Monday, November 18, 2013
International stock markets continue to perform well. The broad international index, the MSCI EAFE NR, is up 20.0% year-to-date (YTD). The European-heavy STOXX 600 index is up 15.5%, the Asia/Pacific region is up 10.2%, while the Emerging Markets region continues to trail with a loss of 5.3% YTD.
YOU AND DURATION
I am going out on a limb and make a prediction.
Now everyone who has read my Market Update and Commentary since I began writing them some four years ago knows that I do not like making predictions. The reason is that predictions are nearly impossible to get right repeatedly. So while it may be fun to speculate about future events and outcomes, they rarely provide the basis for consistently sound investment decisions. However, today I am going to do it anyway and here it is: 98% of people find talk about bonds and bond theories boring! Yep, that’s it. With this prediction in mind, I am going to have a discussion with you about bond theory. Why? Because it is very important and many, many investors have a lot of money tied up in bonds. So consider yourselves forewarned and grab a cup of coffee or Red Bull before you read the next couple of paragraphs.
One of the most important concepts for investors to understand is that when interest rates go up, bond prices fall. This happens because as rates increase, a bond owner with a fixed-rate bond must reduce the value of their bond in order to attract buyers. If the bond owner has a bond paying 5% and yields for similar bonds is now 6%, why would a bond buyer purchase a 5% bond when they could get a 6% bond? The answer is they would not, so the bond owner drops the price of their bond until the effective yield to the buyer is 6%.
Therefore, bond owners realize that if interest rates go up, they are likely to lose principal. If they own one bond, the calculation to determine how much the bond’s value will fall as rates rise is relatively easy to determine. But what happens if the bond owner has many different bonds and they want to know the impact of rising interest rates on the overall value of their portfolio? This is where the concept of duration comes in.
If you are still with me, here is what I want you to take away:
1) You must be very aware of the duration of any bond portfolios you own.
2) This time it is different because interest rates are coming off historically low bottoms.
3) I believe there is more risk in bond portfolios than most people realize today.
4) There are more options to invest in bonds than ever before and a smart bond sector strategy can help mitigate the risks of a rising interest rate environment.
Markets continue to reach higher and higher levels. As this happens more articles are appearing in the media about bubbles and corrections. There have only been two down months so far this year (June and August for the DJIA and S&P 500) and these pullbacks were relatively modest. The analysis provided by DorseyWright & Associates continues to favor stocks over bonds, currencies, money market, and commodities. Therefore, I am continuing to recommend that investors stay focused on stocks (US and International) for now.
My next Update and Commentary will be published in two weeks.
Paul L. Merritt, MBA, C(k)P®, AIF®, CRPC®
NTrust Wealth Management
P.S. If you think this type of analysis would be of benefit to anyone you know, please share this communication with them.
Past performance is not indicative of future results and there is no assurance that any forecasts mentioned in this report will be obtained. Technical analysis is just one form of analysis. You may also want to consider quantitative and fundamental analysis before making any investment decisions.
Emerging market investments involve higher risks than investments from developed countries and involve increased risks due to differences in accounting methods, foreign taxation, political instability, and currency fluctuation. The main risks of international investing are currency fluctuations, differences in accounting methods, foreign taxation, economic, political, or financial instability, and lack of timely or reliable information or unfavorable political or legal developments.
The commodities industries can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions. Past performance is no guarantee of future results. These investments may not be suitable for all investors, and there is no guarantee that any investment will be able to sell for a profit in the future. The Dow Jones UBS Commodities Index is composed of futures contracts on physical commodities. This index aims to provide a broadly diversified representation of commodity markets as an asset class. The index represents 19 commodities, which are weighted to account for economic significance and market liquidity. This index cannot be traded directly. The CBOE Volatility Index - more commonly referred to as "VIX" - is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500® Index (SPX) option bid/ask quotes. VIX uses nearby and second nearby options with at least 8 days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.
TIPS are U.S. government securities designed to protect investors and the future value of their fixed-income investments from the adverse effects of inflation. Using the Consumer Price Index (CPI) as a guide, the value of the bond's principal is adjusted upward to keep pace with inflation. Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.
The NYCE US Dollar Index is a measure that calculates the value of the US dollar through a basket of six currencies, the Euro, the Japanese Yen, the British Pound, the Canadian Dollar, the Swedish Krona, and the Swiss franc. The Euro is the predominant currency making up about 57% of the basket.
Currencies and futures generally are volatile and are not suitable for all investors. Investment in foreign exchange related products is subject to many factors that contribute to or increase volatility, such as national debt levels and trade deficits, changes in domestic and foreign interest rates, and investors’ expectations concerning interest rates, currency exchange rates and global or regional political, economic or financial events and situations.
Corporate bonds contain elements of both interest rate risk and credit risk. Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. U.S. Treasury bills do not eliminate market risk. The purchase of bonds is subject to availability and market conditions. There is an inverse relationship between the price of bonds and the yield: when price goes up, yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income.
The bullish percent indicator (BPI) is a market breath indicator. The indicator is calculated by taking the total number of issues in an index or industry that are generating point and figure buy signals and dividing it by the total number of stocks in that group. The basic rule for using the bullish percent index is that when the BPI is above 70%, the market is overbought, and conversely when the indicator is below 30%, the market is oversold. The most popular BPI is the NYSE Bullish Percent Index, which is the tool of choice for famed point and figure analyst, Thomas Dorsey.
Posted by Paul Merritt at 11:05 AM