Home Sales stunk, and the Fed Governors are squabbling. Ergo: markets sold off. This strikes us as more than casual market noise, and it appears as though there has been a very significant shift in Fed policy. Throughout the fall of 2009 and spring of 2010, the Fed had been on course to measurably terminate various types of monetary accommodation. They were well on course with their stealthy tightening until last week when they announced that they would be reinvesting principal payments from their $2.3 trillion portfolio. That’s a big deal. It is a major about-face. It seems they tried to temper the severity of their move by disclosing that there were dissenters among their ranks. It looked like a way to try to make their dovish shift a bit edgy. (Aren’t they required to report what is said in the meetings?)
They may have sent the wrong message or at least their message may have unintended consequences. Wall Street has conferred upon the Fed mystical powers of solomonesque omniscience. Squabbling undermines the Fed’s mandate. It makes them appear downright mortal and perhaps even fallible. Steve Roach said on CNBC that he thought that this Fed was being reactionary and not strategic. He may be right, or it may be that this shift is indeed strategic and indicates a more severe economic condition than most expect. Whether reaction or strategy, the Fed has ceased its contraction and reversed to an expansive posture.
We know that jobs aren’t being added and that consumers have their saving hats on. Neither offers much encouragement for speedy recovery. But pay attention to stocks.
As retail investors continue to exit the stock market and enter the bond market en masse, rates are making record lows. The 2-year Treasury Note auction wrought yields of less than one-half percent. The 10-year Treasury Note traded at and below 2.5%. This message of concern for a return of capital as opposed to a return on capital is deafening. Stocks look ever more reasonable.
Big blue-chip multinational corporations are selling at 11 times earnings, have huge amounts of cash on their balance sheets, and dividends largely in the 2-4% range. If you believe that America’s future will continue to grow and flourish over the years and decades ahead, then this period of contraction will pass as all the others have passed, and these levels will be remembered as a good entry point.
There are always exceptions, and there are some individual municipal bonds that are quite interesting right now. Many deals over the past ten years were issued without a standalone rating but with insurance that garnered a AAA rating. . Now that this insurance is considered of questionable worth, many smaller issues (less than $200 million) don’t have much of a following and tend to trade inefficiently. We believe this has created an opportunity for astute investors with the willingness to dig into the numbers and uncover hidden value. Farr, Miller & Washington’s fixed income manager, Glenn Ryhanych, CFA, CFP, said he’s never seen such relative value among select municipal securities.
DC Ballpark Revenue Bonds are interesting to us. This was a huge issuance that carried an A rating on its face. Revenues from a stadium might raise questions about cash flow necessary for debt service, but a little research tells a different story. The primary source of the debt service fund is a business tax on all DC businesses over $5 million in revenues. The secondary source of debt service income is a utility tax for commercial, not residential, subscribers, while the third source is a tax on revenues generated by stadium vendors, and ticket and merchandise sales. These broad-based revenue supports give us greater comfort in considering these bonds for client accounts. Please note that this is not a recommendation to buy or sell. We may be buying or selling these and other issues for clients’ accounts at any time as we deem appropriate.
***Note to subscribers only*** Our Municipal Bond portfolio under Glenn’s management has around a 4 year duration, as of 6/30/10, and returns have been solid. Please contact us for more information on Glenn’s approach for income investors. Complete disclosure is available upon request.
With diligent research and optimism for the future, we continue to research several stocks and bonds that appear to represent compelling value at current levels. It has gotten tougher to invest, but don’t give up, buckle down and do your homework; it will be worth it.
Hang in there.