August 27, 2013
Don’t Worry About the Fed Raising Rates
The Investment View from Prescott, Arizona
Much of the recent tension in the stock markets has been centered round whether or not the Federal Reserve Board will begin to raise interest rates that have been held at record lows for several years now.
Investors are right to worry because interest rates, a reflection of the bond markets, affect our lives much more directly than, say, the price of Apple stock.
The headline points out that investors are being misled, very much like a magician misdirecting your attention with one hand while the other hand reaches in for the hidden rabbit. One needs to watch what is actually happening, not what is being said.
Rates have already gone up while everyone was looking to see what the Fed would say and do.
On May 1st, the yield on the 30-year US Treasury Bond, the “long bond” which is closely tied to mortgage rates, was 2.83%. As of Friday, August 23rd, this bond is paying 3.88%, more than a full point higher.
Similarly, the intermediate term 10-Year Treasury Note was paying 1.66% on May 1st and is now at 2.9%, all without the Fed really doing anything – anything visible, that is.
So it is really too late to worry about the Fed raising interest rates. That horse already left the barn kicking the bond market in the teeth on the way out.
The ironic part about raising rates is that they seem so enticing to investors who have been starved for investment income the past few years as rates hovered above zero, yet these same income investors are at risk of losing more than just their income as rates rise.
Consider the investor who put money into intermediate term Treasury bonds earlier this year. The Barclay’s 7-10 Year Treasury Fund (ticker symbol IEF) was paying 1.5% in interest. Not much, but better than CDs, right?
However when prices dropped in response to interest rates rising, the price of IEF dropped over 8% between May 1st and August 23rd. That is over 5 years of interest lost for investors in intermediate term Treasuries. So much for Treasuries being safe, huh?
And investors who think they will just wait until rates have quit rising to avoid the risk of capital loss, are attempting the most difficult thing to do in investing, picking exact tops and bottoms in market cycles. It’s a little like trying to catch a falling knife; easy to lose a finger.
Slice of Life
The link below is to 40 maps of the world containing fascinating things most of us never think about. It is a cleaver way to present data.
From the “What’s the World Coming to Department”: in forty of the fifty United States, the highest paid public employees are sports coaches. That’s 80%. Yikes!
Q: What English word has three consecutive double letters?
How’s the Market Doing?
The Market is at a Turning Point
The weak economic growth that I mentioned in my last newsletter seems to be getting a lot of attention now that Wal-Mart, Sears, Nordstrom and Macy’s have reported slowdowns and a significant decline has been recorded in the Consumer Confidence Survey from the University of Michigan/Thomson Reuters. This could be the tip of a big iceberg since 60% of our economy depends upon consumer spending.
As of my last writing 3 weeks ago, the US stock markets had lost their upward momentum but had not turned down. Over the past few weeks a short-term decline has clearly set in.
I pay attention to each small market decline, because every big decline begins as a small one, so every decline deserves respect.
Significantly, major market crashes never happen in isolation. They follow periods of decline, but the declines may occur between quarterly statements and are often overlooked by investors who are brainwashed by Wall Street to believe that every dip in the market is a buying opportunity.
What creates a crash is when enough investors notice the decline and begin to think about selling and then some “out of the blue” event triggers a wave of selling by nervous investors. Many investors act surprised but these events have a lot of warning signals for those attuned to them.
Right now we are getting a lot of warning signals. This does not mean that the market is certain to go down, only that the likelihood of that is increasing quite a bit.
Some negative indicators include the 4-year cycle that is presumed to be related to presidential politics and the pulling on financial strings to position administrations for elections. The market activity averaged out for all second-term presidents shows that we should expect a decline between now and December based on this factor.
Several years ago I noticed that rising volatility of stock prices often preceded market declines and I developed a volatility based market indicator called the HCM Safety Net Indicator. The Safety Net Indicator flashed red last week on August 22nd.
Some indicators signaling caution are very arcane such as clusters of “Hindenberg Omen” signals. I won’t bore you with the construction of this technical indicator, but you can read about it in Wikipedia if you wish. Clusters of these signals have preceded major market declines in 2000 and 2007, as well as smaller declines along the way. Hindenberg Omens are rare in rising markets, so this suggests that a decline is in our future, the question is how big a decline?
So how lucky do you feel? My job is to not rely on luck, but to manage the risks of investing. For the next couple of months, the risks are higher than normal.
Champion football teams almost always have the best defense. Now is the time for winning investors to play defense, too.
What’s Going On In Your Portfolio?
I have substantially changed both our growth and income portfolios* in the past few weeks, keeping only the strongest holdings and adding “hedges”, investments designed to go up as the market goes down, to offset market risk on our remaining investments.
Several times a year I take defensive positions like this, and sometimes they are counterproductive, creating more small losses as the market suddenly recovers before I can readjust the portfolio. Being cautious is not without its costs but is still, I believe, the best way to invest.
In some cases, however, being cautious creates a noticeably positive difference over buy and hold investing, great enough to overcome the small losses created along the way and still leave a good profit with much lower overall risk.
The stock and bond markets have both deteriorated over the past few weeks, enough that I think it is again time to be cautious. This is the kind of market where what you are not invested in may be more important than what you are invested in.
Both our growth and income portfolios* now own gold as it appears to have put in a meaningful bottom after its 13.5 month cycle low which was due in May but arrived in June (These things are never very precise). Gold is countercyclical to the forces buffeting the markets right now and that means it is a good diversification play at the moment.
Our Growth model* has its shock absorbers on, holding 60% stocks offset with enough inverse funds (our hedges) to leave only 20% stock market exposure. We also own about 20% in gold and gold mining stocks.
Income portfolios* have been purged of our high yield bond holdings, which often don’t do well as the economy slows, replacing them with inverse bond funds and gold which has stabilized the portfolio nicely after a small drop earlier this month as interest rates again spiked up.
Municipal bond* accounts are mostly in cash at the moment.
Scottsdale Office Date
Please call the office (928 778-4000) to schedule an appointment with Will if you prefer to meet in Scottsdale.
Am I Meeting Your Expectations?
My style is to not call my clients and bug them. That stereotype is born of commissioned salesmen who must speak to you to sell you on the newest, latest, better-than-the-last-one investment so they can earn another commission.
I just quietly take care of your accounts so you can go about your life and don’t have to worry about where your money is or isn’t.
This newsletter works well as my primary means of communication with you. You can frequently see what I think about the market and what I am doing in accounts to manage the current conditions.
But this medium does not tell me what you are thinking, feeling and experiencing in your lives.
If you have changes in your life circumstances or your tolerance for risk, or if something is just bothering you, please let me know so I can make sure that I am using the appropriate investments for your situation. Please call for an appointment. 928 778-4000
Our Spotlight Strategy
With our Shock Absorber Growth Strategy we strive to provide growth in all markets from a blend of both long and short equity investments.
We first select the strongest of about 40 different stock market segments, sectors and regions, and then select the most complimentary inverse funds to use as a Shock Absorbing hedge for those investments. The HCM Safety Net indicator is designed to warn of sudden potential declines, in which case stock market exposure is quickly reduced. Shock Absorber Growth
If you would like a current copy of our SEC Form ADV, Part 2, it is on our website at hepburncapital.com/form-adv.html
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable; however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.