Daily Archives: December 15, 2016

Heads Up!

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Interest rates are rising! And, we suspect interest rates will rise much further. A most respected bond market guru, Jeffrey Gundlach, CEO of DoubleLine Capital and one of the world’s most successful bond investors, predicts a rise in bond yields that could lift the yield on the 10-year Treasury note to 6% in the next four or five years from its current level of 2.5%.

Trump’s pro-business agenda is inherently “unfriendly” to bonds, Gundlach says, as it could to lead to stronger economic growth and renewed inflation. Gundlach expects President-elect Trump to “amp up the deficit” to pay for infrastructure projects and other programs. That could produce an inflation rate of 3% and nominal growth of 4% to 6% in gross domestic product. “If nominal GDP pushes toward 4%, 5%, or even 6%, there is no way you are going to get bond yields to stay below 2%,” Gundlach says.

Additionally, the current FED Chairperson Janet Yellen’s tenure may end in 13 months. The new FED chair could sell, over time, the $3.5 Trillion of Treasury Bonds and mortgages the FED acquired since 2008. We reckon this will add substantial pressure to lift interest rates even higher.

NOTE: Keep in mind, rising interest rates reduces the price of bond and bond mutual fund currently owned. The longer the bond maturity, the larger the drop in price.

ACTION: Now is the time for implementing the following portfolio strategies: (1) eliminate long term bonds (over 15 years maturity) and long term bond mutual funds; and (2) reduce the holdings of intermediate term bonds and intermediate term bond mutual funds; and (3) invest the proceeds of (1) and (2) into short-term bonds.

The “Heat Map”

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Most of the time, the U.S. stock market looks to 3 factors (call them the “pillars” which support the stock market) to support its upward trend – let’s grade each of the pillars.

CONSUMER SPENDING: This grade is A- (very favorable). Favorable activity in the housing market continues to support growth in the level of spending. This category’s grade will improve if and when the Trump legislation is passed.

THE FED AND ITS POLICIES: This factor is rated C- (DOWN FROM A). Yesterday, the FED raised interest rates .25%. The FED also signaled it might raise rates three times during 2017 which exceeded bond market experts’ prediction of 2 moves during 2017. And, the FED stated it would take a wait and see attitude toward the economic impact of legislation the Trump Administrations has proposed. Some experts believe the FED could raise rates at a faster pace if and when the Trump proposed legislation is passed into law. The FED is in the process of turning from a friend to the stock market to an anchor weighing down profitability, reducing valuations, and constraining growth.

BUSINESS PROFITABILITY: This factor’s grade is rated a B- (above average). Trump’s goal is a 4% growth rate for the U.S. economy. This will increase business profits significantly.

OTHER CONCERNS: The “Heat Map” is indicating the U.S. stock market is in OK shape ASSUMING no international crisis. On a scale of 1 to 10 with 10 being the highest level of crisis, we rate these international risks collectively as a 3 (decrease from the last Weekly Commentary).  These risks deserve our ongoing attention.

The Numbers

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Last week, U.S. Stocks and Foreign Stocks increased, but Bonds declined. During the last 12 months, STOCKS outperformed BONDS.

Returns through 12-9-2016

1-week

Y-T-D

1-Year

3-Years

5-Years

10-Years

Bonds- BarCap Aggregate Index

-.3

2.1

1.7

2.8

2.3

4.3

US Stocks-Standard & Poor’s 500

3.1

12.9

12.8

10.0

14.9

7.1

Foreign Stocks- MS EAFE Developed Countries

2.9

.6

.8

-.7

6.2

.9

Source: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized excluding dividends.

The Markets This Week

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For the market last week, it was time for wallflowers to finally join the party.

It wasn’t simply that all three major indexes rallied to new all-time highs, but that the tenor of the rally appeared to have changed, as well. Sure, the Dow Jones Industrial Average gained 586.43 points, or 3.1%, to 19,756.85, leaving the blue-chip benchmark just 243.15 points away from 20,000. The Standard & Poor’s 500 index rose to 2,259.53, and the Nasdaq Composite, which had been trailing for so long, climbed 3.6%, to 5,444.50.

Yet for the first time since Donald J. Trump’s victory in the 2016 election, the split between apparent winners and losers under his presidency began to narrow. Yes, the financial sector continued to top the S&P 500 after gaining 4.8% last week, but technology, which has been bringing up the rear in recent weeks, was a close second after rising 4.2%. And even health care, which tumbled as much as 2.2% on Wednesday after Trump criticized drug pricing, managed to finish the week in positive territory.

“Instead of health care dragging the market down, the market pulled health care along for the ride,” says Instinet’s Frank Cappelleri.

What’s behind the sudden shift? A big, heaping dose of confidence. On Friday, the University of Michigan’s preliminary consumer confidence index for December rose to 98, the highest reading since January 2015, and is nearing its highest level since 2004. And in a report released last week, Bank of America Merrill Lynch economist Michelle Meyer, after perusing the available anecdotal evidence from company earnings calls and other sources, noted that “there is more optimism about the economy following the election.”

If Trump’s tax cuts and spending plans become reality, that could create a virtuous cycle where “the gain in animal spirits could amplify the boost to the economy from fiscal stimulus,” Meyer wrote.

(Source: Barrons Online)