01/07/15   Bond Demise – Chapter 5

Editor’s Corner

Ron Rowland

The demise of the bond market has been predicted for each of the past four years. Most of the time it was more than a prediction – it was touted as a sure thing. This year was no exception. With a lead-in like that, we probably don’t have to tell you that U.S. Treasury securities constitute one of the best performing asset classes in the early days of 2015. The bond doomsday prognosticators may get it right one of these years. After all, yields are so low they have no place to go but up and take bond prices down in the process, right?

Not so fast. This was the same argument used as we crossed into 2011, 2012, 2013, and 2014 as well as points in between. Yes, unlike stocks that do not have an upside limit, bond yields can’t go below zero, which prevents bonds from achieving infinite price appreciation. However, just because yields can’t go much lower does not mean they will automatically go higher. Take Japan for example. The yield on Japan’s 10-year Treasury notes first fell below 2% in 1997. It’s now 17 years later, and the yield is still below 2%. Maybe it will rise back above 2% one of these years. The current yield on Japan’s 10-year notes is just 0.3%, so it will likely be a while.

The U.S. 10-year Treasury yield dropped below 2% earlier this week. If the U.S. follows a similar course to Japan, we may be looking at even lower 10-year Treasury yields in the year 2030. As we said earlier, low yields do not automatically imply higher yields will follow, no matter how badly the bond doomsday soothsayers want you to believe they will.

However, even if bond yields do not rise in the next 17 years, it does not necessarily make bonds a good investment. Predicting the 10-year return on most investments is futile. The one exception is the U.S. 10-year Treasury note. Anyone buying a 10-year Treasury yesterday at 1.9% and holding it to maturity is locking in a 1.9% annual yield for the next ten years. If you adjust for taxes and inflation, that could easily turn into no yield at all.

Investor Heat Map: 1/7/15

Sectors

The new-year holiday shortened the trading week, but there was no shortage of market volatility.  The Dow saw two days with triple-digit downward moves over the past week, which removed a large amount of investor complacency.  Real Estate was the only sector to gain momentum, and this helped propel it to first place in the rankings.  Utilities held the top spot as 2014 ended but today has slipped to second.  Health Care jumped four places higher in the rankings as it navigated the recent volatility better than most of its peers.  Consumer Staples held steady in fourth, and the improvement in Health Care pushed Consumer Discretionary, Financials, and Technology all a rung lower.  Industrials held its relative position, although it lost nearly all upside momentum and is now in jeopardy of flipping over to a negative trend.  Telecom and Materials swapped places, and both went from green to red.  Crude oil dropped below $48 a barrel this week, a price deemed to be unimaginable a few years ago.  This put further downside pressure on the Energy sector, pushing it deeper into the red.

Styles

The downside market action didn’t shake up the relative rankings of the style categories, although it did suck most of the momentum out of them.  The relative strength ranking of the eleven style categories remains in an inverse-capitalization alignment, suggesting investors haven’t adopted a defensive posture yet.  Micro Cap is on top, followed by Small Cap Growth, Small Cap Blend, and Small Cap Value.  The three Mid Caps occupy the middle ground, with Mid Cap Value leading the trio this week.  Value also took the upper hand among the Large Caps, as it did with Mid Caps.  It is only in the Small Caps where Growth has the advantage over Value.  Mega Cap is still on the bottom and slipped into the red this week.

Global

China is still sitting on top of the world and this week has the seat all to itself as the U.S. lost most of its momentum.  The U.S. kept its #2 ranking and a small sliver of green but is no longer challenging China for first place honors.  World Equity was also in the green a week ago but has succumbed to global selling and now sports a double-digit negative momentum score.  The U.S. dollar gained strength again, producing headwinds for stocks based in other currencies.  Japan held on to its fourth place ranking, while Pacific ex-Japan jumped four spots to grab fifth.  Canada and EAFE swapped places as both weakened significantly.  Emerging Markets climbed two notches while the U.K. slid one.  Europe came under pressure again and this week plunged five places to tenth.  Latin America remains far below the other global categories.  However, Russia has negative momentum about twice the magnitude of Latin America, and it would be far below Latin America if it had its own category.

Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.

 


“If the economy does clearly lose momentum and fall short of expectations, as we suspect, then the Fed is ready and waiting to extend the timeline for liftoff.”

Lindsey Piegza, Economist at Sterne Agee, 1/6/15


DISCLOSURE

© 2015 AllStarInvestor.com All Rights Reserved. Protected by copyright laws of the United States and international treaties. Nothing in this e-mail should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. Any investments recommended in this letter should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company. All Star Investor employees, its affiliates, and clients may hold positions in the recommended securities.

Distribution is encouraged. Please do not alter content.