Interest Rates are Coming Down!

For some time I have indicated that I did not believe a strong market upturn could happen until corporate bond interest rates came down from their high. When interest rates go down the value of bonds rises! I wanted to see the value of our bonds rise! Back in November of 2007, the corporate interest rate on core bonds was about 4.75%. In March, rates had risen to about 6%, which I thought was a good buy. From March until mid-June, interest rates declined to about 5.5%, but then we heard about Freddie Mac and Fannie Mae and their problems. In a matter of days, the interest rates shot up to almost 9.5% on core corporate bonds as many investors left corporate bonds and turned to the safety of short-term U.S. government bonds. Fear was running the markets! It has been my belief that we needed to see the core corporate interest rates decrease to below 7% before we would see relief from the fear that has driven this market all year long. Interest rates last month did finally get down to a range of 7.5% to 7.65% and stalled at that point . . . until this week! I mentioned to some clients that we might see the core corporate interest rates, when they did decrease, look something like the drop in the price of oil, with a rapid drop in rates and a corresponding increase in the value of bonds. Well, it happened! On Monday the interest rates on these bonds dropped to 7.35%. On Tuesday the rate dropped to 7.22%, still higher than my target of under 7% but looking better than we have seen in a long time. On Wednesday they went to 6.91% and I wondered: is this for real? Thursday confirmed the trend with the rate dropping to 6.71%. This is a major change in a very short period of time. Until yesterday there had been no real drop in the interest rates on high yield bonds that had risen from about 11% in March to 23%. Yesterday we saw the first meaningful drop as the rates went down to about 21.65%. The drop in interest rates seems to be the first signal since last June that the fear that has swept the market seems to be receding. I believe this is a good trend and I am optimistic about where we might go from here. Ed Mallon

Holiday, Followed by Turkey

Last week seemed to be an optimistic prelude to the Thanksgiving holiday. The stock market managed four successful up days followed by a fifth on the Friday following Thanksgiving. Unfortunately, on Monday, the market was a “turkey” and gave back about half of what it had gained during those five up days. Some of this is profit-taking after such a run up, but part of it is that the economic news is still not very good. It has been my belief, and still is, that in order for the economy to move forward, we need to see the interest rates on corporate bonds decrease to a level that makes some sense. This has not happened. Interest rates rose in October and were followed by additional increases in November. If it takes lower interest rates to move the economy, then the stock market cannot do much until lower interest rates occur. Corporate bonds, in some cases, are linked to commercial real estate, and as the economy worsens, the question becomes “what is the value of the real estate that supports the bonds”? There seem to be many questions at present but few answers. The old administration in Washington is wrapping up their loose ends and likely will do little between now and the time that the new administration enters. I had a list of what I would do if I were the President-Elect and I must say that Obama is doing all of the things on my list. He will need to hit the ground running, and to this end he appears to have assembled a competent group to help him launch meaningful economic reform. I wish him well! Ed Mallon

False Breakout?

The rally we saw on Tuesday, which appeared to be a breakout moving the markets higher, seems now to have been a false breakout. Yesterday's total market downturn, another 90% down day on the NYSE, was followed by an additional downturn today. From a technical standpoint, the downturn on Wednesday could be seen as a pullback, but today's results seem to indicate that the market may be reversing direction and going back to test the lows of October 10th and 27th. The support level for the S&P 500, for instance, had been considered to be at approximately 930. As of this writing the S&P has broken through that level and is at about 904 (down over 48 points for the interday). In a similar fashion, the support for the DJIA had been considered to be at about 8900 and as of this writing it is at 8696. Historically, the market tends to backtrack and test its lows before rising on a consistent basis. This movement of a rally period followed by a pullback period can take several months after it appears a bottom has been formed in the stock market. I would not be surprised to see the DJIA go back and test, or break the low of 7882 set during the day on October 10th. We will see. For now it would not appear a rush into stocks is a good idea.

Is This the Turn?

Monday, October 13th saw a gain of 936 points, the greatest one-day point gain in the history of the DJIA. It was also the 5th largest percentage gain for the DJIA at 11.08%. The other four historic double-digit gains were back in 1929-1933. As a matter of fact, the next largest gain was on October 21, 1932 and was followed by a decline that took the DJIA down to 33 points and a bottom in February 1933. The point is that double-digit gains have been characteristic of bear markets. You need to have patience in this market. My personal belief is that the bond markets need to see interest move downward before a real economic change is possible.

Give Stocks Credit!

With a loss of more than 500 points on the Dow yesterday the Dow has now lost 875 points in two days. I don't think as a percentage drop this is a record but it is significant! As the stock market heads down my greater concern is with the bond market. In October of 2007 an investment portfolio of investment grade corporate bonds, with an average maturity of about 4.5 years, was offering a yield of approximately 4.75%. In March of 2008 the yield was about 6%. That same yield is now over 8%. As the interest rate goes up the value of the bonds goes down! To make matters worse, the average yield on high yield bonds during the same periods went from approximately 7.25%, to 11.85% and is now over 18%! These are very significant changes. To put all of this into perspective: currently the return on U.S. Government debt is paying interest of 1.68% on the three year, 2.46% on the five year and 3.5% on the ten year debt. What this means is that most of the money leaving the stock market, commodities, etc. is going into U.S. Government instruments. Yesterday the Federal Reserve indicated that they will begin major investments into commercial paper, which is short term lending covering a period from overnight to less than a week. This is an area that is very important to business borrowing. It is hoped that with this move credit markets will free up and money will move into other credit markets such as corporate bonds. If this happens we are likely to see interest rates on investment grade and high yield bonds begin to fall. Ultimately, when the credit market starts to free up the environment for business will get better. Over time this should lead to stock prices stabilizing and bring confidence back to the market. This will not happen overnight but will take time. We must learn patience!

Failed Bailout Vote!

Failed Bailout Vote! It was never certain that the vote on the bailout would pass. With five weeks to go until election day, and with a large segment of the population mad at the idea of bailing out big business, it was a tough call for the House members. What would have happened if the bill had passed? We don't know. My guess is that, with passage, the value of mortgage loans would rise because the Federal Government would be a ready buyer. As the purchases occurred, cash would flow back into the banking system. If the bailout did not pass, I would expect to see the value of the mortgage loans drop even farther, the stock market retreat because of the unknown, and greater amounts of money flying to US Treasury bills and notes, reducing the interest paid on these instruments to an insignificant amount. For the vast majority of our clients, we have a very heavy position in cash. On September 19, 2008 the Federal Reserve guaranteed these accounts for the full amount in the accounts, both taxable and tax exempt. As I indicated in a recent newsletter, the bonds in our accounts seem good, are paying interest and are paying back the principal when the bonds mature. I believe we have taken a defensive posture that we should maintain even while it appears there are buying opportunities in this market. I am not sanguine about what is happening. I believe that what we have witnessed in the past several weeks is a lack of leadership in Congress and the business community. Usually at times like this the Executive Branch provides the needed leadership, but this administration has lost its credibility for many and must rely on others to move the process along.

That Nasty Four-Letter Word!

It's a nasty four-letter word that none of us likes to use. Matter of fact, most of us never want to think about it. But it is a word that is always there, hovering in the background, pouncing when least expected. We are tormented with its unspoken presence in the media, our daily discussions with friends and family and in the workplace. The word of course is "FEAR". The idea of fear keeps us in place, like a deer caught in the headlights of a car, unable to move. What should we do? Where should we go? Will we be okay? This past year has been a period of increasing fear for many of us. First we read about subprime mortgages and how people were losing their homes. Then we saw the price of a barrel of oil go up to more than $145. Then we had the crisis with Fanny Mae and Freddie Mac seeming to bring ordinary people's mortgages to the brink and hurting home values. If this was not enough, we heard about three major investment banks going bust, with one being sold by the Federal Reserve for pennies on the dollar, another merging with a major bank and the third going bankrupt. Along with the investment banks we discovered the largest insurance company in the US was being taken over by the government! Fear! To say that this is unprecedented is not idle chatter. It has been compared to the period of the: "Great Depression" and the period just after WWII. Its root cause: greed! Not just plain old greed but a very high level of greed practiced by top executives of very large companies. It makes me MAD that we taxpayers are going to bail out companies who had the audacity to give their executives bonuses of $80 Million or more for their "stellar performance". I have no doubt that Congress, in which both political parties allowed this to go on, will do what they need to do to bring liquidity and an attempt at stability and oversight to the business community. Eventually we will all go back to our "normal lives" and this crisis will pass and be forgotten. The problem is that the solution seems to say to those large companies that took big risks and some of those individuals who took big risks, “we will not let you suffer the consequences.” For the majority of us who have been paying our taxes, doing things "the right way" we now have the privilege to aid those who pursued their greed. I'd like to see the US Government go back to the Chief Executives of Citi Bank, Merrill Lynch, AIG and others and collect back those big outlandish bonuses and terminate those lucrative pensions and give the money back to the taxpayers! Some have FEAR on this occasion. I am just MAD! I do not think we are a greedy society but a society that has some very greedy people who are in a position to hurt our society!

Today the U.S. Government announced that the jobless rate now exceeds 6.1%. This was an unexpected jump, with most analysts believing we would not see 6% until the end of the year. What might this mean? With this jump in unemployment, the Federal Reserve, which has been worried about the economy all summer, will likely leave rates unchanged after their meeting on September 16th. Also we will likely see consumer-spending decrease substantially in the third quarter, after the rise in spending from the incentive tax rebate of the second quarter. All in all, the economy appears to be slowing down and will likely show little growth, or perhaps a downturn, for the balance of the year. Additionally, the sub-prime loan problems have driven interest rates on bonds to recent new highs. Refinancing of the majority of sub-prime mortgage loans should be complete by February and we may see the housing market begin to pick up again this spring. In my opinion, the inflationary effects of the oil price increases will also take until February or March to totally work their way through the economy. When this occurs, we are likely to see prices stabilize. Perhaps the most important issue is that by November, we should know who has been elected President. The stock market likes to know who will be serving in the White House, and this uncertainty is likely to continue to make the market volatile through Election Day.

Can it rain and be sunny at the same time?

On Monday of this week, the inflation rate for the month of July was reported to be 0.8% or an annualized rate of 9.6%. This compares with an annualized rate in June of 7.2%. This would appear to be bad news because it means the price of goods and services are going up at a much higher rate than the Federal Reserve Board (Fed) would like to see (1.5% to 2.5%). In such a situation, you would expect to see the Fed increase their key interest rate. On Tuesday, the Fed met and left the key interest rate unchanged at 2%. This also means that the prime leading rate stays at 5%. The stock markets took this as good news, with a healthy advance in prices. The bond market took it as bad news with interest rates rising (and therefore the price of bonds declining). It would seem that, with the price of oil falling for the past week and the economy not looking its best, the Fed decided to gamble that prices will stabilize as oil prices are reduced. The lower oil prices could benefit food and transportation costs. This in turn could mean that inflation will be reduced. What we are seeing, in any event, is that the current Fed is more concerned with the economy than with inflation. Ed Mallon

Fearful Headlines

I have been noticing that the headlines used by the media during the past month seem to evoke fear. An example of some of today's headlines: "Oil Prices Plunge More Than $10 a Barrel!" "Fed Chief Details Woes in Markets, Housing, Jobs" "Bush: Troubled Financial System is Basically Sound" "Wholesale Prices Soar in June; Sales are Sluggish" Fear is what many Americans are feeling right now. They wonder if the financial system will be okay and more important, if they will be okay. We are driven by our emotions and the emotions of others around us. The more negative the news, the more negative and fearful we become. We are "news junkies" who need a constant infusion of the "latest news." The problem with all of this is that it does not give us perspective or context of the events happening around us. Most media personalities have little understanding of how the events fit into a broader pattern of economic and social forces. For example: What does oil plunging by $10 a barrel really mean? It likely means that some of the speculation in oil is giving way to more realistic pricing. If this trend continues inflation will be lowered and the value of the dollar strengthened. When the Fed chief details the "woes," do people realize that what he is saying is that the growth we are having is likely to be less than anticipated and that he still expects the economy to grow during 2008? When President Bush talks about the financial system, he is really saying that the government believes that the actions that are being taken by the Fed and Treasury will alleviate the current problems. Saying wholesale prices "soar" is simply saying that the "real inflation rate" which includes fuel and food, is rising at an annualized rate of 13.2 (1.1% in June multiplied by 12 months) as opposed to the "core inflation rate," which does not include the volatile fuel and food sectors, which is rising by an annualized rate of 2.4% (0.2% in June). Real people eat food and use energy! Until June when the Fed finally started to mention the real inflation rate, they had been consistently looking at the core rate of inflation and indicating that inflation was not a big problem. They now "get it" and will do what they need to do to contain real inflation. The inflation rate has meant a higher amount of income is going to essential expenses (food, fuel), leaving much less for other spending. I still believe we are going though a recession that is similar to the one we had in 1990, along with a bear market in stocks. The confluence of a bear market in stocks, a bear market in housing, and rising oil and food prices is unsettling. In the bigger picture, these events are setting the stage for the next new direction of the market. I am already seeing articles about new developments in "Green Technology." Keep oil up in price and, in the long term, the US will respond to become more self-reliant, stronger financially and better disciplined.

FED changes

Yesterday, June 25th the Federal Reserve Board (FED) made a change. The change was that there was no change. They kept a key Federal Funds lending rate (the interest rate) at 2.00%! This was an expected decision by the investment markets around the world. It did confirm however that the FED is concerned with “REAL” inflation and is not talking about the “Core Inflation Rate” as they did at prior sessions. Since the Clinton administration decided to mess around with how the inflation rate is calculated (as well as the calculation of unemployment) reality has taken a holiday! When you hear about the inflation rate you are usually hearing about the “Core Inflation Rate.” What is the “Core Inflation Rate?” Let me put it this way: someone asks me what I had for dinner last night and I tell them “A plate, a knife, fork, spoon and napkin.” No food? Food doesn’t count in the “Core Inflation Rate”. How did you get to work today? By car. How did the car move you from home to work? On wheels. Energy doesn’t count in the “Core Inflation Rate.” How are cost of living adjustments that are made by the US Government on things such as Social Security determined? Of course, using the “Core Inflation Rate.” Food and energy costs have gone up substantially in the past six months. In addition, the increased cost of food and energy are rippling through other products we buy and services we use, such as plastic products and restaurant price increases. The FED is in a dilemma! On one hand the economy appears to be in a recession while on the other hand inflation is a problem. To curb inflation you raise the interest rate. To help the economy you lower the interest rate. The current answer by the FED was to do nothing! In March of this year we moved some investment money into investment grade bonds and into high yield bonds. At the time we had seen the investment grade bond interest rates go from about 4.75% in October to 6% at the beginning of March. A bigger change had occurred with the high yield interest rates going from about 7.25% to 12%. Since that time the investment grade rates and high yield rates had been going down to 5.8% and 10.5% respectively. I told some of you that I was very cautious about how much money we should place into these investments because I was worried about inflation. I am very glad I was cautious. As of today the investment grade interest rate is over 6.20% and the high yield rate is now up over 11.40%. High interest rates are not good for business and therefore not good for stocks. Based on the above I believe that stocks will go down more and longer term interest rates will continue upward until the FED begins to raise their Federal Fund interest rate and show that they are serious about fighting inflation. At some point, when the interest rates get high enough, longer term interest rates will be a real buy!

What a Week

What a Week! This past week saw the Dow go down 3.39%, the S&P down 2.83%. This was in part a response to economic events that were reported during and at the end of the week. On Tuesday, Standard & Poor’s/Case –Schiller’s national home price index fell 14.1% in the first quarter. On Friday, the government announced that the unemployment rate rose by an unexpected 0.5% to 5.5%. Oil futures hit $138.54 per barrel on Friday, and an investment banking firm on Wall Street said they thought it could hit $150 by summer. A consensus was building that the US economy is either in or going into a recession. The outlook for Europe is not good either. Wow! What does all of this mean? Having money in cash or cash equivalents certainly seems to make sense. Having money in investment-grade and high-yield corporate and municipal bonds paying interest seems to make sense. With the dollar on the decline, even international investments make some sense. For example: even with the worst earthquake in 32 years China’s passenger-car sales grew 16% last month. Global growth seems to be unabated. How about commodities? Commodities tend to move in the opposite direction of the dollar. This would include oil, gold, silver, etc. The commodity markets indicate that there is widespread speculation occurring presently. The head of the Federal Reserve, Ben Bernanke, is talking about a strengthening dollar. This could mean the federal government is about to get serious about reversing the dollar’s direction. Such a move would likely not be good for commodities. Could the bubble burst and the price of oil tumble? Some say world demand is such that, when coupled with flat output, this could not happen. I don’t believe it! I lived through the period when the Hunt Brothers tried to corner the market on silver. From $1.95/oz. in 1973, silver skyrocketed to $54/oz. Ordinary people were buying silver with the expectation that it would just keep rising. Bang! Down went silver prices. From 1980 through 1987, silver prices dropped to about $10/oz. Today silver is priced at about $17/oz. (More recently, Americans were sure that real estate would just keep on rising! Ugh!) Is the same now true with oil? Ed’s pendulum theory says: “Every investment market swings from being underpriced, relative to the norm, to being overpriced!” In this process it is possible for an investment market to establish a new “norm” but it will be within the range of over- and under-pricing. This is not to say that an individual investment within that market will outperform or underperform. But, the overall market, such as the market for oil, must go through this process. With commodities like oil, it is often thought that there is a finite amount of something and therefore its price can go up with no end in sight. In fact, it appears that when a particular commodity becomes overpriced, a new substitute will either be found or it will become cost-efficient to utilize a competing commodity. The question in my head now is: “Are we ready to become Green as a society and invent new ways of living?” Ed Mallon

Prices Soar!

The federal government in releases yesterday and today gave initial indications of how the economy did in March. The picture was subdued as the government concentrated on the “good news” that “core” inflation was only growing at a 0.2% rate for the month or an annual rate of 2.4%. This is considered to be within the government’s targeted rate for “core” inflation. The “core” rate does not include food increases or the rise in fuel costs. For March, energy prices were up 2.9%, the biggest increase since November. Even this percentage seems out of line since they also report that heating oil was up 13.1% and diesel fuel, used by truckers to get your goods to the local store, was up 15.3%. Food prices for the month were up 1.2% (this would be 14.4% annualized), reflecting the increases in cost for vegetables, rice and beef. Anyone going to the grocery store or buying gas for their car is seeing the jump in prices on almost a daily basis. The question that must be asked is: will this lead to a jump in longer term inflation or is it simply a factor of the cost of oil as it passes thru the various parts of our economy? We also must remember that as the value of the dollar has been going down, against other world currencies, the cost of oil is bound to go up in dollar terms. The Federal Reserve Board (Fed) which has been lowering the Fed discount rate to stimulate the economy must now consider how big a problem inflation is and where it might be going in the future. The lower discount rate also has a negative impact on the value of the dollar in world markets. The former head of the Fed believed that fighting inflation was job one for the Fed. Thus far it appears the new chairman has been more concerned with the economy than inflation. At the last meeting we saw the first decent in many years with some Fed members beginning to question the sharp reduction in interest rates as inflation seems to be accelerating. Raising the Fed discount rate tends to slow or moderate the inflation rate. Will the rate be lowered (help the economy), left the same (no clear decision) or raised (moderate inflation and perhaps help the dollar)?

2008 How’s it going so far?

As I am writing this, on Friday April 11, 2008, the market has just made another one of its downturns. After having gone through a succession of downturns from the beginning of the year until the middle of March it seemed to have taken an upward beat and perhaps it is now ready to start downward again. Since I believe we are in a Bear Market this would be a classic Bear Market event. Times of upward movement in the market tend to give hope followed by declines. The Lowry Service, which is an organization we use for technical information, has been indicating that even when the market has moved up it has done so on less supply (fewer stocks being offered and less volume) rather than real strength in the market. The Boston Globe, in the April 6, 2008, business section noted that the average diversified US equity fund lost 11% in the first quarter, according to Morningstar Inc., while Asian stock funds, excluding Japan, fell 20% and technology funds fell 16%. The Dow Jones Industrial average, of 30 stocks, by comparison was down only 8%. As noted above it seems most of the losses for the quarter occurred before the middle of March when the market moved up a bit. With money market funds and CD’s getting less and less interest it seems a shift into investment grade bonds is inevitable. For our clients where we have taken a defensive position we are moving more of the funds into intermediate investment grade bonds with just a splash of high yield bonds to give us a higher overall yield. In these cases we are keeping the exposure to equities rather limited for the foreseeable future.

Market Stimulus 3/19/08

This has been an eventful week with the Federal Reserve having done a lot to increase liquidity in the markets, by both lowering the Federal Funds rate and the Discount rate, while also feeding more funds into the economy thru banks in investment firms. The impetus for this seems to have been the fear that Bear Stearns would go under and that other investment banking firms might follow. With the help of the Federal Reserve's finances J.P. Morgan bought the venerable old firm, cheap! The initial reaction to all of this activity was to see the stock market hold its own on Monday and go roaring up on Tuesday! This was followed today, Wednesday, with another downturn in the stock market. All and all it would seem that there are still more sellers than buyers in the market. We have not reached the bargain basement yet! The Federal Reserve seems to have restored the sense of adequate liquidity to the fixed markets and municipal bond markets in particular, that went through a very difficult period from the middle of February up until about a week ago. In my opinion, the changes that the Federal Reserve has made will take time to go through the economy before they have the desired effect. Generally such changes take anywhere from three to six months after implementation before they make the desired positive change. The changes made by the Federal Reserve at the end of January have not fully been realized! My thinking remains that the economy is in a recession, that there are currently some opportunities in fixed securities (bonds) and that stocks will either be lack luster or down until mid year. I also believe that the much-maligned U.S. Dollar is going to see a rebound during this period, which makes me hesitant to venture too much investment money into international stocks or bonds. The one overriding concern that I have is inflation. With the monetary policy of the Federal Reserve focused on the economy and making money readily available it may lead to higher levels of inflation. Time will tell.

A Changing Picture 2/20/08

Today the minutes from the January 29th Federal Reserve meeting were made available. It showed that the Fed is worried that the economy is going to slow more than originally forecast, joblessness will be higher (5.2%-5.3%) and inflation could be a problem. Yesterday we saw oil hit more than $100 per barrel, the inflation rate for January go to 0.4% (or 4.8% anualized) and housing permits to build drop to the lowest level since 1991. All of this seems to indicate that we could have inflation and at the same time have a slowing of the economy. That being the case, it is possible that we will see longer term interest rates on bonds go up while equities do not do very well. This may present a buying opportunity for bonds. Ed

The Trend Continues

The S&P 500 dropped more than 3% today. With the information on the loss of jobs, for the first time in four years, released last week and the release today of the dramatic drop in the service sector, to a low not seen in seven years, indications are clear that we are nearing recession conditions. To be a recession the economy must undergo two quarters of decline. Adding to this contention is the fact that the Federal Reserve saw fit to drop the discount rate a total of 1.25% in a little over a week at the tail end of January while the President and Congress were working on pushing through a "stimulus package" in hopes of staving off a recession. It seems at this point supply outweighs demand creating deep downward moves in stock prices. On the other hand liquid assets such as money market funds, municipal bonds, U.S. Gov't fixed investments and high quality corporate bonds are doing OK. More about all of this is contained in my new Newsletter for February. Ed

In Tune with the Stock Market - January 2007

It has been said that "the trend is your friend!" If that is the case, with stocks having been going down since the high in October, the trend is not a friend to stocks! It has been our position for this past year that a defensive strategy for individuals who are near retirement or are retired makes a great deal of sense. This has been a good time to be in liquid fixed investments, especially municipal bonds. We have seen a flight to high quality and more liquidity as the market has continued down. Times change and the market will change too. We are waiting to see what the Federal Reserve does on January 29th and 30th.