Current Thinking June 7, 2013 To Taper or not to Taper, that is the question…whether it is nobler to suffer the slings and arrows of economic pundits or to stay the course on this bond buying binge – that is the question that the Federal Reserve is no doubt dealing with (all due respect to Shakespeare, of course). Payrolls increased 175,000 last month beating the median estimate of 163,000. The unemployment rate rose to 7.6% from 7.5% as more people entered the labor force. Bloomberg reports that the underemployment rate, part-time workers who want a fulltime job and people who have given up the search, dropped from 13.9 to 13.8%. Business news outlets are fixated on the question of Fed tapering, or when will the Federal Reserve begin to slow down their $85 billion a month bond buying. Frankly so are we. And then we started thinking: just how much does this $85 billion a month mean to the US bond market? Seems like a lot, but is it? The Securities Industry and Financial Markets Association reports on their website (sifma.org) that the average daily volume of US bonds (everything from municipals to corporates and governments) was $843.1 billion in 2012. Doing some quick math and using 20 trading days a month just to keep it easy, this $85 billion a month buying habit is only 50 basis points (one half of one percent) worth of daily volume. Not much in our opinion – we would suggest that the Fed’s efforts are more psychological in nature. Readers of Current Thinking have heard us proclaim that the yield on the U.S. ten year Treasury bond is perhaps the most important number in our lives (it currently stands at 2.12% as we write this). It drives the cost of borrowing – the cost of money is expressed as an interest rate. We have a new generation of consumers that have never experienced life with a ten year yield of over 8% (early 1990 was the last time). Many of you remember double digit bank CD rates as well as double digit mortgage rates – to our younger consumers this is the stuff of horror stories. So – we are done with the history and math lesson – now what? We are entering into one of those perverse periods where good economic news will be met with a bad market reaction. As the economy improves, the possibility of the Fed tapering, or reducing, their bond buying increases. The stock market likes easy money, and the market will not like the removal of this easy money. “Don’t fight the Fed” has been the mantra of stock market participants for decades. This Quantitative Easing policy of the Fed is psychological - it has kept interest rates down. As this psychology changes so will the market. One well known pundit described a U.S ten year Treasury yield of 2.50% as taking 500 to 600 points off of Dow Jones Industrial Average (currently at 15,190.78). We continue to hold more short term high grade corporates with only 35% of our portfolios allocated to equities. Markets will adjust to a new normal of higher rates – we just think the first part of the adjustment will be down – and we would like to miss that. Have great summer and safe Fourth of July! Erick, ezanner@jdminvestmentcounsel
Posted on: Mon, 10 Jun 2013 15:24:29 +0000
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