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In This Issue
ETF Trends
History Speaks
Chart of the Month
Asset Class Returns
Market Commentary
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IHA MonthlyTop
July 2013
InnerHarbor Advisors, LLC is a private Financial Planning firm based in New York City founded by Michael J. Keating and John O'Meara. 
Financial Planning Video Highlight
ETF Trends
  
History Speaks
Orange County In The Red
  
The recent abrupt rise in interest rates brings to mind a similar period nearly 20 years ago which resulted in the bankruptcy of Orange County, California. 1994 was a tumultuous period for bonds as the benchmark federal funds rate rose nearly 3 percentage points. This caused pain for a lot of investors but perhaps nobody as much as Robert Citron, treasurer of Orange County. Mr. Citron had run a successful investment strategy that seemed to produce above average returns with minimum  
Robert L. Citron
volatility. It was so successful that many surrounding counties gave their money to Mr. Citron to invest. His strategy amounted to borrowing money on a short term basis and lending money on a longer term basis. He then collected the difference in yields between the two. In itself this strategy did not produce very high returns which Mr. Citron solved by borrowing $12 billion to put alongside his $8 billion fund. The risk in his strategy was that short term rates move higher than long term rates - precisely what happened in 1994. Mr. Citron seemed to have no strategy in the event this happened - at one point he consulted an astrologer and psychic on the direction of interest rates. The plunge in value of investments- paper losses were over $1.6 billion- caused Orange County to declare bankruptcy in December 1994. In the aftermath of the crisis, Orange County was forced to layoff one thousand employees, Mr. Citron spent a year in jail and his primary broker, Merrill Lynch, paid $400 million to settle their liability in the case.
Chart of the Month
Funds Flowing Out of Bonds
 
The one sure thing on Wall Street is that investors- large and small- chase performance. From FT Alphaville, this chart shows the epic outflow of money from bond funds in June as losses mounted with rising interest rates.
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Asset Class Returns
Through June 30th, 2013

Returns assume dividend reinvestment and do not include any types of management fees, transaction costs or expenses. 

     

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 Commentary

July Commentary

 

June was a tough month for nearly all asset classes, even for US stocks which have seemed impervious to bad news in 2013. Notable among the losses, nearly all types of bond funds were down for the month. As bond prices move inversely to yield, this reflects a marked rise in rates over the last two months. There is little doubt that this is a result of investors repricing bond holdings purely due to the fear the Federal Reserve will begin "tapering" their asset purchases later in the year. The other drivers of bond yields have remained benign as GDP growth was restrained in the first quarter and is likely to be so in the second quarter. Inflation expectations are declining as reflected in the chart below which shows the difference between 10 year treasury yield and 10 year TIP yield. In essence this shows the future inflation rate investors expect to see, and it has been declining rapidly the last quarter.

 

In summary- rising rates can expose some problems (see the History Speaks section above regarding Orange County in 1994) and a first order effect will be a flow of investor dollars out of bond funds (see our Chart of the Month above). There has been a noticeable effort by the Federal Reserve to dial back the market's expectation on the timing and speed it will slow down its asset purchases. While Fed officials would prefer to see rates go higher in the longer term, rapid moves in yields can have adverse effects on bonds, mortgages and the banking sector. In the meantime, we still advise caution to those tempted to abandon their bond holdings. Bonds still play an important role in limiting volatility and providing stability in a diversified portfolio. Large moves down in any asset class inherently cause investors- large and small- to consider selling and walking away, but making these reactive decisions in the midst of such a move rarely works out to an investor's advantage. 

 

Please 'reply' to this email with thoughts and ideas. Feedback is appreciated.

Thank you for reading.

 

 

 

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InnerHarbor Advisors, LLC
420 Lexington Ave, NYC 10170
212-949-0494
Managing Partners:
John O'Meara, CFP, M.S.             j.omeara@inneradv.com 
Michael J. Keating, CFP    m.keating@inneradv.com

 
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