RISK HAPPENS FAST

It's often been said that markets take the stairs higher and the elevator lower.

It appears that comments from the Federal Reserve last week caused investors to rethink their positions in credit and equity markets.  I have a variant view on what has transpired.  I believe the Fed saw a ghost in the form of a stock market that went straight up for six months, ostensibly on the back of easy money policy and opened-ended quantitative easing (QE).

The Fed began hinting in their February and March meeting minutes that they were concerned with the potential risks of too much QE - i.e. the creation of imbalances and excesses that plagued monetary policy for much of the last twenty years.

Enter talk of tapering.  Fed chair Ben Bernanke said last week that they could begin tapering the latest round of bond purchases as soon as this fall, but that the decision would be data-dependent.  What is curious is he/they chose to begin the "tapering talk" at the same time that inflation is weakening (the Fed's preferred measure of inflation - the PCE deflator is at a record low) and unemployment remains above their stated rate of 6.5%.

I believe their primary purpose is to reign in some speculative fervor that is manifesting itself in various markets.  Stocks rose uninterrupted for six months, margin debt has again reached all-time record highs, junk bond yields reached record lows.

But this a dangerous game to play with levered market participants.  Currency disruptions in Asia, combined with the risk of convexity blowouts in mortgage backed securities could lead to a reflexive bout of volatility across various markets.  While I don't believe the Fed intended a sharp spike in interest rates, the impact of a 1% rise in the benchmark 10-year Treasury yield 1.6% to 2.6% over a span of several weeks puts investors on their heels.  While housing has bounced strongly off its lows, the shift higher in mortgage rates (back above 4% for 30-year borrowers) risks derailing the strongest part of the economy.

We have been extra cautious in positioning our bond allocations with yields on the deck, and that has been the right decisions thus far.  We have also been cautious adding stock positions as domestic stocks have rallied in a parabolic manner for the majority of 2012.  We have reduced incremental exposure to the higher risk small cap and emerging market sectors, and focused on yield-producing parts of the market.

We expect the shift in Fed dialogue, along with volatility in interest rates and currencies will likely usher in a period of choppy trading for the remainder of the summer.

We will continue to look to find assets that offer a compelling risk/reward trade-off but will be patient in deploying capital - Risk happens fast!.

SRP

BOND INVESTORS FEEL PAIN FROM RISING RATES

We've been extremely cautious deploying capital toward bonds/fixed income in an environment where interest rates scrape the bottom of the floor.  The New York Times comments on the pain investors are feeling with rates on the rise...

"As if it wasn’t bad enough for the millions of Americans scraping by on paltry interest payments, now they face another threat: the loss of principal on their bonds and other fixed-income assets. The month of May, and this first week of June, was terrible for many fixed-income investors who have spent the last few years reaching for higher yields. If there was an index for fixed income with the status of the Dow Jones Industrial Average or Standard & Poor’s 500 Index for stocks, the carnage in fixed-income markets would have been a big story and we’d all be talking about a bear market in bonds.
Consider the damage: mutual funds that invest in long-term United States Treasury bonds lost an average 6.8 percent in May, according to Morningstar, with the loss in principal wiping out years of interest payments. But that’s not the worst-hit sector. Higher-yielding bonds and fixed-income securities, to which investors have turned in droves in recent years, have suffered even more, especially mortgage-backed securities and emerging market debt, as well as just about anything that uses borrowing to increase returns. Many individual securities and funds were hit much harder than the averages. Vanguard’s Extended Duration Treasury Index fund was down more than 6 percent in the last month. In the mortgage area, Annaly Capital Management, a popular real estate investment trust that invests in mortgages, fell 8.7 percent, and an iShares mortgage exchange-traded fund lost 10.4 percent. Pimco’s Corporate Opportunity Fund, which is managed by the star analyst Bill Gross and which invests in a mix of corporate bonds and mortgage-backed securities and uses some borrowing, lost nearly 13.4 percent. Annualized, such declines are off the charts." 

Welcome!

Welcome to the online blog for Cypress Wealth Advisors.  Our team will use this medium to share content related to all aspects of wealth management, including investments, financial planning, tax issues, estate planning.  Much of what we will share will be macro-economic related data points that we follow to craft our investment thesis.

We hope this a useful outlet to connect with clients, friends and folks to share our thought process as we navigate an increasingly confusing financial landscape.

SRP