Market Digest
6.24.15
Observations
Fixed Income: Preparing for Rising Rates

Eventually, the Fed will raise interest rates, a fact that has many fixed income investors worried about losses. While it's true rising rates do cause the market value of bonds to fall, unlike the equity markets, the primary driver of long-term return in fixed income is interest income--not capital appreciation. With a diversified portfolio of individual bonds, investors can reinvest at higher market yields, thereby building their portfolio's return over time.

Vehicles & Investments with Greater Interest Rate Risk
And there are other ways to limit interest-rate risk and increase total return:

 

1) If possible, invest in a separately managed account (SMA). SMA's have distinct advantages over pooled funds - including full transparency and control. You will not be forced to realize losses when fund liquidations cause sales.

 

2) Get defensive by shortening duration and diversifying your maturity structure. Shorter duration portfolios tend to perform better in rising rate environments. Plus, having short and intermediate securities positions your portfolio for faster reinvestment at higher rates.

 

3) Reap the losses to off-set gains in your equities, and reinvest in higher yielding bonds. Yes, it might make sense to take those losses. Always look holistically at your tax strategy to maximize your total return after taxes, across all your investments.

 

4) Make sure you're not paying too much to purchase your bonds. The costs are often hidden in the bid-ask spread but can wipe out up to a year or two of income.

    

5) Hire a professional fixed income manager to take advantage of opportunities across the credit markets and benefit from changes in the shape of the yield curve. A sleepy buy and hold strategy may feel safe, but will most likely underperform a fixed income manager who uses extensive research to actively seek out the best investments on a daily basis.  

Successful fixed income investing in a rising rate environment is not an oxymoron, but it does require skill and expertise. If you would like a no-cost analysis of your current fixed income portfolio to see if you are positioned for long-term success, please give us a call.

 

Market Update
Stocks across the board ended last week higher, largely based on positive signals coming out of the Federal Reserve Open Market Committee meeting. Many traders now believe the Fed will follow a "one and done" policy in which they will raise interest rates slightly and then pause to see what the effect will be on financial markets and the economy. The gains may have been stronger had it not been for the ongoing Greek debt negotiations, which saw little constructive progress last week.

 

Equity Index Returns
Source: Yahoo! Finance
Economic Commentary
> Labor Market, Inflation and the Economic Cycle:The labor market is a lagging indicator of overall economic activity. The current economic expansion began in June 2009, but the private sector economy did not regularly begin creating jobs until early 2010. If GDP growth achieves a 3% growth rate over the remainder of 2015, the economy should routinely create between 200,000 and 250,000 jobs per month - as it has during the middle of every business cycle over the past 30 years when economic growth was between 3% and 4%.

 

Economic Cycle

Although rising wages and inflation often begin to emerge as the business cycle ages, many more factors are still pushing down on inflation than lifting it higher, both in the U.S. and globally. The tepid pace of the current economic expansion in the U.S. - combined with intermittent economic growth in  Europe and Japan, and a decelerating Chinese economy - has maintained the threat of deflation.  Furthermore, a rising dollar and a sharp drop in commodity prices over the past year have left many  economies on the brink of deflation. 

 

> Inflation: Service sector inflation has accelerated since 2010 and remains poised to potentially move  even higher as the economy accelerates, even though goods inflation (commodities, clothing, food, etc.) decelerated sharply in recent years.

Service Sector Inflation
 
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