Posts tagged ‘Qe3’

Bernanke: Santa Claus or Grinch?

Santa - Grinch

I’ve written plenty about my thoughts on the Fed (see Fed Fatigue) and all the blathering from the media talking heads. Debates about the timing and probability of a Fed “taper” decision came to a crescendo in the recent week. As is often the case, the exact opposite of what the pundits expected actually happened. It was not a huge surprise the Federal Reserve initiated a $10 billion tapering of its $85 billion monthly bond buying program, but going into this week’s announcement, the betting money was putting their dollars on the status quo.

With the holiday season upon us, investors must determine whether the tapered QE1/QE2/QE3 gifts delivered by Bernanke are a cause for concern. So the key question is, will this Santa Claus rally prance into 2014, or will the Grinch use the taper as an excuse to steal this multi-year bull market gift away?

Regardless of your viewpoint, what we did learn from this week’s Fed announcement is that this initial move by the Fed will be a baby step, reducing mortgage-backed and Treasury security purchases by a measly $5 billion each. I say that tongue in cheek because the total global bond market has been estimated at about $80,000,000,000,000 (that’s $80 trillion).

As I’ve pointed out in the past, the Fed gets way too much credit (blame) for their impact on interest rates (see Interest Rates: Perception vs Reality). Interest rates even before this announcement were as high/higher than when QE1 was instituted. What’s more, if the Fed has such artificial influence over interest rates, then why do Austria, Belgium, Canada, Denmark, Finland, France, Germany, Japan, Netherlands, Sweden, and Switzerland all have lower 10-year yields than the U.S.? Maybe their central banks are just more powerful than our Fed? Unlikely.

Dow 128,000 in 2053

Readers of Investing Caffeine know I have followed the lead of investing greats like Warren Buffett and Peter Lynch, who believe trying to time the markets is a waste of your time. In a recent Lynch interview, earlier this month, Charlie Rose asked for Lynch’s opinion regarding the stock market, given the current record high levels. Here’s what he had to say:

“I think the market is fairly priced on what is happening right now. You have to say to yourself, is five years from now, 10 years from now, corporate profits are growing about 7 or 8% a year. That means they double, including dividends, about every 10 years, quadruple every 20, go up 8-fold every 40. That’s the kind of numbers you are interested in. The 10-year bond today is a little over 2%. So I think the stock market is the best place to be for the next 10, 20, 30 years. The next two years? No idea. I’ve never known what the next two years are going to bring.”

READ MORE ABOUT PETER LYNCH HERE

Guessing is Fun but Fruitless

I freely admit it. I’m a stock-a-holic and member of S.A. (Stock-a-holic’s Anonymous). I enjoy debating the future direction of the economy and financial markets, not only because it is fun, but also because without these topics my blog would likely go extinct. The reality of the situation is that my hobby of thinking and writing about the financial markets has no direct impact on my investment decisions for me or my clients.

There is no question that stocks go down during recessions, and an average investor will likely live through at least another half-dozen recessions in their lifetime. Unfortunately, speculators have learned firsthand about the dangers of trading based on economic and/or political headlines during volatile cycles. That doesn’t mean everyone should buy and do nothing. If done properly, it can be quite advantageous to periodically rebalance your portfolio through the use of various valuation and macro metrics as a means to objectively protect/enhance your portfolio’s performance. For example, cutting exposure to cyclical and debt-laden companies going into an economic downturn is probably wise. Reducing long-term Treasury positions during a period of near-record low interest rates (see Confessions of a Bond Hater) as the economy strengthens is also likely a shrewd move.

As we have seen over the last five years, the net result of investor portfolio shuffling has been a lot of pain. The acts of panic-selling caused damaging losses for numerous reasons, including a combination of agonizing transactions costs; increased inflation-decaying cash positions; burdensome taxes; and a mass migration into low-yielding bonds. After major indexes have virtually tripled from the 2009 lows, many investors are now left with the gut-wrenching decision of whether to get back into stocks as the markets reach new highs.

As the bulls continue to point to the scores of gifts still lying under the Christmas tree, the bears are left hoping that new Fed Grinch Yellen will come and steal all the presents, trees, and food from the planned 2014 economic feast. There are still six trading days left in the year, so Santa Bernanke cannot finish wrapping up his +30% S&P 500 total return gift quite yet. Nevertheless, ever since the initial taper announcement, stocks have moved higher and Bernanke has equity investors singing “Joy to the World!

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. 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.

December 22, 2013 at 1:45 am Leave a comment

QE: The Greatest Thing Since Sliced Bread*

Sliced Bread4

Quantitative easing (QE), or the Federal Reserve’s bond buying program, has been a spectacular success. Arguably, the greatest innovation since sliced bread. Don’t believe me? I mean, if you listen to many of the experts, strategists, economists, and blogosphere pundits, the magical elixir of QE can be the only explanation rationalizing the multi-year economic recovery and stock market boom. Don’t believe me? Well, apparently many of the bearish pros make sure to credit QE for all our financial/economic positives. For example…

  • QE is the reason the stock market is near all-time record highs.
  • QE created seven million jobs in the U.S. over the last four years.
  • QE turned around the housing market.
  • QE turned around the auto market.
  • QE weakened the U.S. dollar, resulting in flourishing exports.
  • QE has lowered borrowing rates, thereby cleansing consumer balance sheets through deleveraging.
  • QE is the reason Facebook Inc. (FB) hired 1,323 employees over the last year.
  • QE is the reason Google Inc. (GOOG) has spent $7.8 billion on R&D over the last year.
  • QE explains why McDonald’s Corp. (MCD) plans to open more than 1,400 stores this year.
  • QE explains why Warren Buffett and 3G capital paid $28 billion to buy Heinz.
  • QE is the reason Elon Musk and Tesla Motors (TSLA) invented the model S electric vehicle.
  • QE exhibits why Target Corp. (TGT) is expanding outside the U.S. into Canada.
  • QE is the reason why S&P 500 companies are expected to pay $300 billion in dividends this year.
  • QE is the reason why S&P 500 companies were buying back shares at a $400 billion clip this year.
  • QE is the basis for corporations spending billions on efficiency enhancing cloud-based services.
  • QE led to a record number of new FDA drug approvals last year.
  • QE has caused a natural gas production boom in numerous shale regions.

Wow…the list goes on and on! Heck, I even hear QE can take the corrosion off of a rusted car battery. Given how incredible this QE stuff is, why even consider tapering QE? Financial markets have been volatile on the heels of tapering the 3rd iteration of quantitative easing (QE3), but why slow QE3, when the FED could add more awesomeness with  QE4, QE10, QE 100, and QE 1,000?

All of this QE talk is so wonderful, but unfortunately, according to all the bearish pundits, QE has created an artificial sugar high, thus creating an asset bubble that is going to end in a disastrous cratering of financial markets. 

I know it’s entirely possible that QE may have absolutely nothing to do with the financial market recovery (other than a bid under Treasury & mortgage backed security prices), and also has no bearing on why I buy or sell stocks, but I guess I will need to hide in a cave when QE3 tapering begins. Although the end of dividends, share buybacks, housing/auto recoveries, acquisitions, expansion, innovation, etc., caused by QE tapering sure does not sound like a cheery outcome, at least I still have a loaf of sliced bread to make a sandwich.

*DISCLOSURE: For those readers not familiar with my writing style, I have been known to use a healthy dose of sarcasm. Call me if you want a deeper explanation.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE II : Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and GOOG, but at the time of publishing, SCM had no direct position in FB, TSLA, MCD, BRKA, TGT, or any other security referenced in this article. 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

August 24, 2013 at 11:40 pm 4 comments

Confessions of a Bond Hater

Source: stock.xchng

Source: stock.xchng

Hi my name is Wade, and I’m a bond hater. Generally, the first step in addressing any type of personal problem is admitting you actually have a problem. While I am not proud of being a bond hater, I have been called many worse things during my life. But as we have learned from the George Zimmerman / Trayvon Martin case, not every situation is clear-cut, whether we are talking about social issues or bond investing. For starters, let me be clear to everyone, including all my detractors, that I do not hate all bonds. In fact, my Sidoxia clients own many types of fixed income securities. What I do hate however are low yielding, long duration bonds.

Duration…huh? Most people understand what “low yielding” means, when it comes to bonds (i.e., low interest, low coupon, low return, etc.), but when the word duration is uttered, the conversation is usually accompanied by a blank stare. The word “duration” may sound like a fancy word, but in reality it is a fairly simple concept. Essentially, high-duration bonds are those fixed income securities with the highest sensitivity to changes in interest rates, meaning these bonds will go down most in price as interest rates rise.

When it comes to equity markets, many investors understand the concept of high beta stocks, which can be used to further explain duration. There are many complicated definitions for beta, but the basic principle explains why high-beta stock prices generally go up the most during bull markets, and go down the most during bear markets. In plain terms, high beta equals high octane.

If we switch the subject back to bonds, long duration equals high octane too. Or stated differently, long duration bond prices generally go down the most during bear markets and go up the most during bull markets. For years, grasping the risk of a bond bear market caused by rising rates has been difficult for many investors to comprehend, especially after witnessing a three-decade long Federal Funds tailwind taking the rates from about 20% to about 0% (see Fed Fatigue Setting In). 

The recent interest rate spike that coincided with the Federal Reserve’s Ben Bernanke’s comments on QE3 bond purchase tapering has caught the attention of bond addicts. Nobody knows for certain whether this short-term bond price decline is the start of an extended bear market in bonds, but mathematics would dictate that there is only really one direction for interest rates to go…and that is up. It is true that rates could remain low for an indefinite period of time, but neither scenario of flat to down rates is a great outcome for bond holders.

Fixes to Fixed-Income Failings

Even though I may be a “bond hater” of low yield, high duration bonds, currently I still understand the critical importance and necessity of a fixed income portfolio for not only retirees, but also for the diversification benefits needed by a broader set of investors. So how does a bond hater reconcile investing in bonds? Easy. Rather than focusing on lower yielding, longer duration bonds, I invest more client assets in shorter duration and/or higher yielding bonds. If you harbor similar beliefs as I do, and believe there will be an upward bias to the trajectory of long-term interest rates, then there are two routes to go. Investors can either get compensated with a higher yield to counter the increased interest rate risk, and/or they can shorten duration of bond holdings to minimize capital losses.

Worth noting, there is an alternative strategy for low yielding, long duration bond lovers. In order to minimize interest rate risk, these bond lovers may accept sub-optimal yields and hold bonds to maturity. This strategy may be associated with short-term price volatility, but if the bond issuer does not default, at least the bond investor will get the full principal at maturity to help relieve the pain of meager yields.

Now that you’ve survived all this bond babbling, let me cut to the chase and explain a few ways Sidoxia is taking advantage of the recent interest rate volatility for our clients:

Floating Rate Bonds: Duration of these bonds is by definition low, or near zero, because as interest rates rise, coupons/interest payments are advantageously reset for investors at higher rates. So if interest rates jump from 2% to 3%, the investor will receive +50% higher periodic payments.

Inflation Protection Bonds: These bonds come in long and short duration flavors, but if interest rates/inflation rise higher than expected, investors will be compensated with higher periodic coupons and principal payments.

Shorter Duration: One definition of duration is the weighted average of time until a bond’s fixed cash flows are received. A way of shortening the duration of your bond portfolio is through the purchase of shorter maturity bonds (e.g., buying 3-year bonds rather than 30-year bonds).

High Yield Bonds: Investing in the high yield bond category is not limited to domestic junk bond purchases, but higher yields can also be earned by investing in international and/or emerging market bonds.

Investment Grade Corporate Bonds: Similar to high yield bonds, investment grade bonds offer the potential of capital appreciation via credit improvement. For instance, credit rating upgrades can provide gains to help offset price declines caused by rising interest rates.

Despite my bond hater status, the recent taper tantrum and interest rate spike, highlight some advantages bonds have over stocks. Even though prices declined, bonds by and large still have lower volatility than stocks; provide a steady stream of income; and provide diversification benefits.

To the extent investors have, or should have, a longer-term time horizon, I still am advocating a stock bias to client portfolios, subject to each investor’s risk tolerance. For example, an older retired couple with a conservative target allocation of 20%/80% (equity/fixed income) may consider a 25% – 30% allocation. A shift in this direction may still meet the retirees’ income needs (especially if dividend-paying stocks are incorporated), while simultaneously acknowledging the inflation and interest rate risks impacting bond positions. It’s important to realize one size doesn’t fit all.

Higher Volatility, Higher Reward

Frequent readers of Investing Caffeine have known about my bond hating tendencies for quite some time (see my 2009 article Treasury Bubble has not Burst…Yet), but the bond baby shouldn’t be thrown out with the bath water. For those investors who thought bonds were as safe as CDs, the recent -6% drop in the iShares Aggregate Bond Index (AGG) didn’t feel comfortable for most. Although I am still an enthusiastic stock cheerleader (less so as valuation multiples expand), there has been a cost for the gargantuan outperformance of stocks since March of ’09. While stocks have outperformed bonds (S&P vs. AGG) by more than +140%, equity investors have had to endure two -10% corrections and two -20% corrections (e.g.,Flash Crash, Debt Ceiling Debate, European Financial Crisis, and Sequestration/Elections). If investors want to earn higher long-term equity returns, this desire will translate into more volatility than bonds…and more Tums.

I may still be a bond hater, and the general public remains firm stock haters, but at some point in the multi-year future, I will not be surprised to hear myself say, “Hi my name is Wade, and I am addicted to bonds.” In the mean time, Sidoxia will continue to optimize its client bond portfolios for a rising interest rate environment, while also investing in attractive equity securities and ETFs. There’s nothing to hate about that.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), including floating rate bonds/loan funds, inflation-protection funds, corporate bond ETF, high-yield bond ETFs, and other bond ETFs, but at the time of publishing, SCM had no direct position in AGG or any other security referenced in this article. 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.

July 20, 2013 at 4:05 pm 2 comments

Jobs and the DMV Economy

Line of People

If you have ever gone to get your driver’s license at the Department of Motor Vehicles (DMV)…you may still be waiting in line? It’s a painful but often a mandatory process, and in many ways the experience feels a lot like the economic recovery we currently have been living through over the last four years. Steady progress is being made, but in general, people hardly notice the economy moving forward.

My geographic neighbor and blogger here in Orange County, California (Bill McBride – Calculated Risk) has some excellent visuals that compare our sluggish DMV economy with previous economic cycles dating back to 1948:

Source: Calculated Risk

Source: Calculated Risk

As you can see from the chart above, the current economic recovery (red-line), as measured by job losses, is the slowest comeback in more than a half-century. Basically, over a two year period, the U.S. lost about nine million jobs, and during the following three years the economy regained approximately seven million of those jobs – still digging out of the hole. Last Friday’s June jobs report was welcomed, as it showed net jobs of +195,000 were added during the month, and importantly the previous two months were revised higher by another +70,000 jobs. These data points combined with last month’s Fed’s QE3 tapering comments by Ben Bernanke help explain why the continued rout in 10 year Treasury rates has continued in recent weeks, propelling the benchmark rate to 2.71% – almost double the 1.39% rate hit last year amidst continued European financial market concerns.

As with most recessions or crashes, the bursting of the bubble (i.e., damage) occurs much faster than the inflation (i.e., recovery), and McBride’s time series clearly shows this fact:

Source: Calculated Risk

Source: Calculated Risk

While pessimists point to the anemic pace of the current recovery, the glass half-full people (myself included) appreciate that the sluggish rebound is likely to last longer than prior recoveries. There are two other key dynamics underlying the reported employment figures:

  • Continued Contraction in Government Workers: Excessive government debt and deficits have led to continued job losses – state and local job losses appear to be stabilizing but federal cuts are ongoing.
  • Decline in the Labor Force Participation Rate:  Discouraged workers and aging Baby Boomer demographics have artificially lowered the short-term unemployment figures because fewer people are looking for work. If economic expansion accelerates, the participation contraction trend is likely to reverse.

Skepticism Reigns Supreme

Regardless of the jobs picture and multi-year expansion, investors and business managers alike remain skeptical about the sustainability of the economic recovery. Anecdotally I encounter this sentiment every day, but there are other data points that bolster my assertion. Despite the stock market more than doubling in value from the lows of 2009, CNBC viewer ratings are the weakest in about 20 years (see Value Walk) and investments in the stock market are the lowest in 15 years (see Gallup poll chart below):

Source: Gallup

Source: Gallup

Why such skepticism? Academic research in behavioral finance highlights innate flaws in human decision-making processes. For example, humans on average weigh losses twice as much as gains as economist and Nobel prizewinner Daniel Kahneman explains in his book Thinking Fast and Slow (see Investing Caffeine article: Decision Making on Freeways and in Parking Lots). Stated differently, the losses from 2008-2009 are still too fresh in the minds of Americans. Until the losses are forgotten, and/or the regret of missing gains becomes too strong, many investors and managers will fearfully remain on the sideline.

The speed of our economic recovery is as excruciatingly agonizing, and so is waiting in line at the DMV. The act of waiting can be horrific, but obtaining a driver’s license is required for driving and investing is necessary for retirement. If you don’t want to go to investing jail, then you better get in the investing line now before job growth accelerates, because you don’t want to be sent to the back of the line where you will have to wait longer.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. 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.

July 6, 2013 at 10:41 pm Leave a comment

Hammering Heads with Circular Conversations

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This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (July 1, 2013). Subscribe on the right side of the page for a complete monthly update.

Deciphering what is driving the markets on a day-to-day, week-to-week, or month-to-month basis can feel like repeatedly hammering your head. In order to grasp the reasons why financial markets go up and down, one must have a conversation with your brain explaining that good news can be bad for asset prices, and bad news can be good for asset prices. Huh…how can that be? These circular conversations are what keep newspapers, magazines, media commentators, and bloggers in business… and what baffle many investors.

For example, headlines often reflect sentiments such as these:

  • “Unemployment Figures Disappoint…Dow Jones Rallies +200 Points on QE3 Continuation Hopes”
  • “Unemployment Figures Delight…Dow Jones Tanks -200 Points on QE3 Discontinuation Fears”
  • “Economic Figures Revised Lower by -0.2%…Dow Jones Skyrockets +200 Points as Lower Interest Rates Propel Stock Prices.”
  • “Economic Figures Revised Higher by +0.2%…Dow Jones Plummets -200 Points as Higher Interest Rates Deflate Stock Prices.”

On rare occasions these headlines make sense, but often online media outlets are frantically changing the headlines as the markets whip back and forth from positive to negative. News-producing editors are continually forced to create ludicrous and absurd explanations that usually make no sense to informed long-term investors.

It’s important to recognize that if the financial markets made common sense, then investing for retirement would be simple and everyone would be billionaires. Unfortunately, financial markets frequently make no sense in the short-run. Stocks are volatile (often times for no rational reason), which is why stocks offer higher returns over the long-run relative to more stable asset classes.

Explaining the latest spike in stock/bond price volatility has been exacerbated in recent weeks as a result of the nation’s banker (the Federal Reserve) and its boss, Ben Bernanke, attempting to explain their future monetary policy plans. In theory, bringing light to a traditionally mysterious, closed-door Washington process should be a good thing…right?

Well, ever since a few weeks ago when Ben Bernanke and the FOMC (Federal Open Market Committee) disclosed that the stimulative bond buying program (QE3) could be slowed in 2013 and halted in 2014, financial markets globally experienced a sharp jolt of volatility – stock prices dropped and interest rates spiked. Counter-intuitively, Bernanke’s belief that the economy is on a sustained recovery path (expected GDP growth of +3.25% in both 2014 & 2015) spooked investors. More specifically, in the month of June, the S&P 500 index declined -1.5% in June; Dow Jones Industrial Index -1.4%; and the 10-year Treasury note’s yield jumped +0.3% to 2.5%. Greedy investors, however, should not forget that the stock market just posted its 2nd best quarter since 2009 – the S&P 500 climbed +2.4%. What’s more, the S&P 500 is up +13% and the Dow up +14% in the first half of 2013.

Bernanke Threatening to Take Away Investor Lollipops

Another way of looking at the recent volatility is by equating investors to kids and stimulative QE bond buying programs (Quantitative Easing) to lollipops. If the economy continues on this improvement trajectory (i.e., unemployment falls to 7% by next year) and inflation remains benign (below 2.5%), then Bernanke said he will take away investors’ QE lollipops. But like a pushover dad being pressured by kids at the candy store, Bernanke acknowledged that he could continue supplying investors QE lollipops, if the economic data doesn’t improve at the forecasted pace. At face value, receiving a specific timeline given by the Fed should be appreciated and normally people are happy to hear the Chairman speak rosily about the economy’s future. However, the mere thought of QE lollipops being taken away next year was enough to push investors into a “taper tantrum” (see also Investing Caffeine – Fed Fatigue article).

With scary headlines constantly circulating, a large proportion of investors are sitting on their hands (and cash) while staring like deer in headlights at these developments. Rather than a distracted driver texting, investors should be watching the road and mapping out their future investment destinations – not paying attention to irrelevant diversions. Astute investors realize that uncertainty surrounding Greece, Cyprus, fiscal cliff, sequestration, presidential elections, Iran, N. Korea, Syria, Turkey, taxes, QE3, etc., etc., etc., have been a constant. Regrettably the fear mongers paying attention to these useless headlines have witnessed their cash, gold, and Treasuries get trounced by equity returns since early 2009 (the S&P 500 index is up about +150%, including dividends). Optimists and realists, on the other hand, have seen their investment plans thrive. While the aforementioned list of concerns has dangled in front of our noses over the last year, we will have a complete new list of concerns to decipher over the coming weeks, months, and years. That’s the price a long-term investor pays if they want to earn higher returns in the volatile equity markets.

As strategist Don Hays points out, “Nothing is certain. Good investors love uncertainty.” Rather than getting consumed by fear with the endless number of changing uncertainties, the real risk for investors is outliving your savings. Paychecks are being stretched by inflationary pressures across all categories (e.g., healthcare, gasoline, utilities, food, movies, travel, etc.) and entitlements like Social Security and Medicare will likely not mean the same thing to us as it did for our parents. Unless investors plan on working into their 80s as greeters at Wal-Mart, and/or enjoy clipping Top Ramen coupons in a crammed apartment, then they should do themselves a favor by taking a deep breath and turning off the television, so they can be insulated from the constant doom and gloom. 

So as intimidating, circular conversations about good news being bad news, and bad news being good news continue to swirl around, focus instead on building a diversified investment plan that can adjust and adapt to the never-ending list of uncertainties. Your head will feel a lot better than it would after repetitive hammer strikes.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and WMT,  but at the time of publishing, SCM had no direct position in any other security referenced in this article. 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.

July 1, 2013 at 8:31 am 2 comments

Fed Fatigue Setting In

Girl child

Uncle…uncle! There you have it – I have finally cried “uncle” because I cannot take it anymore. I don’t think I can listen to another panel or read another story debating about the timing of Fed “tapering”, or heaven forbid the Fed actually “tighten” the Federal Funds rate (i.e., increasing the targeted rate for inter-bank lending). Type in the words “Bernanke” and “tapering” into Google and you will get back more than 41,000,000 results. The build up to the 600-word FOMC (Federal Open Market Committee) statement was almost deafening, so much so that live coverage of Federal Reserve Chairman Ben Bernanke was available at your fingertips:

Source: Yahoo! Finance

Source: Yahoo! Finance

Like a toddler (or a California-based, investment blog writer) going to the doctor’s office to receive an inoculation, the anxiety and mental anguish caused in anticipation of the event is often more painful than the actual injection. As I highlighted in a previous Investing Caffeine article, the 1994 interest rate cycle wasn’t Armageddon for equity markets, and the same can be said for the rate hikes from 1.0% to 5.25% in the 2004-20006 period (see chart below). Even if QE3 ends in mid-2014 and the new Federal Reserve Chairman (thank you President Obama) raises rates in 2015, this scenario would not be the first (or last) time the Federal Reserve has tightened monetary policy.

Source: Wikipedia

Source: Wikipedia

Short Memories – What Have You Done for Me Lately?

People are quick to point out the one-day -350 Dow point loss earlier this week, but many of them forget about the +3,000 point moon shot in the Dow Jones Industrial index that occurred in six short months (November 2012 – May 2013). The same foggy recollection principle applies to interest rates. The recent rout in 10-year Treasury prices is easily recalled as rates have jumped from 1.5% to 2.5% over the last year, however amnesia often sets in for others if you ask them where rates were a few years ago. It’s easy to forget that 30-year fixed rate mortgages exceeded 5% and the 10-year reached 4% just three short years ago.

Bernanke: The Center of the Universe?

Does Ben Bernanke deserve credit for implementing extraordinary measures during extraordinary times during the 2008-09 financial crisis? Absolutely. But should every man, women, and child wait with bated breath to see if a word change or tonal adjustment is made in the eight annual FOMC meetings?

Like the public judging Ben Bernanke, my Sidoxia clients probably give me too much credit when things go well and too much blame when things don’t. I love how Bernanke gets blamed/credited for the generational low interest rates caused by his money printing ways and QE punch bowl tactics. Last I checked, the interest rate downtrend has been firmly in place over the last three decades, well before Bernanke came into the Fed and worked his monetary magic. How much credit/blame are we forgetting to give former Federal Reserve Chairmen Paul Volcker, Alan Greenspan, and other government policy-makers? Regardless of what happens economically for the remainder of 2013, Bernanke will do whatever he can to solidify his legacy in the waning sunset months of his term.

Another forgotten fact I like to point out: There is more than one central banker living on this planet. If you haven’t been asleep over the last few decades, our financial markets have increasingly become globally interconnected with the assistance of technology. I know our 10-year Treasury rates are hovering around 2.50%, and our egotistical patriotism leads us to hail Bernanke as a monetary god, but don’t any other central bankers or government officials around the world deserve any recognition for achieving yields even lower than ours? Here’s a partial list (June 22, 2013 – Financial Times):

  • Japan – 0.86%
  • Germany – 1.67%
  • Canada – 2.33%
  • U.K. – 2.31%
  • France – 2.27%
  • Sweden – 2.15%
  • Austria – 2.09%
  • Switzerland – 0.92%
  • Netherlands – 2.07%

Although it may be fun to look at Ben Bernanke as our country’s financial Superman who is there to save the day, there are a lot more important factors to consider than the 47 words added and 19 subtracted from the latest FOMC statement. If investing was as easy as following central bank monetary policy, everyone would be continually jet setting to their private islands. Rather than wasting your time listening to speculative blathering about direction of Fed monetary policy, why not focus on finding solid investment ideas and putting a long-term investment plan in place. Now please excuse me – Fed fatigue has set in and I need to take a nap.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and GOOG,  but at the time of publishing, SCM had no direct position in any other security referenced in this article. 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.

June 22, 2013 at 11:08 am 8 comments

U.S. Small-Caps Become Global Big Dog

Saint Bernard

With the emerging market currencies and financial markets under attack; Japan’s Nikkei index collapsing in the last three weeks; and the Federal Reserve hinting about its disciplinarian tapering of $85 billion in monthly QE3 bond purchases, one would expect higher beta small cap stocks to get hammered in this type of environment.

Before benchmarking results in the U.S., let’s take a closer look at some of the international carnage occurring from this year’s index value highs:

  • Japan: -19% (Nikkei 225 index)
  • Brazil:  -22% (IBOVESPA index)
  • Hong Kong: -12% (Hang Seng index)
  • Russia:  -19% (MICEX/RTS indexes)

Not a pretty picture. Given this international turmoil and the approximately -60% disintegration in U.S. small-cap stock prices during the 2007-2009 financial crisis, surely these economically sensitive stocks must be getting pummeled in this environment? Well…not necessarily.

Putting the previously mentioned scary aspects aside, let’s not forget the higher taxes, Sequestration, and ObamaCare, which some are screaming will push us off a ledge into recession. Despite these headwinds, U.S. small-caps have become the top dog in global equity markets. Since the March 2009 lows, the S&P 600 SmallCap index has more than tripled in value ( about +204%, excluding dividends), handily beating the S&P 500 index, which has advanced a respectable +144% over a similar timeframe. Even during the recent micro three-week pullback/digestion phase, small cap stocks have retreated -2.8% from all-time record highs (S&P 600 index). Presumably higher dividend, stable, globally-diversified, large-cap stocks would hold up better than their miniature small-cap brethren, but that simply has not been the case. The S&P 500 index has underperformed the S&P 600 by about -80 basis points during this limited period.

How can this be the case when currencies and markets around the world are under assault? Attempting to explain short-term moves in any market environment is a hazardous endeavor, but that has never slowed me down in trying. I believe these are some of the contributing factors:

1)      No Recession. There is no imminent recession coming to the U.S. As the saying goes, we hear about 10 separate recessions before actually experiencing an actual recession. The employment picture continues to slowly improve, and the housing market is providing a slight tailwind to offset some the previously mentioned negatives. If you want to fill that half-full glass higher, you could even read the small-cap price action as a leading indicator for a pending acceleration in a U.S. cyclical recovery.

2)      Less International. The United States is a better house in a shaky global neighborhood (see previous Investing Caffeine article), and although small cap companies are expanding abroad, their exposure to international markets is less than their large-cap relatives. Global investors are looking for a haven, and U.S. small cap companies are providing that service now.

3)      Inflation Fears. Anxiety over inflation never seems to die, and with the recent +60 basis point rise in 10-year Treasury yields, these fears appear to have only intensified. Small-cap stocks cycle in and out of favor just like any other investment category, so if you dig into your memory banks, or pull out a history book, you will realize that small-cap stocks significantly outperformed large-caps during the inflationary period of the 1970s – while the major indexes effectively went nowhere over that decade. Small-cap outperformance may simply be a function of investors getting in front of this potential inflationary trend.

Following the major indexes like the Dow Jones Industrials index and reading the lead news headlines are entertaining activities. However, if you want to become a big dog in the investing world and not get dog-piled upon, then digging into the underlying trends and market leadership dynamics of the market indexes is an important exercise.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including emerging market ETFs, IJR, and EWZ, but at the time of publishing, SCM had no direct position in Hong Kong ETFs, Japanese ETFs, Russian ETFs, or any other security referenced in this article. 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.

June 15, 2013 at 7:34 pm Leave a comment

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