Tag Archives: bonds

the April 2013 Employment Situation report–strong gains again

May 3, 2013 By in Current Market Thoughts, economics, employment, Employment Situation report, Strategy Tags: , , , , , , , , Leave a comment

the report

At 8:30 EST this morning, as usual,  the Bureau of Labor Statistics of the Labor Department released its monthly Employment Situation report.  The April figures, +165,000 net new jobs added during the month (+176,000 in the private sector, -11,000 in the public), are considerably higher than the +140,000 that economists had been forecasting.  They also run counter to the downbeat results of the quirky ADP monthly employment survey released on Wednesday.

the revisions

More important than the April numbers, I think, is the story that the revisions tell us.

Not all the participants in the Establishment Survey from which the employment figures are drawn get their data in on time.  So the monthly numbers are revised twice, once in each of the two months following their initial publication.

The revisions for April are as follows:

February figures:  initially reported as +236,000, revised in March to +268,000, revised in April to +332,000

March figures:  initially reported as +88,000, revised in April to +138,000.

Together, the revisions show that +114,000 more new jobs than we thought a month ago were created in February/March.  And the March figures, which seemed pretty awful in their original form, no longer look that bad–especially sandwiched between a blowout  in February and a healthy gain in April.

my take

This ES report is much better than anticipated.

You can make a case that the March/April dropoff from February’s spectacular job gains is the early effect of the sequester being felt–and that the negative effect of the sequester on the economy is not that bad.  There aren’t enough data to know whether this is true, but when has that ever stopped people from speculating?

Policymakers could take this thought and run with it in two different ways, something that bears monitoring.  Washington could argue to itself that there’s no economic need to undo any of the sequester    …or it could argue that undoing just a little bit (really, a lot of little bits) might bring disproportionately large job gains.  For now, I don’t want/need to decide about this.  My hunch, though, is that the latter path is the one Congress would take.

So:  the numbers are good for stocks, and they might lead to Congressional action (oxymoron?) that’s also good for stocks.  At the same time, continuing good jobs news would advance the day when the Fed begins to raise interest rates–very bad for bonds.

the 4% rule for retirees

March 5, 2013 By in Basic Concepts, Constructing a Portfolio, Current Market Thoughts, Portfolio management, the 4% rule Tags: , , , , , , , , Leave a comment

Yesterday’s Wall Street Journal has a discussion of the 4% rule for retirees, with the observation that it no longer seems to be working.  What is the rule?  Why is it failing now?

the 4% rule

It’s the product of an extensive study of past securities returns done by a financial planner, William Benger, on his PC during the 1990s.  I began to read about the rule a few years later.  Every source I looked at cited Mr. Bengen’s work, which as far as I can tell everyone had taken at face value and no one had verified.  Weird, but typical of most financial writing.  (Mr. Bengen’s work has since been duplicated by several discount brokers.)

The rule is this:

–at retirement, invest 60% of your savings in the S&P 500 and 40% in 10-year Treasuries;

–withdraw 4% of the starting amount in year 1;

–in subsequent years, adjust the prior-year amount for inflation and withdraw that;

–rebalance annually to restore the 60/40 mix.

If you do so, Mr. Bengen concluded, history showed that you had an overwhelming chance that your retirement savings would last at least 30 years.

is it working today?

Not so well.  10-year Treasuries and stocks have both been yielding around 2% for the past half-decade.  Therefore, withdrawing 4%+ per year starting around the high point for the S&P 500 in mid-2007 would have meant that your nest egg has shrunk by well over 15%.

The WSJ cites T. Rowe Price as saying that had you started the 4% plan in 2000 (another S&P high point) your portfolio would be down by a third–and your chances of it lasting 30 years under the 4% rule reduced to 29%.

why not?

The Journal thinks it’s an issue Mr. Bengen overlooked–that the starting point matters.  Begin at the start of a “Lost Decade” for stocks and you’re in trouble.  One solution is to withdraw 4% plus the inflation adjustment of the current value of the portfolio, not the starting value.  Not so hot for the turn of the century retiree, however..

I have a different take

1.  Look at the historical periods Mr. Bengen analyzed.  He went from 1926 onward.  Up until 1960, the dividend yield on the S&P averaged about 6%.  From that point onward until 2000, the yield was never below 3%.  As to 10-year Treasuries, yields averaged about 3% before 1960.  They were never below 4% subsequently–and reached as high as 15% in 1981.

In other words, unlike today, the interest/dividend payments on the portfolio exceeded the withdrawals almost all the time.  This was partly a function of investor attitudes toward risk–early on, stocks were considered a risky kind of bond and so had a higher yield.  It was also a function of considerably higher inflation.

Yields were high enough that periodic stock market swoons didn’t make that much difference.  Today, risk tolerances and inflation expectations are different.

2.  Just as important, in my view, is the conventional economic wisdom that the way to fight economic slumps is to push interest rates below the rate of inflation.  This temporarily shifts income away from savers and makes credit cheaper and more available to borrowers, whose extra spending restores economic growth.  So retirees get thrown under the bus in support of the common goods.

This time, however, Washington made the economic mess a lot bigger than it should have been.  And continuing dysfunction, including failure to address deficit spending, has made recovery much more difficult.

The Baby Boom clearly doesn’t understand the link between Washington failure and Boomers’ diminished retirement prospects.  Otherwise, there’d be an uproar about having much more effective national fiscal policy.

 

the Italian election–investment significance

February 26, 2013 By in Current Market Thoughts, economics Tags: , , , , , , , , , , , , 1 Comment

I’ve always found the Italian stock market–yes, there is one–to be a waste of time for foreigners.  There aren’t very many interesting companies (I’ve only held Tod’s and Bulgari in my portfolios, other than when I’ve taken on turnarounds).  Also, to my mind the market there is run for the benefit of political and industrial insiders, not for the average Italian, and certainly not for investors from other parts of the world.  Even if I could have tapped into the underground flow of inside information, it’s not clear it would be usable without violating US securities laws.

Anyway, the current election issue isn’t about the viability of Italian stocks.  It’s about the viability of the euro.

setting the stage

Italy is the third-largest economy in Euroland, after Germany and France.

Italy has a very inflexible, high-cost, slow-growing economy.  Many of its industries are under competitive attack, not only from elsewhere in Europe but from emerging Asian giants like China, as well (think:  clothing, leather goods and furniture).  Rather than allow/force adjustment to the new reality, the Italian government has borrowed lavishly and spent with abandon to help keep an uncompetitive economy above water.  For a long time, although bond investors saw the government debt piling up–it’s now around 140% of GDP, they assumed that Euroland as a whole was guaranteeing repayment.

Then the Greek crisis erupted.   …and bondholders began to work out that:

(1) maybe Euroland wasn’t really guaranteeing Rome’s borrowings, and

(2) the debt was so big that maybe Euroland couldn’t make good even if it wanted to.

Seeing the credit markets closing their doors to Italy, the country ousted the prime minister, Silvio Berlusconi, who had overseen the creation of much of the mess, and replaced him with a “technocrat,” Mario Monti.  (“Technocrat” means combination hatchet man and fall guy–someone who would make necessary, but politically suicidal, reforms and then fade into the woodwork.)

Monti did heroic work.  He wasn’t able to address sky-high labor costs, but he did restore government spending to what’s called a primary surplus, meaning that government income is covering all expenses, ex interest on debt.  The country’s government bond mountain is no longer growing; it’s starting, very slowly, to shrink.  To put this in context, this is more than Washington has had the courage to do.

the election

Monti got nudged out and an election was called to form a replacement government.  It was held last Sunday/Monday.

Four main parties:

–the Democrats; labor-backed, reform-friendly;  led by Pier Luigi Bersani

–People of Freedom; roll back reforms, start spending again; Berlusconi (a figure sort of like a cross between Nixon and Rupert Murdoch, without the redeeming qualities)

–Civic Choice; pro-reform; Mario Monti (who decided not to fade into the woodwork)

–Five Star; get rid of the political establishment, default on government debt, leave the euro; Beppe Grillo (like Jon Stewart, only taken seriously).

pre-election polls 

Polls from fifteen days ago, the latest allowed by law, predicted the Democrats would get the most votes (45%?)  and would form a coalition with Civic Choice (15%?).  Grillo might get 15%.  With 25%, Berlusconi would be left out in the cold.

“instant” exit polls

In Italy these are done by phone.  They’re not reliable.  But they showed the expected outcome.

as it stands now

Later polls, and preliminary voting results, show a different picture.

The Democrats will win the lower house outright.

In the Senate, however, it looks like this, according to USA Today:

Bersani          32%

Berlusconi          30%

Brillo          24%

Monti          14%.

In other words, the two pro-reform parties, led by Bersani and Monti, would fall short of a majority in the the upper house, so the coalition they had been planning on forming would be useless.  Why?    …both Brillo and Berlusconi did a lot better than expected.

where to from here?

No one knows for sure.

None of the others want to link up with Berlusconi.  That leaves a possible Bersani-Brillo combination.  But it’s not clear they have enough in common to form a coalition.

It may be that another election is on the cards.

investment significance

From the perspective of a global investor with no intention of buying Italian equities–Prada IPOed in Hong Kong, after all–it isn’t, strictly speaking, necessary for me to see Italy solve its structural problems.  All I need is for the country to limp along in its current state of denial, on the road to insignificance.  I might even be able to stomach a rollback of some of the Monti reforms.   That’s providing Italy doesn’t repudiate its debt, leave the euro, turn its primary surplus into a deficit or otherwise punch a big hole in the bottom of the euro boat.

At this moment, I consider the stuff on my “bad” list as highly unlikely to occur.  Nevertheless, absent a miracle solution to the Italian Senate partisan logjam, we’re going to go through a period of Euroland jitters until Italy has a new government.  My guess is that the shaking will mostly take the form of euro weakness.  Also, dedicated European equity investors will likely make their portfolios a bit more defensive, and will probably get the funds for doing so by aggressively trimming recent outperformers.

With little European exposure myself, I’m content to remain on the sidelines for now, with an eye out to possibly add shares of Europe-based multinationals that may come under selling pressure.

Note:  One minor conceptual worry–not one for today or tomorrow, though.  I’ve been channeling my inner Trotsky for a while now.  I’ve already consigned Japan and Europe to the dustbin of history–with a potential double dose of bin for Greece and Italy.  If I  keep on going like this, at some point there’s more dustbin than anything else.    That would be bad.

the latest Japanese election comes on Sunday

December 14, 2012 By in economics, Japanese development Tags: , , , , , , , , Leave a comment

getting scared straight

Cable network A&E is now into its third season of Beyond Scared Straight. This is the latest iteration in the Scared Straight genre, created in the 1970s, in which budding criminals visit prisons and are supposedly frightened back onto the straight and narrow by Ghost of Christmas Yet to Come-like interaction with the inmates.  I’ve never had enough interest to try to figure out how much is real and how much is staged.

There is a real-life Scared Straight, though, for economics and public policy.  It’s called Japan.  Maybe we should send our elected officials in Washington for a visit.

Japan

The Japanese economy has been in neutral for almost a quarter-century, during which the standard of living for average Japanese citizens has steadily eroded. The workforce is aging (it’s actually been shrinking for about a decade) but Tokyo doesn’t allow immigration.  Weak management is slowly (sometimes, not so slowly) killing even iconic companies, but foreign turnaround specialists aren’t allowed to take control.

Worse, the government borrows heavily to spend on pork barrel “stimulus” projects that yield no economic return.  As a result, national debt now exceeds 2x annual GDP. That’s a Greece-like number. Perversely, because Japan is almost devoid of good new investment opportunities (small “counterculture” companies run by younger managers are an exception), citizens continue to plow their savings back into government bonds, even though they yield next to nothing–creating a continuing cycle of misery. The Diet has not been overwhelmed by the interest expense of its reckless borrowing, nor has it had trouble, so far, in raising fresh funds to squander.

There’s an election on Sunday, in which the hapless Democratic Party of Japan is likely to be replaced by the Liberal Democrats, who have been the dominant force in modern Japanese politics.  The DPJ was voted in a few years ago to change the patronage culture, but almost immediately lost its way in a frenzy of intra-party bloodletting.

why the election is interesting–and maybe important

Shinzo Abe, who will become the Prime Minister if the LDP wins, is running on a platform that includes dismantling the independent central bank.  If Mr. Abe gets his way, the bank will be forced to print money as fast as the presses can turn, until this action creates at least 2% annual inflation.

Wow!

I guess the idea is to weaken the currency so that even arthritic export-oriented manufacturing companies will be able to make a profit.   There’s also the “advantage” that the currency markets, rather than the legislature, may take the blame for the immense loss of national wealth that would ensue.  At the same time, to the degree that the LDP is successful in creating inflation, it will also likely triple or quadruple the interest rate on new government debt–potentially making it impossible for Tokyo to service.  Scary.

Implosion isn’t imminent.  Mr. Abe hasn’t won yet.  Maybe he’ll change his tune after he’s in office.  Maybe the Bank of Japan won’t simply roll over and do what he says.  But, to mix metaphors a bit, that’s kind of like saying that the fuse to the dynamite that’s being lit is very long.  Japan could be an Asian version of Greece if a few years.

the really scary part for the US

In a nutshell, Japan’s basic problem is that since the early 1990s it has chosen to prop up the status quo, in the face of a changing world, no matter what the cost.  What’s really scary for an American is that Washington seems to be taking a turn down the same road.

US bond market environment, October 2012 (II)

October 19, 2012 By in Bond Environment, Current Market Thoughts, economics, inflation vs deflation, Portfolio management, Strategy Tags: , , , , , , , , Leave a comment

Here’s the second installment of the Bond Market Environment letter to clients by Denis Jamison of Strategy Asset Managers.  The first appeared yesterday.

debt without cost

Federal government borrowing has spiraled since 2008.  Total public debt outstanding–an amount that includes the notional amount owed by the Federal government to the various government trust funds–was $15.2 trillion at the end of 2011 compared with $9.2 trillion four years earlier.  Now, that debt is probably a trillion higher and exceeds nominal Gross Domestic Product.

You would think that much borrowing would put a huge strain on the federal government’s budget.

Well, it hasn’t.

In fact, for the year ended December 31, 2011, the interest payments on the federal debt were just 5% higher than in 2007, despite a 65% increase in the debt outstanding.  Moreover, the interest on the federal debt last year was just 1.5% of GDP.  That’s less than the 3%-plus drain on the country’s earnings during the second half of the Eighties and through the Nineties.

two reasons for this happy situation:

–first, the growth miracle during the Clinton Presidency provided a huge expansion in GDP while temporarily reducing the actual level of federal government debt.  And,

–second, the Federal Reserve’s zero interest rate policies begun in 2008 that reduced the interest cost of that debt from about 4.5% to less than 3%.

The trend in the cost of the federal government’s debt is glacial.  It takes a while for old bonds to mature and be replaced by new ones.  So the federal government’s debt costs will remain manageable for the next few years.  Investors should be very aware that the higher level of  federal debt to GDP plus the extraordinary low level of current interest payments could provide a severe headwind to economic growth down the road.

???

Bond investors have every reason to be confused.  They have enjoyed thirty years of high rates of return caused by steadily declining interest rates.  For various reasons, we experienced a secular decline in inflation since 1985.  Meanwhile, monetary policy amplified the impact of that decline on bond prices by steadily reducing the real rate of return (the nominal yield less the inflation rate).  We may have gone as far as we can down this road.  Real yields of most US Treasury securities are negative.  That’s happened before–in the Seventies.  Then it was caused by high inflation against a backdrop of loose monetary policy.  The inflation cure involved tight money, sharply higher interest rates and back-to-back recessions in the first half of the Eighties.

While Fed Chairman Bernanke draws parallels between the economic problems of the Thirties with those of today, he might want to consider the legacy of the Burns and Miller policies of the Seventies.  After the 1.5% inflation rates of the Sixties, these Fed chairmen didn’t think future inflation would be a problem, either.  And low interest rates seemed a good idea in exchange for economic growth.

It is likely bond investors will suffer a bear market someday–we just don’t know when.  For the moment, the music is still playing, so you have to keep dancing.

The only way to earn a real return today is to accept greater risk–maturity (or call) risk, credit risk, currency risk, liquidity risk and a lot of other risks that you won’t know are risks until something bad happens.  While I can’t pick the next winners (or losers), I can see a sector by sector return pattern created by the various waves of Federal Reserve policy.

By pushing short-term interest rates to zero, the Fed caused a huge rally in the US Treasury securities.  The gains now are limited because the real yield from these securities has reached zero.  Next, mortgages rallied as they were seen as a low risk alternative to government debt.  Now they, too, are exhausted because, at current price levels, prepayment losses are wiping out most of their coupon income.  That leaves maturity risk and credit risk still on the table for most investors.

maturity risk

The yield spreads between ten and thirty-year bonds are still attractive.  In the US Treasury market, that spread is about 125 basis points.  But the price risk for any change in interest rates is very high.  For example, investors in the current US Treasury thirty-year bonds would lose 15% if rates increase from the  current 3% to 3.5% ove the next six months.

credit risk

Assuming maturity risk isn’t to your liking, maybe the answer is corporate bonds.  Of course, there’s a lot of supply here because companies are busy selling new bonds to pay off old ones.  Maybe all this supply is keeping yields relatively high.  The spread between AAA-rated corporate bonds to ten-year US Treasuries is about 160 basis points.  If you can stomach BBB-rated securities, you’ll earn a 300 basis point advantage over governments.

Investors face difficult choices.  Old strategies aren’t working well in the current investment environment.  Unfortunately, when you step out on a new path, you never know where it will lead.

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