June-Here’s To Your Wealth
The U.S. investment market’s mid-year report card is a mixed picture. Bonds continue to do well while stocks continue to be flat to down year to date.
All those who said interest rates couldn’t go any lower and avoided the bond market, continue to miss a nice rally. Of course, the high yield bond correction in late 2015 put a temporary wrench into things, but as soon as oil rebounded earlier this year so did high yield bond prices. These past few years, there was constant worry that interest rates would rise. We have consistently written that for a variety of reasons we disagreed with this assessment. And now, with Britain leaving the European Union, the U.S. Federal Reserve has another reason to not raise rates – or at least not raise rates until after our election.
Who can say for sure that this bond market rally, which has been fueled by lower interest rates is over? The U.S. ten year Treasury may be hovering around all-time lows of about 1.50% but it can still go lower. Disagree? Have you seen what is happening with German interest rates? Germany’s ten year note is paying below zero percent! So when you hear “rates have to go lower” ask the person what is their reason for that pontification. And while those sitting on cash wait to be right, they continue to miss one of the best U.S. bond market rallies in recent history. To be sure, the bond rally will end, but for now, we don’t see a catalyst for a jump in U.S. interest rates.
These lower rates are creating a major planning conundrum: How do near retirees and retirees invest in lower risk assets (like U.S. Treasury bonds and investment grade corporate bonds) if the yield on those investments is so low? The cost of the Federal Reserve low interest rate policy may have unintended consequences for investors who instead are chasing higher returns in higher risk assets classes. These investors may be attracted to “Income Funds” but many of these funds invest overseas, in high yield bonds, dividend paying U.S. stocks and other risky assets. For a moderate or high risk investor willing to experience wide fluctuation in account value these funds may be a good fit. But for retirees who previously were invested in bank CD’s they may someday get a rude awakening.
Some disappointment has already been felt by investors in the U.S. stock market and more noticeably by investors in overseas stocks. We have been underweight overseas stocks for a few years now. Prior to the Brexit (Britain voting to exit the European Union) we were poised to gradually invest more into developed overseas markets like Europe. But for now, that is on hold as we see uncertainty in the Eurozone and our focus will continue to be more on domestic stocks. Even though the U.S. has been outperforming most overseas markets, for the past 18 months, most major U.S. stock market indexes are flat to down, and year-to-date, some indices like the NASDAQ and the Russell 2000 (small cap) are down about 10 percent or more. It seems that the risk to the U.S. stock market is that the stronger U.S. dollar would negatively impact the earnings of large, U.S. multi-nationals whose exports would now be more expensive. This, on a relative basis, would help smaller companies who derive most of their revenue domestically. But this has not been the case and small caps continue to under perform.
Perhaps U.S. large cap stock are benefiting from a flight to dividend income brought about by (former) bank CD and bond investors seeking yield wherever they can. In this environment, that might mean large cap, dividend paying stocks that can generate yields greater than the aforementioned German and U.S. government debt. Retirees who need income usually cannot afford to see wide swings in their portfolios. But these days, if they want yield, they need to climb the risk ladder.
Times like these remind me of what a wise fund manager at Sun Trust unequivocally told me: “there is no such thing as a safe stock”. And these days, with headlines blaring and the world in turmoil, investors should know the risks they are taking.
Quote of the Day:
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”- Warren Buffett
Mark Avallone, MBA, CFP®, CRPS®. www.PotomacWealth.com
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