SNL's Rendition of Blue Oyster Cult's "Don't Fear The Reaper"
Did you hear that bell clanging this week? A loud cowbell clang?
In case you missed it, interest rates rose dramatically. The yield on a 10 year US Treasury rose from 2.03% to 2.31%!
Yields on 10 year Treasuries have been trading in a tight range for months, from about 1.80% to 2.10% (It's why they call it fixed income, yields seemed fixed at a perpetually low level). This weeks breakout to the upside in yields was dramatic.
Remember that when yields rise, the prices on the bonds falls. If 10 year Treasury yields were to rise from 2% to 3% over the next year, you could expect to find the average treasury bond fund lose about 10%. This weeks 30 basis point rise led to a 3% loss in the average treasury ETF.
One of my biggest worries is interest rate risk. When yields are near zero, we invest with the knowledge that we'll make nothing, hopefully we'll get our money back, and hopefully rates won't rise too quickly. Very dangerous; zero return and two hopefully's in one sentence. But where else do we run for "Risk off"?
This week our Treasury bond indicators moved from bullish to neutral, and we subsequently lowered our weight from 13% to 9%. This is the 1st such move in a year.
So, what caused the spike in yields this week, and more importantly should we expect a more sustained rise?
As with all things market oriented there is no clear answer to the first question, and only speculation on the second.
There are several potential culprits for this weeks rate rise, each probably played a role, but we will never know to what extent:
1) Economic growth - It does appear that the economy is growing a bit. It is still early to tell whether or not it can sustain momentum without the Fed's helping hand, but it is moving in the right direction.
2) Chinese growth slowing and their trade surplus dropping - With a declining trade surplus the Chinese may be buying fewer Treasury bonds.
3) Quantitative Easing slowing - The Fed kind of hinted to the fact that the economy may no longer need their intervention. We've seen similar pronouncements from the Bank of England, the ECB, and the BOJ.
4) Unwinding of the "Risk-off" Trade - As Europe fears abate, investors are repatriating funds back to Europe and the Emerging Markets.
5) Inflation - Even though the CPI printed a 2.9% annual inflation picture, real inflation in things like food and fuel is running considerably higher.
Is this rise in rates sustainable, will it go higher, or will they fall back below 2%? No one knows, and if they tell you otherwise walk away.
I know what I see (and in this case hear), the markets are telling me that hiding out in fixed income can be very dangerous to your net worth. We've lowered our weight to neutral, and we're ready to move in whatever direction the market tells us to move. If you are sitting with a large fixed income position (especially funds or ETF's) you should be sweating.
Listen to that cowbell.
Our International equity indicators have also moved this week from Neutral to Bullish. Subsequently we've increased our exposure to developed international equities (EFA), and emerging market equities (VWO) to our full bullish weights of 10%. Even international REIT's increased from neutral to bullish.
One area we did cut back was in our Chinese Yuan currency position, as the risk of a hard landing in the Chinese economy increased.
More Signs of a US Industrial Renaissance
Because of the plentiful and cheap natural gas in the region, Royal Dutch Shell has just announced that they have chosen Beaver County, PA (about 35 miles north of here), as the site for their new $2 billion petrochemical plant. This is the first new petrochemical plant to be constructed in the US since 2000. Obviously this is great news for the Pittsburgh region! Shell expects about 10,000 construction jobs, and 10,000 permanent jobs at the plant and surrounding supplier industries. Give Governor Corbett a huge thank you as he worked to out pitch both Ohio and West Virginia. Unemployment in Beaver County is 6.8%, look for that to fall to the sub 5% level over the next several years.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
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This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
