Winter 2015 Edition
A March Back to Bonds
Post-QE Fixed Income Investing
Troy Noor, CFP®, CFA
Aaron Kolkman, CFP®, AAMS®
From December 2008 to October, 2014, the Federal Reserve System (Fed) moved through three rounds of Quantitative Easing (QE) designed to expand money supply and provide economic stimulus, purchasing a whopping $3.410 trillion in Treasury bonds, Mortgage-backed securities (MBS) and Government-sponsored enterprises (GSE) debt, (such as Fannie Mae and Freddie Mac). Unfortunately, money supply did not expand per se; rather, cash shifted to commercial banks which remain at once reluctant, and - post-Dodd-Frank Financial Reform (2010) - less able, to lend it. Meanwhile, from March 10, 2009 through December 26, 2014 global equity prices marched higher for 12 months longer than the average bull market, setting new all-time highs in major indexes, and lining investors pockets with re-recreated wealth, as one of the six longest bull markets in U.S. history moved domestic equity indexes up over 200%.*
So what about bonds? A slightly upward-sloping yield curve became the norm over the 2009-2014 period, with short-term rates held near zero and long-term yields receiving downward pressure from the aforementioned QE exercises [10-year Treasury bonds held between 1.49% (Jun 30, 2012) and 3.84% (Dec 1, 2009)].
As the Fed concluded its QE programs in October, 2014, fixed income investors initially feared lower demand and lower prices for bonds, and corresponding increases to long-term yields. So far, the opposite has occurred, a trend likely to continue in the short run.
Volatility in equities. Over the past 5 years, profit margins for S&P 500 constituents are at all-time highs due primarily to 1) productivity gains received from technology infrastructure improvements, financed by relatively inexpensive capital, and 2) low wage inflation. As capital costs rise and labor markets tighten, margins compress and earnings growth becomes harder to achieve. These dynamics can drive increased stock price volatility, as more companies fail to meet earning expectations.
Global demand for credit quality. Ongoing stock market volatility shifts conservative capital to seek safety in bonds – the same investors who generally demand a higher credit quality portfolio (after all, this “March Back to Bonds” is a flight to safety in the first place, not a search for yield). This increasing demand for high-quality bonds means price stability for investors in both government and agency securities, as well as with companies with solid balance sheets.
QE Capital Reinvestment. Although QE has ended officially, an accommodative monetary policy remains. Further, the Fed’s own balance sheet has already exhausted its short-term Treasury holdings in favor of longer-term maturities. The Fed’s current dovish stance indicates that any near-term maturities will likely be reinvested into longer bonds, keeping downward pressure on long-term interest in the years ahead.
For additional information, contact Aaron Kolkman at: (877) 664-2583 or email@example.com.
The Risk Manager (February, 2015)
Mean Variance Optimization Part I: Measuring Aggregate Risk
The Risk Manager (March, 2015)
Mean Variance Optimization Part II: A Tale of 2 Portfolios
*S&P 500 Mar 9, 2009 close = 676.53 / S&P 500 Dec 26, 2014 close = 2092.70
*DJIA Mar 9, 2009 close = 6547.05 / DJIA Dec 26, 2014 close = 18,053.71
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