JUNE 4, 2018
Last week, world markets were buffeted by a clamor of good, bad, and unexpected news last week. Events that captured media and investor attention included:
- Taxing America’s allies. Early in the week, investors weren’t the only ones riled by the administration
announcementit would impose hefty trade tariffs on American allies. “Brussels’ top trade official vowed to respond to Donald Trump’s new tariffs on imports of steel and aluminum from the EU, Canada, and Mexico with measures of its own, and warned that the EU has “closed the door” on trade talks with the U.S.”
- Breaking protocol. A strong unemployment report helped settle volatility stirred up by tariff talk. However, a preemptive Presidential tweet introduced controversy. “While not breaking the 8:30 a.m. EDT embargo on the actual numbers, Trump’s tweet appeared to violate a 1985 federal rule barring members of the executive branch from commenting on the employment report until one hour after the release of the report in order to avoid affecting ‘financial and commodity markets,’” reported Barron’s.
- Counting chickens. Although the summit with North Korea is on the calendar again, the commemorative Korea Peace Talks Coin is selling at a 20 percent discount in the White House gift shop.
- Puzzling choices. Giuseppe Conte is Italy’s new Prime Minister. He has a tough job ahead. Despite electing “…western Europe’s first anti-establishment government bent on overhauling European Union rules on budgets and immigration,” Italians aren’t keen on leaving the euro behind. Last week, “…opinion polls…showed between 60 and 72 percent of Italians did not want to abandon the euro,” reported Reuters.
Despite the noise, the Standard & Poor’s 500 Index and NASDAQ forged ahead last week. That may have something to do with valuations. Barron’s wrote, “…the S&P 500…now trades at 16.5 times 12-month earnings estimates, down from 18.2 at the beginning of the year…
Key points for the week
- There are now more Americans working than ever before, over 148 million.
- The unemployment rate dropped to 3.8% in May, tying the lowest reading since 1969
. Nonfarmpayrolls grew 223,000 in May and are up 2.4 million in the past year. Civilian employment, an alternative gauge of jobs that better measures small business start-ups, grew 293,000 in May and is up 2.3 million in the past year . Manufacturingpayrolls are up 259,000 in the past year, the fastest twelve-month increase since 1998.
How to Prepare for a Changing Bond Market.
The words ‘bear market’
Bonds and a bear market
Many people believe bonds are
- Inflation risk, which is the possibility your savings may grow more slowly than inflation increases.
- Credit risk, which is the possibility the company issuing a bond will fail to make interest payments and/or repay principal in a timely way.
- Interest rate risk, which is the possibility the value of bond holdings will fall as interest rates rise.
Interest rate risk is associated with a bear market in bonds. Barron’s explained it like this:
“Unlike the stock market, where a 20 percent drop in prices is considered the marker of a bear market, there is no consensus about what constitutes a bear market in bonds…To distinguish between temporary spikes and actual bear markets, we think it’s reasonable to define a bear market in bonds as a sustained decline in prices (or rise in yields, which move inversely to prices) during a period of tighter monetary policy from the Federal Reserve.”
One reason the definition of a bear market in bonds is poorly specified is
That doesn’t mean bond rates haven’t fluctuated. Barron’s reported, at least nine times during the bond bull market, rates increased significantly. In other words, there were times when rates rose and bonds lost value during the bull market in bonds, just as there were times during a bull market in stocks when values fell before rising again.
Bonds and stocks are very different types of investments, though. When investors buy stocks, they become owners of companies. If a company does well, its shares may gain value. If a company performs poorly, its shares may lose value.
When investors put money in bonds, they are lending that money to a government, a company, or another entity. The investor expects to receive timely interest payments and a return of principal when the bond matures.
There is an inverse relationship between bond rates and bond prices. Imagine two children sitting at opposite ends of a seesaw. Typically, when interest rates go up, bond prices fall, and when interest rates go down, bond prices rise.
Challenges and opportunities in a rising rate environment
Currently, we appear to be on the cusp of a period of rising interest rates. The Federal Reserve began encouraging higher rates in December 2015 when it increased the Fed funds rate for the first time in a decade. Since then, the Fed has raised rates six times.
Early on, the rate on 10-year Treasuries remained stubbornly low despite the Fed’s efforts. In fact, it fell below 2 percent following the rate hike and stayed there until November 2016. This year, bond rates have pushed higher.
As the interest rate environment changes, talk with your financial advisor about the ways they will approach the challenges and opportunities created. Your advisor may employ strategies such as:
- Rebalancing to maintain a consistent average maturity. One way to address the risk of rising rates is to include bonds with different maturities in your portfolio. The higher rates on new bonds added to the portfolio may help offset any capital losses caused by rising interest rates.
- Reducing portfolio duration. Duration is a measure of a portfolio’s sensitivity to changes in interest rates. The longer the duration, the greater the change in price relative to interest rate movement. The shorter the duration, the lesser the change in price relative to interest rate movement. Barron’s explained:
“A bond with a duration of five years typically will move down in price by about 5 percent for every 100-basis-point increase in interest rates. A bond with a 2-year duration typically will move down by about 2 percent.”
While bond bear markets create challenges, they also create opportunities. For example, investors may have a chance to:
- Reduce portfolio risk. During the past decade, investors who
soughtincome shifted assets from historically low-yielding bonds to dividend-paying stocks, lower-rated bonds, and other higher-yielding sectors of the market, according to T. Rowe Price. This may have increased the preferred risk level of conservative investors’ portfolios. As bond rates rise, portfolios may be able to meet income objectives by investing in lower-risk bonds.
- Find bargains among dividend stocks. If investors move out of dividend-paying stocks and into bonds, the prices of some companies’ shares may become more attractive, according to Barron’s.
Bear markets, whether in stocks, bonds, or another type of investment, make many investors uncomfortable. Two ways to weather any type of bear market are to minimize risk through portfolio positioning and capitalize on opportunities created as the market environment changes. If you would like to learn more, give us a call.
It’s Water Under the Bridge.
Water is so common we tend to take it for granted. We drink it, cook with it, wash with it, swim in it, and rarely give it much thought. We should, though, because fresh water is rarer than many people realize. According to National Geographic, “Over 68 percent of the fresh water on Earth is found in
- Our planet is mostly H2O. However, more than 96 percent of the water on Earth is salt water.
- The atoms in the water you drink today were around when dinosaurs roamed the Earth.
- Water is the only compound on earth that can be found naturally in three forms – solid, liquid, and gas.
- The average person in the United States uses 80 to 100 gallons of water each day, according to the U.S. Department of Interior’s estimates.
- Thermal power plants generate the majority of the world’s electricity – more than 81 percent – and cannot run without water.
- ‘Day Zero’ is the day Cape Town, South Africa will become the first major metropolis to run out of
water. When it arrives, residents will receive rations of seven gallons a day.
McKinsey & Company estimates suggest current water supplies will meet just 60 percent of global demand by 2030. The fraction may be lower in countries like China, India, and South Africa where water supplies are already under stress.
“To find the universal elements enough; to find the air and the water exhilarating; to be refreshed by a morning walk or an evening saunter…to be thrilled by the stars at night; to be elated over a bird's nest or a wildflower in spring – these are some of the rewards of the simple life.”
~ John Burroughs, American Naturalist
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RJFS and SPC do not offer or provide legal or tax advice. Tax services and analysis are provided by the related firm, S&M through a separate engagement letter with clients. Portions of this newsletter were prepared by Carson Group Coaching. Carson Group Coaching is not affiliated with RJFS, SPC or S&M. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation of an offer to buy, hold or sell any security referred to herein. There is no assurance any of the trends mentioned will continue in the future. Any opinions are those of the author and not necessarily those of RJFS. Any expression of opinion is as of this date and is subject to change without notice.
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