 for a decrease of 1.10% for the week. The Nasdaq Composite dropped by 0.33% to close the week at 4,567.60. International markets could not fight the tide as the Dow Jones Global (ex US) Index gave back 1.75% for the week. After last week’s losses, market averages are still higher for the year-to-date period with the Dow Jones Industrial Average up 2.5% and the NASDAQ ahead by 9.4%. The S&P 500 is showing higher year-to-date gains as it is up 7.4%. The 10-year Treasury sold-off to close the week at a yield of 2.61% … nervousness around the end of QE (in October) and the upcoming Fed meeting prompted investors in bonds to take some profits.

Economic news released last week was mixed – stronger showings in the U.S. for consumer credit, retail sales and consumer sentiment were offset by disappointing data overseas. Geopolitical tensions and sanctions have, no doubt, impacted economic growth around the world.

The week ahead is sure to provide investors with a bit of excitement and anxiety (what’s new?). The Fed meets on Tuesday and Wednesday, and investors will anxiously await their comments (no doubt, in true Fed-speak) regarding future monetary policy. Scotland’s vote on independence will surely impact markets, and investors around the world await the results of the September 18th vote. Lastly, Alibaba’s IPO on Friday will create some excitement in the markets.

I’m William Wallace, and the rest of you will be spared. Go back to England and tell them… Scotland is free!
– William Wallace

QSS – Get Used to It!

September 8, 2014

To most investors the term QSS probably brings a major shrug, what is it?  Yet in recent years it has become a more closely followed economic indicator.  QSS is short for the Quarterly Services Survey and measures revenues for covered services industries.  QSS measures a surprisingly broad number of services- Utilities, Transportation, Information services, Finance and insurance, Real Estate, Administration and support, Education, Healthcare, Arts and entertainment, and Lodging.  A survey of approximately 18,000 services providers is taken.

QSS can have its calculation problems which impact the GDP report.  Government economists estimated a strong first quarter spending for healthcare based on Medicaid funding under the ACA.  After the QSS came out on June 11 the GDP had to be revised down to a – 2.9% contraction from a 1.0% drop.  It would seem the timing of the various reports could be better coordinated.   QSS is scheduled to be released 75 days following the end of each quarter.

It is anticipated that health care spending will show up as increasing in the second quarter, meaning that the GDP number might get a boost when the adjustment is made for QSS.  Stay tuned for further revisions in GDP.

“Yesterday is history, tomorrow is a mystery, today is God’s gift, that’s why we call it the present.”
-Joan Rivers

Mixed News

September 2, 2014

Last week U.S.  stock and bond markets continued their August advance. The DJIA rose 0.57% and the S&P 500 rose 0.75% for the week and 3.2% and 3.8% respectively for the month of August. The bond market also advanced with U.S. treasuries returning 1.06% for the month and the U.S. ten year treasury ending the month with a yield of 2.347% near a 14 month low.

In economic news, the 2nd quarter GDP revision was reported at 4.2%. Also, CPI numbers for the month of July were 0.1% and only up 1.6% from a year ago giving the Fed further breathing room on when they might have to consider raising short term interest rates. On the negative side consumer spending continues to be sluggish with consumer spending in July declining 0.1% from June. Consumer spending is about two-thirds of the U.S. economy.

Also, personal income only rose 0.2% in July. The smallest monthly increase this year. As a result some forecasters reduced their GDP growth estimates  to mid 2% rates for the 3rd quarter.

This week the major economic news will be the monthly jobs report on Friday which is again expected to be over 200,000 jobs for the month.

” The key to a winning season is focusing on one opponent at a time.  Winning one week at a time.  Never look back and never look ahead.”
-Chuck Noll

Advancing on a Wall of Worry

August 25, 2014

The stock market advanced ~1.6% last week, extending the advance that began August 7th.

Janet Yellen’s speech at the Fed’s annual conference asserted that the healthy drop in the unemployment rate was misleadingly positive [factoring in underemployment and the low participation rate]. It is true that motor vehicle production trends are temporarily depressing the number by ~15,000, but the big picture is that the Fed is still targeting mid-2015 for the first Fed Funds rate hike [internal dissention notwithstanding]. The markets did not significantly react to the speech [futures markets still expect an initial hike to 0.25% next June followed by 0.5% in Sept and ~0.75% by 12/15] , suggesting that the steady-as-she-goes stance is already built into the market.

 

On another front, the St. Louis Fed released its study on the experience of performance-chasing fund investors. As expected, following past returns result in asset-class purchases at their highs. This cost these fickle investors ~200 basis points over the first 12 years of the century. Buy-and-hold achieved a 5.6% return [thru 2012] while the return chasers could only get a 3.6% return.

Patience is its own reward.

 

 

Geopolitical Unrest … The New Normal?

August 18, 2014

Another volatile week as tensions between Ukraine and Russia rattled investors’ nerves.  Iraqi extremists and ongoing issues between Israel and Hamas didn’t help the situation.  Is the current state of geopolitical unrest the new normal?  It certainly seems so, but perhaps it has always been this way.  Regardless, the unrest certainly has economic and market consequences.  Since 25% of S&P 500 companies receive over 50% or more of the earnings outside the U.S., it is indeed worthwhile to understand the political and economic dynamics of today’s geopolitical unrest.  An already fragile Europe (see GDP results below) can hardly afford more biting sanctions against Russia.

Yet the markets found a way to go higher last week.  For the week, the Dow Jones Industrial Average finished at 16,662.91 to close the week higher by 0.66%.  The broader-based S&P 500 closed at 1,955.06 for an increase of 1.22% for the week.  The Nasdaq Composite advanced by 2.15% to close the week at 4,464.93.  International markets finished higher than the broad U.S. market as the Dow Jones Global (ex US) Index advanced 1.90% for the week.   After last week’s gains, market averages are higher for the year-to-date period with the Dow Jones Industrial Average up 0.5% and the NASDAQ ahead by 6.9%.  The S&P 500 is showing higher year-to-date gains as it is up 5.8%.  The 10-year Treasury was rallied to close the week at a yield of 2.345% … down from last week’s 2.42% yield (a flight-to-safety into U.S. treasuries).

Economic news released last week was mixed – weaker retail sales in the U.S. were offset by 2nd quarter earnings that were better-than-expected at 10% year-over-year growth.  News out of Europe was disappointing as Germany’s 2nd quarter GDP saw a 0.2% decline while France’s GDP was an anemic 0.1%.  Euro-zone industrial production also missed the mark.  In a weird kind of way, markets rallied last week in hopes that ECB President Mario Draghi would implement another round of quantitative easing in Europe.

The week ahead is sure to provide investors with a bit of excitement and anxiety (what’s new?).  As always, we urge investors not to pay attention to the noise in the markets.  Instead, focus on long-term goals, and enjoy the last month of summer.

“We are all born for love. It is the principle of existence, and its only end.”

–          Benjamin Disraeli

Domestic News Good-International?

August 11, 2014

First let’s look at the news on the home front since it makes more pleasant reading.  We are coming to the end of second quarter earnings season and the results are substantially better than expected.  S&P 500 sales growth is running at 4.1% led by Health Care, Technology, Consumer Discretionary and Energy.  More impressive is the earnings results.  Non-Financial go ahead is 12.3% versus expectations of 5-7%.  Productivity in the quarter advanced 2.5% and the unemployment data is trending positively.  We read recently that some unemployed who weren’t looking for jobs are returning to the workforce!

The situations around the globe seem to require almost daily tracking.  In Iraq we see that the Kurds have had some progress, aided by our humanitarian air drops and our strikes on Isis.  The political situation in Baghdad is not good since Maliki is consolidating his military support in the city.  The Ukraine situation is encouraging on the surface as Ukraine forces advance, but we all fear what Putin will do as they advance further.  And finally there is Gaza and Israel.  We are thankful for the cease fire but fearful of what comes next.  One bright spot internationally is China.  Their market is up 7% year to date and exports have hit a 15 month high.  There is speculation of positive reforms for state owned enterprises.

We would summarize by saying to focus on the improved U.S. economic data, but to be vigilant on developments around the globe.

Slow Improvement

August 4, 2014

Last week equity markets pulled back with the DJIA declining 2.8% for the week and the S&P 500 dropping 2.7% over investor concerns about Argentina and when the Fed might start raise interest rates.  This was the largest weekly drop for the S&P500 since June 2012.  Bond prices also declined, particularly for high yield bonds where prices declined 1.8% for the week and funds continued to flow out of the sector.  Is this the start of a larger correction?  Possibly but economic news continues to show improvement from the first quarter.

The major economic report last week was the monthly jobs report which showed the U.S. added 209,000 jobs.  While this was lower than expectations of 230,000 jobs it was the 6th consecutive month of over 200,000 new jobs.  Also, average hourly earnings rose by only one cent indicating that wage inflation is still not an issue for the Fed. In addition 2nd quarter earnings, with approximately 3/4 of S&P 500 companies reporting, are on track to increase by 7.7% which is the fastest since the 4th quarter of 2013.  These earnings are being supported by improving revenues.  Revenues are projected to increase by 4.3% from the previous year which is a sign that consumers are starting to spend.