Category: Market commentary

Don’t Let These Worry Traps Discourage You From Investing

Have you ever noticed that most of the people who forecast what the stock market is going to do predict that it will either crash, or at least go down sharply? Even when the stock market’s going up there are people who predict the market’s next move is down and that it’s time to head to the sidelines. The fact is that fear sells, that’s why so many prognosticators emphasize the negative.

Of course they have something to sell that will “protect” you from the upcoming catastrophe. If they scare you witless they will sell you gold, annuities, structured products or their newsletters.

It’s easy to be fearful when markets go down and you see the value of your portfolio decline. If the decline is sharp, investors get frightened. If the headlines scream of financial doom, people can panic. To help you cope when fear hits, here’s a list of “worry traps” that you should recognize. Worry traps are phrases that you will recognize because you have heard most of them before. They are part of the playbook that doomsayers bring out to frighten you. Here are four examples:

  • The “sucker’s rally” trap. This never fails. Whenever the market turns down and there’s a move to the upside, any number of people will tell you that it’s a sucker rally. What they’re basically telling you is that if you buy stocks that have been reduced in price you’re a “sucker.” If you listen to them, buying stocks after a dip is foolish. Of course, the way to make money is to buy low and sell high and the only way to do that is to buy stocks when they’re “on sale.”
  • The “Bear Market Rally” trap. This is a variant on the “sucker rally” comment. The problem is that people can’t even agree on the definition of a Bear Market and nobody rings a bell when one ends. The people who use this term will never admit that a Bear Market is over so any recovery after a dip will be called a Bear Market Rally. Listening to this advice is sure to keep you from buying stocks when they’re cheap.
  • The “wise market” trap. Have you ever noticed that financial “experts” are always talking about what “the market is telling us?” The market isn’t an organism and it isn’t telling us anything. It’s a counting mechanism that allows people to participate in the financial affairs of a free market economy. In many cases it’s reacting to the news of the day, which is replaced by the news of tomorrow when the new day dawns. It often reacts to internal market dynamics which have nothing to do with the real world. This is especially true with computer-driven trading. From one day to the next the market is neither rational nor wise which means that investors must take the long view and look at economics as their guide.
  • The “laundry list” trap. This is a list of all the reasons why the market will go down. It’s a laundry list of problems: economic, financial, political, or military that make it hazardous to invest. These currently include slowing global economic growth, Fed policy, political uncertainty, trade issues, Brexit, commodity prices, and regional military conflicts. The problem is that there is always such a list. As problems are addressed, new worries pop up that replace the old. There’s another old Wall Street saying: “Bull markets climb a wall of worry.” Know problems are almost always discounted by the market. It’s the unknown surprises that represent danger.

Most people are psychologically drawn to these common traps. It’s scientifically shown that people withdraw money from their investments at market bottoms and buy at market tops – selling low and buying high. That’s where an experienced financial advisor is worth their weight in gold. They know these traps and how to avoid them.

The Financial Planner as a Healer

[This is the most popular post we have published; it’s worth posting again]

Money is a significant source of stress for most people.  In many studies, it ranks above issues such as work, children and family.  Chronic financial stress is often the leading cause of family break-ups.

How A Financial Planner Can Help You Physically and Emotionally

Chronic stress is also associated with all sorts of health problems, psychological problems, marriage conflicts and behavior issues such as smoking, excessive drinking, depression and overeating.

Men and women under stress have often relied on medical and mental health professionals.  However, financial planners are uniquely positioned to help people address what is likely the number one source of stress in their lives – their relationship with money.  Dealing with these issues head-on with a financial planner can lead to improved emotional and physical health, an improvement of work-related problems and improved relationships with family and friends.

A competent and caring financial planner does a great deal more than manage investments or create a financial roadmap.  He listens and empathizes with the conflicting issues that people face when attempting to manage their personal finances.

Discussing the issues that cause worry with a financial planner can lead to setting realistic goals, analyzing alternatives, prioritizing actions and implementing an easy-to-follow plan.  Just as important, it allows the client and the planner to review progress on a regular basis.

As a result the client gets a sense of personal control over his or her finances.  Someone who is in control of their life has much lower stress than someone who feels that events and outside agents control them.

For a relationship between a client and a Virginia Beach financial planner to work well together, they must have shared views and expectations of financial planning, financial markets, investment philosophy, and managing risk.  An initial meeting between a client and a financial planner should establish a comfort level and determine whether the planner is actually interested in the client, or just the client’s money.

Financial Planner’s Goal For You

The planner’s goal should be to help their clients organize their financial affairs, and to discuss the client’s past, present and future – including death.  The planner should create a level of trust that allows him to keep the client from self-injury, which often results from fear surrounding money.  The financial planner should provide a sort of reality check to the client, reducing both excessive pessimism and irrational optimism.  A client should feel able to discuss money honestly and openly with their planner without a fear of judgment.

In many ways, a financial advisor can be the confidant to whom you can take your financial concerns … and make it all better.  For more information or to speak with a financial advisor, contact us today!

A Client Asks: What’s the Benefit of Inflation?

One of our retired clients sent us the following question recently:

“I can’t understand the FED condoning and promoting any inflation rate. To me inflation means that the value of money is simply depreciating at the inflation rate. Further, any investment paying less than the inflation rate is losing money. A quick review of CD rates and government bonds show it is a rare one that even approaches the promoted 2.25% rate. It seems to me to be a de-facto admission of wanting to screw conservative investors and forcing them into riskier investments… Where is there any benefit to the financial well-being of the ordinary citizens?”

I suspect that there are a lot of people who feel the same way. It’s a good question. Who wants ever rising prices?

Here’s how I addressed his question:

Let me answer your inflation question first. My personal opinion is that 0% inflation is ideal, and I suspect that you agree. However, lots of people see “modest” rates of inflation (say 2%) as healthy because it indicates a growing economy. Here’s a quote from an article you may want to read:

Rising prices reflect a growing economy. Prices typically rise for one of two reasons: either there’s a sudden shortage of supply, or demand goes up. Supply shocks—like a disruption in the flow of oil from Libya—are usually bad news, because prices rise with no corresponding increase in economic activity. That’s like a tax that takes money out of people’s pockets without providing any benefit in return. But when prices rise because demand increases, that means consumers are spending more money, economic activity is picking up, and hiring is likely to increase.

A case can be made that in a dynamic economy you can never get perfect stability (e.g. perfectly stable prices), so it’s better for there to be more demand than supply – driving prices up – rather than less demand than supply – causing prices to fall (deflation). Of course we have to realize that “prices” here includes the price of labor as well as goods and services. That’s why people can command raises in a growing economy – because employers have to bid up for a limited supply of labor. On the other hand, wages grow stagnant or even decline when there are more workers available than jobs available.

But for retirees on a fixed income, inflation is mostly a negative. Your pension is fixed. Social Security is indexed for inflation, but those “official” inflation numbers don’t take food and fuel costs into consideration, and those tend to go up faster than the “official” rate. The stock market also benefits from modest inflation.

Which gets us to the Federal Reserve, which has kept interest rates near zero for quite a while. It’s doing this to encourage business borrowing, which in turn is supposed to lead to economic expansion.  However, the actual effect has been muted because other government policies have been detrimental to private enterprise. In effect you have seen the results of two government policies in conflict. It’s really a testimony to the resilience of private industry that the economy is doing as well as it is.

The effect on conservative investors (the ones who prefer CDs or government bonds to stocks) has been negative. It’s absolutely true that after inflation and taxes the saver is losing purchasing power in today’s low interest rate environment. The FED is not doing this to intentionally hurt conservative investors, but that’s been part of the collateral damage. The artificially low rates will not last forever and the Fed has indicated they want to raise rates. They key question is when, and by how much?

4 Reasons Why You Need a Good Financial Advisor Now

A good financial advisor has a number of roles: planner, investment manager, educator who is willing to teach you about investing, and sounding board with whom you can share your fears and aspirations.

Why is a Registered Investment Advisor (RIA), a fiduciary who puts your interests ahead of his own, so important now? People often get over-confident during a Bull Market. It’s when the market gets scary that financial professionals really prove their worth.

We have all heard the old sayings about being diversified, buy low and sell high, and stay the course. That’s often harder to do than it looks, especially in trying times such as these, when investor psychology overtakes reason. A financial advisor’s job sometimes involves protecting investors from themselves. And to protect them from all the bad advice that’s out there and from the bad actors in the industry.

  1. The first thing that a fiduciary does is tell their clients that despite what you hear, no one can time the market. There may be some people who are exceptionally good at stock picking, but those rare individuals are not giving away their advice to you on TV, in Money Magazine, or in newsletters; I don’t care what they claim. If they exist at all, they are managing their own portfolios on an island in the Caribbean.
  2. The retail financial services industry has an incentive to sell you expensive products as often as possible. And they are very good at it. Don’t get caught in the frequent trading trap; it’s not to your benefit. A fee-only RIA does not have an incentive to sell you investments to earn a commission.
  3. Investors typically allow their portfolios to get too risky during the good times. When the stock market is going up, it’s too easy to get caught up in the excitement and ignore asset allocation guidelines. A good investment manager will rebalance your portfolio regularly to keep you from running into a Bear Market with a portfolio overloaded with risky stocks.
  4. A fee-only RIA works for you. Stockbrokers, insurance agents, even mutual fund managers, work for the companies that pay them. They are legally required to work in the best interest of their employers, not their clients. Some of them do try to work in their clients’ best interests, but there can be large financial incentives to do otherwise. A fee-only RIA works only for you. We act in your best interest and use our expertise to allow you to take advantage of opportunities in good markets and weather the bad ones.

During volatile markets, we focus on the important things that really matter, not the daily chatter. We keep open lines of communication with our clients, helping them make sense of what’s going on, providing perspective, and helping them distinguish between what’s just noise and what’s a genuine trend. We work hard to control risk and manage portfolios to help our clients maintain confidence in their financial future.

If you want to receive our weekly commentary, view our latest guides, or get a free download of the first three chapters of our book “Before I Go”, or just find out about us, visit us at www.korvingco.com.

The lure and risks of “alternative investments.”

The financial world has been deluged marketing offers from investment firms offering “alternative investments.” “Alts” are non-traditional investments.  They include non-traded REITs, hedge funds and private equity.

The lure of “alts” is summarized in a quote from Financial IQ:

“The 2008 financial crisis scarred investors enough that they’re still seeking new ways to diversify out of stocks and bonds. Meanwhile, investors also are hungry for yield amid persistently low interest rates.”

The problem with “alts” is that they are not well understood.

Many are not liquid – in other words they cannot be sold at a moment’s notice.

In addition, most are not transparent – you can’t always tell what you own because the “alts” managers are secretive, unwilling to reveal their strategy in detail.

Third, the fees charged by “alts” managers are often much higher than those charged by traditional managers.

Many of the “alts” use derivatives which are difficult to understand and can lead to risks that are not obvious. An example are the “guaranteed” structured notes created prior to 2008. When Lehman Brothers collapsed it was revealed that the “guaranteed” notes issued by Lehman were backed by the claims paying ability of a bankrupt company.  People lost millions and learned a painful lesson.

Our philosophy is to invest our money in securities we understand. We always want to know: what’s the worst thing that can happen? If we don’t understand the risk, we don’t invest.  It’s a lesson learned over the years as we keep in mind the first rule of making money:  don’t lose it.

Pricking the Stock Market Bubble Debate

We recently posted a note about the definition of a “bubble.”  We thought it would be worth our while to share the thoughts of billionaire Ken Fisher’s firm on this issue.  We share this, not as a firm prediction, but an analysis by an individual who’s more often right than wrong.

Are stocks about to froth over? With many indexes routinely clocking new highs, bubble chatter is easy to come by. One former presidential budget advisor says stocks are in a bubble! Our soon-to-be Fed head and one of her predecessors say no such bubble exists! A popular newspaper weighed in, too, corralling a few “experts” to opine on the issue. All the hoopla suggests there is a bubble … in bubble talk! In stocks, however, evidence suggests otherwise—this bull has plenty of fundamental support and rational reasons to keep on running.

What tends to move stocks most is the gap between economic and business fundamentals and the degree to which these fundamentals are appreciated. A stock market bubble forms when expectations about publicly traded companies’ future earnings exceed reality—when expectations become inflated. In the late 1990s, for example, Tech stocks with little revenue, unproven track record of success and poor business models shot sky high. Euphoric sentiment was defying fundamentals—glee, driven largely by past returns, was the only thing holding them up. Fundamentals eventually won the day, and sentiment followed after investors gradually saw their irrational bets go south. The bubble burst.

But today’s market looks nothing like that. Expectations are pretty low—few fathom that profits can keep growing and the global economy stay firm or even reaccelerate. Signs of optimism are guarded at best, and are often loaded with “yeah buts.” And keep in mind, bubbles don’t form overnight and are very difficult to detect. So difficult, in fact, that if everyone’s talking about them, they probably aren’t there. Constant bubble talk is self-deflating—it fosters fear and skepticism.

So why do some argue that we are in a bubble? Perhaps it’s because of the recent spate of social media IPOs, which may scare folks into thinking that markets are partying like it’s 1999—just before the Tech bubble burst. However, there are many differences between now and then. Sure, there may be some euphoria in social media, but social media is a small subset of IPOs. Consider: In 1999, there were 368 IPOs in tech alone. In 2013, Twitter made 33. Even if you think Social Media firms are frothy, they’re a tiny portion of the overall market and don’t necessarily reflect broader sentiment. Among tech companies, recent IPOs are trading at 5.6 times sales, compared with 26.5 times sales in 1999—investors aren’t placing exuberant valuations on yet-to-be-seen sales. And most of today’s IPOs aren’t Tech—they span most sectors, and many are higher-quality companies with real business plans compared to the flash-in-the-pan tech companies from the ‘90s. Hilton, an IPO scheduled to launch soon, has a rather time-tested business model, if nothing else.

Others believe stocks are propped up by something artificial (ahem, quantitative easing) and once it’s removed, the market will crash. The case: The Fed’s QE program has pushed investors from Treasurys to equities, in search for better return, and this is why the stock market has done well. Once interest rates rise, investors will drift back to fixed income, and stocks will fall. Yet data don’t support the notion of some massive rotation from bonds to stocks since QE began. Nor would that even be necessary for stocks to rise—there is a seller for every buyer. Stocks are an auction market—buyers’ willingness to pay higher prices is what matters, not the sheer number of buyers.

Philosophically, too, the notion fixed-income investors would chase higher yields in stocks is flawed. Perhaps some might, but many investors own bonds to reduce expected short-term volatility, particularly if they have higher cash flows. If they were dissatisfied with Treasury yields, they probably wouldn’t rush headlong into stocks, a more volatile asset class. They’d likely move to another form of fixed income (e.g., corporate bonds).

Finally, some suggest hot stock markets are detached from slow economic growth. True, this expansion is one of the slowest in modern history, but stocks aren’t the economy. Stocks are shares of publicly traded companies and reflect the private sector. While headline GDP growth hasn’t been stellar, much of the detraction has come from state, local and Federal government spending reductions. Business investment is closing in on all-time highs, profits are at all-time highs and rising, and S&P 500 earnings and revenues continue growing. Heck, earnings hit their first all-time high two years ago! Stocks hit theirs earlier this year. Stripping this influence out shows a stronger private sector—and the gap between how folks perceive the economy (pervasive claims of a sluggish, flat, fake or only “technical” recovery) is a great illustration of the dearth of euphoric sentiment. With this in mind, it seems tough to argue stocks are wildly higher than reality warrants. It seems more like the reverse.

 

What’s a "Bubble?"

The word “bubble” has been thrown around a great deal with the Dow Jones Industrial Average (DJIA) at 16,000, the S&P 500 at 1800, and the Nasdaq Comp above 4000.  The term “bubble” is a scare word that makes people think of a repeat of the Tech Crash of 2000 or the real estate bubble that led to the financial crisis of 2008.

Cluifford Asness, whose firm manages $80 billion has a pet peeve and one of them is the loose use of the term “bubble.”

“The word “bubble,” even if you are not an efficient market fan (if you are, it should never be uttered outside the tub), is very overused. I stake out a middle ground between pure efficient markets, where the word is verboten, and the common overuse of the word that is my peeve. Whether a particular instance is a bubble will never be objective; we will always have disagreement ex ante and even ex post. But to have content, the term bubble should indicate a price that no reasonable future outcome can justify. I believe that tech stocks in early 2000 fit this description. I don’t think there were assumptions — short of them owning the GDP of the Earth — that justified their valuations. However, in the wake of 1999-2000 and 2007-20008, and with the prevalence of the use of the word “bubble” to describe these two instances, we have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as “expensive” or possessing a “lower than normal expected return.” The descriptions “lower than normal expected return” and “bubble” are not the same thing.

Bloomberg columnist Barry Ritholtz comments:

“It would only take a small marginal improvement in the economy, or a small uptick in hiring, or heaven help us, even a modest increase in wages to increase revenues and drive profits significantly higher,”he current market valuations do not, in my opinion, have the characteristics of a “bubble.” “

Whether stocks, bonds or commodities are fairly valued, undervalued or overvalued will become apparent over time.   In the meantime, unless you are being paid to opine, it’s best to realize that fortune-telling is not the way to manage your portfolio.  Creating an all-weather portfolio with the asset allocation that will allow you to face any reasonable future is the best strategy.

 

Government shuts down: No sign of economic problems

The news has been co-opted by the partial government shut down with its attendant predictions of economic catastrophe if the government doesn’t re-open all its branches in a few hours.  Meanwhile in Realville, First Trust notes:

we’ve still seen the two ISM indices (on manufacturing and services), auto sales, chain-store sales, and two weeks of unemployment claims.  None of these reports suggests the economy has broken out either to the upside  or the downside from the pattern of Plow Horse growth of the past few years.  While real GDP itself probably slowed in Q3 to around 1.5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} growth, the economy as a whole looks to be expanding at roughly a 2{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} annual rate over a two or three quarter average.
The bottom line on  the economy right now is that there is no sign the partial shutdown, or anything else for that matter, has knocked it off the same course it’s been on for the past few years.  Hopefully, when the government finally opens back up, it’ll do so with a better set of polices, which would help the plow horse pick up his pace.

It’s a different view than we get on the 24/7 cable shows, but it helps to look at reality when those around you are losing their heads.

Market commentary as we begin the fourth quarter of 2013

As the third quarter of 2013 came to a close, focus turned to Washington with the government shutdown and the looming November 1 debt limit.  As we write this, it remains to be seen how the competing factions will come to a resolution or if they’ll just end up kicking the can down the road, as they have done so many times in the past, without making any real compromises on the underlying issues.  From 1976 to 1996, the government shut down 17 times, spanning a total of 110 days.  Historically, government shutdowns have had no detectable long term effect on the markets.  The last, and longest, shutdown doesn’t appear to have hurt the economy.  That was mid-December 1995 until early January 1996, a three-week shutdown under President Clinton.  The year before the shutdown, real GDP grew 2.3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  In the fourth quarter of 1995 it grew at an annual rate of 2.9{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} and then during the first quarter of 1996 it grew at an annual rate of 2.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  This was despite the shutdown and the East Coast Blizzard in January 1996, which was then followed by large floods.

While headline news will have short term effects on markets, over the long term, economic conditions and the direction of corporate profits will have the greatest and most long-lasting effects on portfolios.  Economic conditions have been slowly and steadily increasing over the past few years, and now Europe seems to have stabilized and may be beginning to experience modest growth.  China’s new leadership is working to transform that country’s economy from being export-oriented to one that is more focused on increased consumer consumption.  This will have a major impact on the future of global trade.

As we have said for several quarters now, we continue to remain optimistic about stocks and cautious on bonds.  Even though the Federal Reserve has indicated that they will not begin easing until the economy improves, and they have spelled out what they’ll consider improvement, just the mere mention by the Fed of future rate hikes sends bonds tumbling.  As we said last time, we think that the Fed being able to remove itself from the equation of the U.S. recovery is a net positive, not a net negative.  Additionally, we now have the November 1 debt ceiling looming, which could send both stocks and bonds oscillating as politicians and pundits take to the airwaves to bring a little “Halloween cheer” (sarcasm alert).  We think a last-minute deal will be struck to avoid any real damage, aside from the emotional toll imparted upon people who watch the news or the stock markets very closely.

Whatever comes our way, we are always positioning our portfolios to participate in further market gains and to cushion any market declines.  Over the long term the trend is up.  Please call if we can be of any other assistance to you or someone you care about.

How Does a Government Shutdown Affect Investments?

The stock markets do not like uncertainty and a government impasse leading to a partial shutdown leads to uncertainty.  People begin asking questions like: How long will it last?  Who will be affected?  What are the long-term consequences?  The day before the shutdown that began October 1, the Dow Jones Industrial Average fell by 129 points.  Traders said that the markets had been anticipating the political gridlock, which had contributed to the Dow’s recent slide.  The day the government actually shut down, the same index rose 63 points because positive economic news impressed investors more than the shutdown.

Despite the size of government and the number of people they employ, the economy as a whole has a much greater effect on the markets than a shutdown.

During a shutdown, money still flows into the Treasury Department via things like tax receipts and it still flows out via things like Social Security and interest payments on Treasury Bills.  The military, weather service, food inspections, border control, air traffic, prisons and even the U.S. Postal Service (“Neither snow, nor rain, nor sleet, nor hail, nor government shutdown shall keep the postmen from their appointed rounds”), they all keep operating.  And as long as the Treasury Department still has flexibility, it still pays the debt as it comes due without missing a beat.  The interest on the debt runs about $220 billion while tax revenues exceed $2.5 trillion, so there really is not a chance that the U.S. government will actually default.

The government purposely tries to make a shutdown much more painful than it really has to be by, for example, closing the National Mall, the World War II Memorial and other open air monuments and attractions in Washington, D.C., in an effort to get the public to put pressure on Congress to reach a settlement.

But if you need a passport or want to get into a national park (via a park entrance, anyway), you are out of luck.  Non-essential federal workers get furloughed and non-essential services stop.

You’ll surely hear certain analysts, pundits and politicians saying a shutdown will hurt the economy, but if history is any guide that is hard to prove.  Recently, The Washington Post listed every shutdown – there were 17 of them from 1976 to 1996, spanning a total of 110 days – and of those 110 days only 6 were during a recession.  That’s very few considering that the U.S. was in a recession about 14{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} of the time during those twenty years.

The last, and longest, shutdown doesn’t appear to have hurt the economy either.  That was mid-December 1995 until early January 1996, a three-week shutdown under President Clinton.  The year before the shutdown, real GDP grew 2.3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  In the fourth quarter of 1995 it grew at an annual rate of 2.9{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} and then during the first quarter of 1996 it grew at an annual rate of 2.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  This was despite the shutdown and the East Coast Blizzard in January 1996, which was then followed by large floods.

Remember the dreaded sequester?  It was forecast to be an economic and political disaster.  Today few people actually remember it because most never felt it.  Paradoxically, the real result of sequesters and shutdowns may be the realization by the public that the government is spending and wasting too much, and that political wrangling by the two parties in charge does not help the economy and may actually hurt it.  In the late 1990s, that reaction slowed government spending relative to GDP dramatically and the U.S. eventually moved into a surplus.

In other words, if you look back at history and didn’t know beforehand when the government was in a shutdown, you would be hard pressed to ever figure it out.  Keep this in mind as politicians, journalists and pundits work overtime in the coming days trying to scare investors and the public with the ramifications of keeping the government shut.  In more ways than one, it may be a good thing.

With rising interest rates, what to do about bonds.

With interest rates increasing investors are noticing that their bonds are not doing nearly as well as their stocks.  In fact many investors may have lost money on bonds this year.  For example, the typical tax exempt bond fund has lost between 4 – 5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} year-to-date.  What should investors do about bonds when the likelihood of rising interest rates is high?

The October issue of Financial Planning magazine give us an insight into what happened in the past when interest rates rose.

During the five-year period from 1977 through 1981, the federal discount rate rose to 13.42{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} from 5.46{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, an increase of nearly 800 basis points, or 145.8{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. During that period, the five-year annualized return of U.S. T-bills was an impressive 9.84{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  But T-bills are short-term bonds.

But bonds did not fare nearly as well. The Barclays one- to five-year government/credit index had a five-year annualized return of 6.61{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, while the intermediate government/credit index had a 5.63{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} annualized return. The long government/credit index got hammered amid the rising rates, and ended the five-year period with an annualized return of -0.77{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}. Finally, the aggregate bond index had a five-year annualized return of 3.05{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.

As every investor should know, bonds go down in price when interest rates go up but that decline is offset by the interest paid on the bonds.  If an investment manager knows what he is doing and protects his portfolios by avoiding exposure to long-dated government bonds the results will be acceptable. An annualized return of 5.63{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} is quite good when rates are increasing.

But one important note: It does not seem prudent to avoid bonds entirely during periods of rising interest rates. Bonds are a vitally important part of a diversified portfolio containing a wide variety of asset classes – during all times and seasons. Rather than trying to decide whether to be in or out of bonds, the more relevant issue would seem to be whether to use short-duration or long-duration bonds.

This, of course, is consistent with a strategic approach to portfolio design. Rather than completely remove an asset class from a portfolio, advisors and clients would be well advised to thoughtfully modify the components of an asset class. To use a nautical metaphor, rather than swapping boats, we simply trim the sails.

 

Government shuts down, markets rise.

The market does not like uncertainty and as the House and Senate ping-ponged bills at each other yesterday, the markets sold off.  But as the reality hit that there was not going to be a last-minute compromise and the sun rose in the East, people realized that a government shut-down in a free-market economy is not a financial Armageddon.   So at the opening bell, the US stock market rose, as did many markets around the globe.

From the Wall Street Journal:

Stocks rose, shrugging off the first U.S. government shutdown in 17 years, helped by a strong reading on manufacturing activity.
The Dow Jones Industrial Average advanced 63 points, or 0.4{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 15191 in recent trading. The S&P 500 tacked on 11 points, or 0.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 1692, and the Nasdaq Composite Index rose 29 points, or 0.4{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 3800.
Global stocks showed resilience after lawmakers failed to reach agreement to keep the government fully funded to start the new fiscal year as Senate Democrats and House Republicans remained at loggerheads over government spending and the launch of the Affordable Care Act.
Traders said that the markets had been anticipating the political gridlock, which has contributed to the Dow falling seven over the past eight sessions, including Monday’s 129-point slide.
“Most people are pretty sure that this is going to be a short-lived event,” said Ian Winer, director of equity trading at Wedbush Securities. “Even though there were big moves leading up to this, most people are positioned for a near-term shutdown, and it looks like the selling has let up. There’s not a lot of new buying, but guys have sold what they wanted to sell.”

There is an old Wall Street adage: “Buy on the rumor, sell on the news.”  That simply means that an event that is widely anticipated is probably priced into the market by the time it actually comes to pass.  That seems to be what happened in case of this much-anticipated shut-down which, it seems, was actually wanted by both sides.

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