Ahead of the March FOMC meeting, many observers were looking for more guidance on the likely timing of the Fed’s first rate hike. Shortly after the Fed’s March press release, financial headlines focused on removal of the word “patient” from their statement, meaning that the Fed now feels it can raise rates without much warning. (For the full statement, see link at bottom.)
However, the Fed also acknowledged some slowing in the US economy’s rate of growth, as well as a softening in inflation numbers, implying that it likely won’t raise rates until it feels more confident on both scores.
Stocks and bonds rallied on the announcement, suggesting that the market had already priced in the “patient” factor, but not so much the cautionary note on the economy and inflation. In the short run at least, continued low interest rates support stock and bond prices. (more…)
In the latest partisan skirmish among our Washington legislators, we find the US government in partial shutdown. Added to that, the government has reached its legal borrowing limit (the so-called “debt ceiling”), and the Department of the Treasury says it will run out of money on October 17 unless agreement is reached to raise the borrowing limit. The confluence of the October 1 and 17 deadlines cause many observers to link the two into a single debate between the opposing factions in Congress.
The government shutdown is the result of Congress’s failure to pass a budget for the fiscal year that began October 1. The debt ceiling debate is a reprise of a similar event in 2011, which led to both the now familiar automatic spending cuts (the “sequester”) and a Standard & Poor’s downgrade of US Treasury debt from AAA to AA. As long as the US runs budget deficits, spending more than it receives in taxes, the government will need to incur net borrowing to cover the shortfall, which it does through the sale of Treasury debt to investors. In turn, it must periodically raise the debt ceiling limit to permit net additions to the total amount of debt outstanding. In the past fiscal year alone, the US added about $700 billion to its national debt. (more…)
The City of Detroit, burdened by huge financial obligations it cannot meet, declared bankruptcy yesterday. This was no surprise—the city’s industrial base and population have been shrinking for decades. Still, for investors, it’s a reminder that lending money to municipalities, for example through purchase of tax-exempt “muni” bonds, does carry risk. It will be a while before we know the extent of the haircut that bondholders will take, but it could be significant.
In the immediate aftermath, there has been a lot of chatter about the implications for muni bonds generally, much of it in alarming tones. While not discounting concerns specific to Detroit and perhaps Michigan, too, we would point out the following: (more…)
Note: This post is an excerpt from Gould Asset Management’s Economic and Market Review for the Second Quarter of 2013, the entirety of which can be found here. We’ve reprinted it here for the benefit of our blog subscribers.
The run-up in interest rates over the past several weeks has brought a chorus of declarations that the secular decline in rates (and the corresponding bond bull market) which began 32 years ago (just after Ronald Reagan took office!) is officially over. As day follows night, what went down must now go up. And so on. This is at least the 8th time over the three decades that very smart people have announced the end of the run.
Perhaps this time they are right. A look at the accompanying chart confirms that, at a minimum, the next decade will look different than the last three. With a lower limit of zero, interest rates don’t have much room to fall further. However, the same has been said of Japanese interest rates for the past 15 years. Confounding the pundits, rather than commencing a long-term rise, Japanese rates have instead simply languished below 2% for years on end. Countless fortunes have been lost betting on the “inevitable” rise in Japanese bond rates. Of course, there are many important differences between the US and Japan, but the Japanese experience is worth remembering as we think about possible outcomes at home.
Assuming rates do turn upward, there is still the question of whether investors should view higher interest rates as bad news, a position set forth daily by a nearly hysterical financial media over the past several months. Completely lost in the discussion is the question of why rates are rising. If they are climbing as a result of heightened inflation expectations, arguably it is bad news. But this does not describe recent rate hikes. Instead, we’ve seen higher real (net of inflation) returns on fixed income securities. (See chart.) (more…)
One of the market’s periodic storms washed ashore in earnest last week, with both stocks and bonds tumbling together. Actually, bond prices began their downtrend around May 1, while stocks followed suit about three weeks later. Both stocks and bonds accelerated their decline last week after Fed Chairman Bernanke’s remarks about the central bank’s plans for potentially cutting back on its massive and unconventional bonds purchase program ($85 billion monthly), known as Quantitative Easing or QE.
What Did Bernanke Say, Exactly, That Set Off the Storm?
In essence, the Fed said:
1. The US economy is in better shape today than a few months ago.
2. If the improvement continues, the Fed could begin to wean the economy from its QE monetary stimulus before long.
Arguably, both parts of that statement are good news. The economy is doing better – certainly a positive. The Fed might start reducing QE soon – also a good development when one considers how QE and related policies have distorted asset prices, created risks of inflation and market instability, and heavily penalized the most conservative segment of the investing public – those depending on short-term fixed income instruments such as bank CDs and money market funds.
But understandably, investors viewed good news in the longer term as bad news in the short run. After all, any hint that the Fed might remove the punchbowl was bound to dampen spirits. Virtually all asset classes have fallen in concert over the past week.
Also contributing to the market jitters are reports of tightening credit markets and slower growth in China. Given China’s outsized influence on the world economy, any slowdown there will ripple through a host of global markets, including stocks, real estate, and commodities. Still, China’s absolute growth rate is the envy of most developed nations.
What This Means to You
Bond prices are falling, but the sky is not. It’s certainly the case that the price of existing bonds (i.e., the ones you already own) move inversely with interest rates. That said, the media has been nothing short of hysterical on this point, contributing to some panicked selling by retail investors. Consider that in the wake of the sharpest rate spike in more than a decade, a bond index mutual fund (replicating the performance of the entire US taxable bond market) is down about 3% in the past seven weeks. Not pleasant, but hardly a catastrophe. Moreover, almost no one initiated their entire bond portfolio on May 1, so it’s best not to measure performance only from that recent peak.
Also forgotten in the rush is the fact that bond returns have two components – price change and interest income. Even in a rising rate environment, bond investors recoup their price losses over time through reinvestment of interest income at new, higher interest rates. With interest rates on cash stuck near zero for the foreseeable future, bond investors could come out ahead despite rising interest rates.
As for the equity market, it’s worth noting that even after the recent pullback, US stocks are only back down to their late April levels. After a 4-year stretch of rising stock prices and more than 30 years of rising bond prices, it’s easy to forget that the path to our long-term goals is anything but a straight and predictable one-way street.
What to Do—and Not Do
Let’s start with what not to do. Don’t make big changes to your portfolio. Decisions driven by emotion are frequently bad ones. Portfolio strategies adopted in calmer times with a clearer head stand the best chance of achieving one’s long-term goals. That is not to say that either the stock or bond markets have found their bottom. No one can know that in advance. What we do know, from experience, is that greed and fear (today’s prevailing emotion) often lead to ill-timed investment moves. Even those who exit well before the bottom almost never get back in at the bottom. Instead, it’s frequently the case that investors don’t regain the confidence to re-establish their portfolios until prices match or even exceed the earlier sale price.
We do not discount the emotional toll whenever markets get volatile and asset values gyrate. We know it’s stressful, and take seriously our role as a steadying influence. It’s important to remember that we’ve been through these gyrations many times before and no doubt will experience many more in the future. Remind yourself, too, that your ability to keep your eyes focused on the long-term has generally been well rewarded over time. Smartphones and cable TV are wonderful in many ways, but their 24/7 font of breathless financial commentary may be hazardous to your wealth.
However, the Fed also acknowledged some slowing in the US economy’s rate of growth, as well as a softening in inflation numbers, implying that it likely won’t raise rates until it feels more confident on both scores.
Arguably, both parts of that statement are good news. The economy is doing better – certainly a positive. The Fed might start reducing QE soon – also a good development when one considers how QE and related policies have distorted asset prices, created risks of inflation and market instability, and heavily penalized the most conservative segment of the investing public – those depending on short-term fixed income instruments such as bank CDs and money market funds.