Sunday, October 17, 2010

News - October 2010

How low can you go? Bond yields are doing their own version of the limbo as the Federal Reserve threatens another round of quantitative easing; and, for now, prospects for widespread inflation seem muted. In general, “quantitative easing” (QE) is the buying of mostly government- and mortgage-backed bonds by the Federal Reserve in order to influence interest rates lower. The Bank of Japan has even gone a step further and announced their intention to not only buy government fixed income securities, but to also buy privately issued assets like corporate bonds, exchange traded funds, and real estate investment trusts.

The 10-year treasury yield is hovering around 2.5% after rising as high as 4% earlier in 2010. Low rates are typically an indication of low future economic growth, or very low expected future inflation, or a combination. Clearly, the QE is playing into rates also and it’s greatly debatable as to how much of the recent drop in interest rates is attributable to the Fed’s actions, inflation expectations and economic expectations. Some have argued for some time that the various fiscal and monetary stimulus programs are a prelude to significant inflation down the road. But the bond market doesn’t seem to be corroborating that popular thesis, even in light of slightly higher rates in recent days.

Falling bond yields continue to be a boon for investors holding fixed income securities. The BarCap Aggregate Bond Index has advanced 7.9% for 2010 through September 30th. Earlier this year, Bill Gross, the famed bond investor, seemed to indicate that the bond bull market of the past 30 years was drawing to an end and predicted rates would move higher. Six months after Mr. Gross made his prediction, all signs are pointing to the great bond bull market stretching for at least 31 years.

Stocks rose dramatically during the month of September. Fresh off a downdraft in August, markets have alternated between positive and negative monthly returns for the past several months. Stocks advanced during the third quarter just as the chorus for a possible double-dip began to grow a little louder. That song has been quieted a bit for now.

The widely followed Dow Industrial Average is within earshot of the 11,000 mark again after advancing 7.9% for the month and 5.6% for 2010. The S&P 500 is now positive by 3.9% through September 30th for all of 2010 after an 8.9% advance just for the month of September. Small cap stocks outpaced the large cap indexes during September, rising 12.4%, and have gained 9.1% YTD through September 30th.

Developed international stocks posted a strong September as well, rising 9.8% for the month to just barely enter positive territory for the year at positive 1.1%. Emerging markets have fared better than other international investments, advancing 11.2% for the month of September, and have logged a gain of 10.6% for the year. We are seeing some wide discrepancies regarding emerging stock market returns this year as India has far outpaced the gains of its BRIC brethren.

Real estate investments have been the top performer all year despite continued softness in the housing market. Through September 30th, real estate has gained 18.8% for the year, although the category is showing some signs of weakness as the broader stock market gains over the past month have significantly outperformed this sector. REITs are a diverse group as some specialize in apartment housing, operating shopping malls, or commercial real estate, for example.

Gold has continued its decade long run this year. The precious metal has advanced 18% for 2010 as of September 30th. While gold is generally thought of as an inflation hedge, other indicators seem to be flashing muted inflation for some time to come. Long-term U.S. Treasury bond yields have fallen significantly since earlier this year.

Conversely, Financials and Energy/Natural resource stocks have lagged the broader market in 2010. For financial stocks there has been yet another renewed concern over foreclosures and their impact on bank stocks. Clearly the system is not built to process the current massive number of foreclosures and financial institutions are having difficult time adjusting. A recent characterization attributed recent problems to the contrast between our complex system of securitizing mortgage debt with antiquated property laws.

The final employment report before the midterm elections was released and the results were mixed at best. According to the Labor Department, the economy lost 95,000 jobs during the month of September. Private sectors actually added jobs again, although less than the prior month and not enough to bring down the unemployment rate. Governments shed both temporary and permanent positions which overwhelmed the overall jobs picture.

It seems we are in a perpetual “wait and see” mode with this economic recovery. We observe many crosscurrents in the various financial markets and economic indicators. Stock prices have moved higher as corporations have become healthier, leaner and more profitable, but housing prices have only stabilized at best. The economy has stopped shedding jobs, but has not yet starting producing enough jobs to bring down unemployment and increase confidence. Commodity prices are indicating higher inflation and demand, while bond markets suggest the opposite.

To be sure, we are facing an uncertain future, but that has probably been the case and an asset for investors during most of our history. Certainty in the success of investing in stocks or the success in our real estate purchases has almost always been a precursor to a serious correction if not outright collapse in prices. So, uncertainty is good in that it suppresses current asset prices and very well may imply better future returns on those assets than we expect. We hear much about the “certainty” the election in a few weeks will bring. We suppose that elusive state of “certainty” may persist for a couple months perhaps, just until our focus is trained on the next election.

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