Posts filed under ‘Fixed Income (Bonds)’
Equities Up, But Investors Queasy
The market may have recovered partially from its illness over the last two years, but investors are still queasy when it comes to equities. The market is up by more than +60% since the March 2009 lows despite the unemployment rate continuing to tick higher, reaching 10.2% in October. Even though equity markets have rebounded, recovering investors have flocked to the drug store with their prescriptions for bonds. Mark Dodson, CFA, from Hays Advisory published a telling chart that highlights the extreme aversion savers have shown towards stocks.
Source: Hays Advisory LLC (Thomson Reuters Datastream)
Dodson adds:
“Net new fund mutual fund flows favor bonds over stocks dramatically, so much so that flows are on the cusp of breaking into record territory, with the previous record occurring back in the doldrums of the 2002 bear market. Given nothing but the chart (above), we would never in a million years guess that the stock market has rallied 50-60% off the March lows. It looks more like what you would see right in the throes of a nasty stock market decline.”
Checking and savings data from the Federal Reserve Bank of Saint Louis further corroborates the mood of the general public as the nausea of the last two years has yet to wear off. The mountains of cash on the sidelines have the potential of fueling further gains under the right conditions (see also Dry Powder Piled High story).
As Dodson notes in the Hays Advisory note, not everything is doom and gloom when it comes to stocks. For one, insider purchases according to the Emergent Financial Gambill Ratio is the highest since the recent bear market came to a halt. This trend is important, because as Peter Lynch emphasizes, “There are many reasons insiders sell shares but only one reason they buy, they feel the price is going up.”
What’s more, the yield curve is the steepest it has been in the last 25 years. This opposing signal should provide comfort to those blue investors that cried through inverted yield curves (T-Bill yields higher than 10-Year Notes) that preceded the recessions of 2000 and 2008.
Equity investors are still feeling ill, but time will tell if a dose of bond selling and a prescription for “cash-into-stocks” will make the queasy patient feel better?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Drought in Higher Rates May Be Over
The drought in higher interest rates may be nearing an end? Ever since the global financial crisis accelerated into full force in the fall of 2008, there were a constant flow of coordinated interest rate cuts triggered around the world with the aim of stimulating global GDP (Gross Domestic Product) and improving credit flow through the clogged financial pipes. Central banks across the world cut key benchmark interest rate levels and the impact of these reductions has a direct influence on what consumers pay for their financial products and services. More recently, we have begun to see the reversal of previous cuts with rate hikes witnessed in several international markets. Last week we saw Norway become the first western European country to raise rates, following an earlier October rate lift by Australia and another by Israel in August. For some countries, the sentiment has switched from global collapse fears to a stabilization posture coupled with future inflation concerns. In the U.S., the data has been more mixed (read article here) and the Federal Reserve has been clear on its intention to keep short-term rates at abnormally low levels for an extended period of time. That stance would likely change with evidence of inflationary pressures or improved job market conditions.
What Does This Mean for Consumers?
Prior to the financial crisis, credit availability flourished at affordably low rates. Now, with signs of a potential global recovery matched with regulatory overhauls, consumers may be impacted in several financial areas:
1) Credit Card Rates: Beyond regulatory changes in Washington (read more), the interest rate charged on unpaid credit card balances may be on the rise. When the Federal Reserve inevitably raises the targeted Federal Funds Rate (the interest rate for loans made between banks) from the current target rate range of 0.00% and 0.25%, this action will likely have direct upward pressure on consumer credit card rates. The associated increase in key benchmark rates such as the Prime Rate (the rate charged to a bank’s most creditworthy customers) and LIBOR (London Interbank Offer Rate) would result in higher monthly interest payments for consumers.
2) Other Consumer Loans: Many of the same forces impacting credit card rates will also impact other consumer loans, like home mortgages and auto loans. Pull out your loan documents – if you have floating or variable rate loans then you may be exposed to future hikes in interest rates.
3) Business Loans / Lines of Credit: Business owners -not just consumers – can also be impacted by rising rates. When the cost of funding goes up (.i.e., interest rates), the banks look to pass on those higher costs to the customer so the account profitability can be maintained.
4) Dollar & Import Prices: To the extent subsequent United States rate hikes lag other countries around the world, our dollar runs the risk of depreciating more in value (currency investors, all else equal, prefer currencies earning higher interest rates). A weaker dollar translates into foreign goods and services costing more. If international central banks continue to raise rates faster than the U.S., then imported good inflation could become a larger reality.
5) Hit to Bond Prices: Higher interest rates can also result in a negative hit to your bond portfolio. Higher duration bonds, those typically with longer maturities and lower relative coupon payments, are the most vulnerable to a rise in interest rates. Consider shortening the duration of your portfolio and even contemplate floating rate bonds.
Interest rates are the cost for borrowed money and even with the recent increase in consumers’ savings rate, consumers generally are still saddled with a lot of debt. Do yourself a favor and review any of your credit card agreements, loan documents, and bond portfolio so you will be prepared for any future interest rate increases. Shopping around for better rates and/or consolidating high interest rate debt into cheaper alternatives are good strategies as we face the inevitable end in the drought of higher global interest rates.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Misery Loves Company – Ruler Waffling
Besides using a ruler for measuring small distances and rapping disobedient knuckles, the wooden instrument can also be used for extrapolating trends. This ruler is a very convenient tool when rigorous analysis is a second choice.
Misery loves company, so the often maligned pool of inaccurate Wall Street equity analysts are happy to share the limelight with their trend leaning junk bond analyst cousins. As default rate expectations have bounced around like a jack rabbit post the Lehman Brothers bankruptcy, these bond forecasters have been caught flat-footed.
Reuters highlighted the backpedaling of Standard & Poor’s recent forecast changes:
“S&P said it now expects defaults to decline to 6.9 percent a year from now from a September rate of 10.8 percent. On Oct 2, it had said it expected defaults to escalate to 13.9 percent by August 2010.”
For a lazy analyst, extrapolation is a good fall-back strategy. Sticking your neck out by looking out further into the future or grasping the concept of reversion to the mean can be difficult and politically risky from a job retention perspective. It’s much easier to constantly hug current trends because it then becomes virtually impossible to be wrong.
Just as the rating agencies contributed to the subprime and auction rate securities (ARS) debacles by rubber stamping their AAA approvals last year through the financial crisis, so too have we witnessed the failure of bond analysts to properly analyze junk bond default rates.
Hopefully the narrowing of credit spreads is a leading indicator for economic improvement, but regardless the number and amount of high yield deals hitting the market is flowing heavily. The Wall Street Journal recently reported billions of junk bond deals being priced this week and next, including the $500 million Crown Castle International’s 10-year deal; $200 million Mohegan Tribal Gaming’s eight-year bonds; $325 million in Headwaters Inc.’s five-year notes; and over $2.4 billion of bonds from four other borrowers, including Boise Paper Holdings, Reynolds Group, Murray Energy Corp. and Universal City Development.
As larger companies are freely tapping the capital markets for capital, it’s becoming more and more evident that small businesses are having tougher and tougher times accessing credit, thanks in large part to banks hunkering down and reducing lending. Reference the flattening commercial bank credit curve chart provided by the Federal Reserve System:
As we watch the credit flow drama unfold in these uncertain economic times, don’t panic if you wondering what will happen next. Just reach into the desk drawer and pull out the favorite tool of Wall Street equity and junk bond analysts…the righteous ruler.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and its client accounts do have direct positions in HYG shares at the time this article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Gold Market Lunacy Kicking Into Gear
So wait a second, let me get this right. A company pays billions of dollars to buy insurance, and then decides to sell $3.5 billion in dilutive ownership rights (current stockholders losing more than 10% of their ownership) so that they can pay somebody else another $5.6 billion to take that same insurance they previously loved away. In my book, I call that lunacy. This madness is exactly what Barrick Gold (ABX) just decided to do. The world’s largest gold miner issued approximately 95 million common shares at $37 per share to remove gold price hedges (used to lock in gold prices at a certain level), so if gold prices spike Barrick will now be able to participate fully without the drag of the hedges.
Effectively, management has decided to turn the mining company into a Vegas casino, where shareholders can now freely speculate in the price of gold without the volatility reducing hedges in place. Does this outlandish behavior signal a top in gold prices (now hovering around $1,000 per ounce)? I’m not stupid enough to call the end of frothing, speculative behavior – just witness Alan Greenspan’s “irrational exuberance” speech in 1996 when the NASDAQ traded at 1,300 (then went on to peak above 5,000). But what I am bold enough to do is call a spade a spade and to point out how ridiculous this reverse hedging activity is.
Other signs of speculation beyond the 4x price increase over the last 8 years or so, is the fact that gold prices have risen in the face of incredibly weak gold jewelry demand, -22% year-over-year globally in Q2 according to the Gold Demand Trends. This leaves the remaining demand coming largely from speculators and global central banks. If you need more evidence for the gold speculation, just turn on your local AM radio station and listen for the endless number of get-rich-quick on gold advertisements – some stations need to fill the gaping hole once held by those advertisers hawking mortgages.
From a gold investors’ perspective, I would say I fall more into Warren Buffett camp of thinking. Unlike other commodities (some of which I believe will be driven upwards by my emerging market demand and other forces) , gold is something dug up from the dirt in South Africa, melted, transported to another hole, buried in the ground (central bank), and then storage costs are incurred to guard the shiny metal. Sure, jewelry and small commercial applications are drivers for real demand, but the majority of demand is derived from intangible desires. Other commodities, for example oil, copper, uranium, and natural gas offer a lot more utility.
So what’s next when it comes to the price of gold? Peter Schiff an uber-gold bull broker at Euro Pacific Capital believes Armageddon is coming for the U.S. economy and hyper-inflation will drive gold upwards to the $4,000 per ounce price range (See How Peter Schiff’s Other Forecasts Have Performed). Another possibility to consider is a complete collapse in gold prices (and surge in the dollar) like we saw in the early 1980s after Paul Volcker raised interest rates and gold prices did not appreciate for a 25 year period. Hmmm, I wonder what direction interest rates are going next with the Federal Funds rate currently at effectively 0%? Could we see a repeat of the early ‘80s? Seems like a possibility to me. Certainly if you fall into the civil unrest, soup kitchen, and bread line camp, like Schiff and other U.S. bears, then piling into the diluted Barrick Gold shares may not be a bad strategy.
Inflation
Given the massive stimulus, debt loads, money supply growth and legislative agendas currently in place, inflation is a major medium and long-term concern. My remedy is government guaranteed Treasury Inflated Protection Securities (TIPS) that not only compensates investors with interest payments (unlike gold), but will also see principal values increase in tandem with principal if inflation indeed rears its ugly head. For those conspiracy theorists that believe the Consumer Price Index (CPI) is rigged, there are alternative international flavors of TIPs that reset according to other inflation benchmarks. As a kicker, some of these particular securities offer a hedge against a sliding U.S. dollar, which may or may not continue.
So as I lie in my recliner with my popcorn and TIPs, I’ll watch Barrick and other speculators continue the gold buying frenzy, wondering when and how ugly the gold finale will be?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct long or short positions in ABX or gold related securities or BRKA/B at the time the article was published. Sidoxia Capital Management and its clients do have long exposure to TIP shares. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Is Trump’s Business Better than His Hair?
Should Trump's Hair or Business Acumen be Fired?!
Fiery debate still swirls around the authenticity of Donald Trump’s hair (piece), but what about his business acumen? Just this year in February, Trump Entertainment filed for Chapter 11 bankruptcy. Maybe “The Donald” should be “fired?!”
If this was his only economic fatality in Trump’s career, one might cut him a little slack. I however am not enslaved into his glorified status in the media and press. My critical eye lacks the generosity necessary to honor him a free hall pass. When looking at Trump’s career, the tabloids must not forget that Trump’s Taj Mahal Casino was also run into bankruptcy purgatory in 1991. Number #11 must be Trump’s magic number because in less than a year, Trump filed for Chapter 11 on the Trump Plaza Hotel and Casino and Trump’s Castle (March 1992).
Like an infomercial, “But wait, there’s more!” In November 2004, Trump Hotels & Casino Resorts Inc. filed for Chapter 11 bankruptcy. This company reemerged out of bankruptcy as a new operating company, Trump Entertainment Resorts Inc., only to…you guessed it, file bankruptcy again. I think I see a pattern here.
With the vast bankruptcy experience Trump holds and with him and his daughter Ivanka Trump quitting from Trump Entertainment earlier this year, Donald is now trying to scoop up this company for a $100 million steal. The bankruptcy court and creditors will determine if it’s a fair deal. If not approved, rest assured, Donald will have an extra $100 million to spend wisely – possibly building another company into bankruptcy failure or perhaps…better hair care?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Cash Strapped Bond Issuers Should Follow Willie Sutton
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When infamous bank robber Willie Sutton was asked why he robs banks, he coyly responded, “Because that’s where the money is.” Willie Sutton was one of the more prominent bank robbers in American history. During his long career he had robbed close to 100 banks from the late 1920s to 1952. He was known as “Slick Willie” or “The Actor.” As a master of disguise the FBI files show that Sutton masqueraded himself as a mailman, policeman, telegraph messenger, maintenance man and a host of other personas. The Credit Default Swap market has also been disguised in mystery and opaqueness.
With many cash strapped bond issuers looking for ways to negotiate more favorable credit terms during these tough economic times, one strategy has been to approach holders of the CDS instruments. However, CDS holders have no reason to negotiate with corporate bond issuers (for pennies on the dollar) when they stand to collect a full dollar from their bank (due to terms in the CDS contracts). Cash starved corporations rather should listen to Willie Sutton and go straight to the money source – the banks that issued the CDS to the investors. As bankruptcies increase, and bank failures rise, the trio of bond holders, bond issuers, and CDS issuers (banks) will become closer friends (and/or enemies).
Research Reloaded delved more into this issue by discussing the tactics used by media companies, Gannett and McClatchy (Read Article Here). Lots of wrinkles need to be ironed out in the CDS market, measured in the tens of trillions in notional value, but part of the solution involves the bond issuer and investor going straight to the money source (the bank issuer of the CDS). Willie would be proud.
Wade W. Slome, CFA, CFP® www.Sidoxia.com
Treasury Bubble Hasn’t Burst….Yet
10-Year Treasury Chart (5-14-09)
Clusterstlock’s Joe Weisenthal’s takes a historical look on 10-year Treasury yields going back to 1962. As you can see, the yield is still below 1962 levels, despite the massive inflationary steps the Federal Reserve and Treasury have taken over the last 18 months (6-26-09 yield was 3.51%). These trends can also be put into perspective by reading Vincent Fernando’s post at http://www.researchreloaded.com. Take a peek.
Ways to take advantage of this trend include purchases of TBT (UltraShort 20+ Year Treasury ProShares) or short TLT (iShares Barclays 20+ Year Treasury Bond)*.
Reverse View of Historical 10-Year Treasury Yield
*Disclosure: Sidoxia Capital Management clients and/or Slome Sidoxia Fund may have a short position in TLT.
Debt: The New Four-Letter Word
D-E-B-T, our country’s new four-letter word, used to be a fun toy the masses played and danced with to buy all kinds of goods and services. Debt was creatively utilized for all types of things, including, our super-sized McMansions purchased with Option ARM (Adjustable Rate Mortgage) Countrywide loans; our 0% financing car binges (thanks to now-bankrupt Chrysler and General Motors); and our no-payment-for-two-years, big screen plasma TVs (financed at now-bankrupt Circuit City). Eventually consumers, corporations, and governments realized excessive debt creates all kinds of lingering problems – especially in recessionary periods. We are by no means out of the woods yet, but consumers are now spending less than they are taking in, as evidenced by a positive and rising savings rate. This slowdown in spending is bad for short-term demand, but eventually these savings will be recycled into our economy leading to productive and innovative value creating jobs that will jumpstart the economy back on a path to sustainable growth.
Click Here For Excellent Article from the Peterson Foundation
In our hot-cold society, where the pendulum of greed and fear swing dramatically from one side to the next, we are also observing an unhealthy level of risk aversion by financial institutions. This excessive caution is unfortunately choking off the health of legitimate businesses that need capital/debt in order to survive. As we continue to see a pickup in the leading indicators for an economic recovery, banks should loosen up the credit purse strings to provide capital for profitable, growing businesses – even if there are hiccups along the way.
National Debt “Blob” Must Be Slowed
In the famous 1958 sci-fi horror film, “The Blob”, a gelatinous, ever-growing creature from outer space threatens to take over the town of Downingtown, Pennsylvania by methodically engulfing everything in its path. Steve McQueen eventually learns that freezing the Blob will halt its progression. In our country, entitlements, in the form of Medicare and Social Security, serve as our 21st century Blob. As the chart above shows, entitlements have expanded dramatically over the last 40 years and stand to expand faster, as the 76 million Baby Boomers reach retirement and demand more Social Security and Medicare benefits. Clearly the current path we are travelling on is not sustainable, and beyond breakthroughs in technology, the only way we can suitably address this problem is by cutting benefits or raising taxes. We only dug ourselves in a deeper financial hole with the enactment of Medicare Part D (prescription drug benefits for Medicare participants). I must admit I have great difficulty in understanding how we are going to expand health care coverage for the vast majority of Americans in the face of exploding deficits and debt burdens. I eagerly await specifics.
With an enlarging national debt burden and widening deficits, the U.S. is only becoming more reliant on foreign investors to finance our shortcomings. This trend too cannot last forever (see chart below). At some point, foreigners will either balk by not providing us the financing, or demanding prohibitively high interest rates on any funding we request – thereby negatively escalating our already high interest payment streams to bondholders.
Regardless of your political view, the problem pretty simply boils down to elementary school math. The government either needs to cut expenses or raise revenue (taxes or growth initiatives). Politically, the stimulative spending path is easier to rationalize, but as we see in California, eventually the game ends and tough cuts are forced to be made.
Let’s hope the painful lessons learned from this financial crisis will steer us back on path to more responsible borrowing – a point where D-E-B-T is no longer considered a dirty four-letter word.
“Bill, Say It Ain’t So…”
Bond guru and Newport Beach neighbor, Bill Gross, is out with his entertaining monthly PIMCO piece (Click Here). Try to keep a box of tissues close by in case you cry during the read. His views support my stance on short duration bonds and TIPs (Treasury Inflation Protected Securities), but big Bill would NEVER stand to root for equities – especially after his call for Dow 5000 a while back.
In this CNBC piece, he points out the obvious troubles we face from all the debt we’re choking on. As a country, we need the “Heimlich Maneuver!”
"Save to Your Grave"
Building Your Financial Future – Mistakes Made in Investment Planning
Building Your Dream Future Requires a Plan
Building your retirement and financial future can be likened with the challenge of designing and building your dream home. The tools and strategies selected will determine the ultimate cost and outcome of the project.
I constantly get asked by investors, “Wade, is this the bottom – is now the right time to get in the markets?” First of all, if I precisely knew the answer, I would buy my own island and drink coconut-umbrella drinks all day. And secondarily, despite the desire for a simple, get-rich quick answer, the true solution often is more complex (surprise!). If building your financial future is like designing your dream home, then serious questions need to be explored before your wealth building journey begins:
1) Do I have enough money, and if not, how much money do I need to develop my financial future?
2) Can I build it myself, or do I need the help of professionals?
3) Do I have contingency plans in place, should my circumstances change?
4) What tools and supplies do I need to effectively bring my plans to life?
Most investors I run into have no investment plan in place, do not know the costs (fees) of the tools and strategies they are using, and if they are using an advisor (broker) they typically are in the dark with respect to the strategy implemented.
For the “Do-It-Yourselfers”, the largest problem I am witnessing right now is excessive conservatism. Certainly, for those who have already built their financial future, it does not make sense to take on unnecessary risk. However, for most, this is a losing strategy in a world laden with inflation and ever-growing entitlements like Medicare and Social Security. There’s clearly a difference between stuffing money under the mattress (short-term Treasuries, CDs, Money Market, etc.) and prudent conservatism. This is a credo I preach to my clients.
In many cases this conservative stance merely compounds a previous misstep. Many investors undertook excessive risk prior to the current financial crisis – for example piling 100% of investment portfolios into five emerging market commodity stocks.
What these examples prove is that the average investor is too emotional (buys too much near peaks, and capitulates near bottoms), while paying too much in fees. If you don’t believe me, then my conclusions are perfectly encapsulated in John Bogle’s (Vanguard) 1984-2002 study. The analysis shows the average investor dramatically underperforming both the professionally managed mutual fund (approximately by 7% annually) and the passive (“Do Nothing”) strategy by a whopping 10% per year.
Building your financial future, like building your dream home, requires objective and intensive planning. With the proper tools, strategies and advice, you can succeed in building your dream future, which may even include a coconut-umbrella drink.
Investing Caffeine 
