So, when is the Federal Reserve going to increase the rate for overnight borrowing?

It’s a question that has plagued bond investors throughout the first quarter of 2015. In January, 10-year Treasury yields fell as low as 1.6 percent. Early in March, they rose to about 2.2 percent before falling back below 2.0 percent. The Financial Times reported:

“Higher volatility is typical when markets are on the cusp of a major turning point, and that has been the story so far this year for U.S. Treasury debt… The year has already been characterized by big swings in bond yields, which move inversely with prices… The lack of a clear signal over when policy shifts towards a tightening phase may provide the central bank with greater flexibility but does not quell the uncertainty facing investors.”

In recent weeks, Fed Chairwoman Janet Yellen indicated the timing and pace of a rate change would be determined by economic data. In general, the Fed considers a variety of employment and inflation measures when determining policy. The Times suggested bond markets have priced out the possibility of a June rate hike, although several Federal Reserve officials recently said a June increase is still under consideration.

U.S. stock markets reflected investor uncertainty last week, too. Turmoil in the Middle East sparked concern an oil price reversal could occur if supply is disrupted. In addition, investors worried weaker-than-expected economic data might indicate U.S. economic growth was slowing. The Commerce Department reported business investment spending plans fell for the sixth straight month. That could result in reduced expectations for first quarter growth, as well as delay a Fed rate increase. Stock markets showed signs of life late in the week but finished lower.

S&P 500, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT Total Return Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Your grandparents and great-grandparents saw a lot of things change during their lifetimes… During the 20th century, the first Nobel prizes were awarded. The first license plates were issued. The first World Series was played. Americans lived through McCarthyism, the Great Depression, and Orson Welles’ ‘The War of the Worlds’ broadcast. Rock and roll became popular. The first theme parks opened, NASA was formed, and Earth Day was introduced. Two World Wars were fought as well as the Vietnam, Korean, and Gulf Wars. The Gold Standard ended and the tech revolution arrived.

Many of these events had immediate or eventual implications for industries – automobiles, sports, communications, entertainment, defense, technology, and others – as well as financial markets. The last decade has seen some significant changes, too. Here are a few milestones we’ve witnessed:

2006: The United States population passed 300 million. (100 million in 1915; 200 million in 1967)
2007: More babies were born in the United States than in any other year in American history.
2008: Nielsen reported texting had become more popular than calling.
2009: More people lived in urban areas than in rural areas across the globe.
2010: This was the hottest year since 1880 – until the record was broken again in 2014.
2011: Digital music sales overtook physical music sales for the first time ever.
2012: China became the world’s biggest trading nation and largest pork producer.
2013: The United States overtook the Saudis to become the world’s biggest oil producer.
2014: China’s economy surpassed that of the United States.
2015: Millennials (born 1980 to late 1990s) became our nation’s largest living generation.

When considering investment opportunities, it can be helpful to ponder the ways in which demographic and economic shifts may affect the future and what types of businesses may benefit (or not benefit) from the changes.

Weekly Focus – Think About It

“Friendship is always a sweet responsibility, never an opportunity.”
--Khalil Gibran, Lebanese poet and writer

Are central banks throwing a progressive party?

You know, the kind of party where folks travel from house to house feasting and drinking and enjoying the proffered hospitality. For years pundits have speculated about what will happen to the U.S. stock market party when the spiked punch bowl of quantitative easing is gone. Last week, they got an unexpected answer: Come on over to Japan’s house.

On Wednesday, the U.S. Federal Reserve announced October marked the end of its third round of quantitative easing (QE). Since late 2008, the Fed has purchased trillions of dollars of government and mortgage-backed bonds in an effort to spur economic growth (by increasing liquidity and lending) and head off deflation. In October, The New York Times reported, “The good news is that economy has been growing remarkably steadily since the middle of 2009… Still, the pace of growth has been perpetually disappointing for anyone expecting or betting on a return to the pre-crisis trend.”

Not long after the Fed announced QE closing time, Japan’s central bank, Bank of Japan (BOJ), startled stock markets with a Godzilla-sized surprise – it was expanding an already significant quantitative easing program. As if that weren’t enough, the President of Japan’s Government Pension Investment Fund (the world’s largest pension fund) said the fund’s assets were being reallocated. Instead of having 60 percent invested in bonds, it would keep 35 percent in bonds and move the balance to stocks. The news electrified stock markets. Barron’s reported:

“Stocks soared around the globe while the yen plunged against the dollar and the euro. Extending the previous week’s surge, the major U.S. equity gauges ended at records on Friday, while stocks in Tokyo jumped more than 7 percent on the week to the highest level since November 2007. Not to be left out, European stocks gained 3 percent, their best weekly showing since last December.”

Barron’s also pointed out the real effect of a falling yen was to export deflation to Japan’s trade partners. The drop in the value of the yen on Friday translated into a $1,500 price cut on a $60,000 Lexus or Acura, increasing competition for luxury German automobiles.

So, what’s the next stop for revelers at the central bank fête? The New York Times speculates it may be the Eurozone.

S&P 500, Gold, Bloomberg Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT Total Return Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

WHY ARE PEOPLE WORRYING ABOUT DEFLATION?, Deflation is a general decline in prices. For anyone who has been struggling to make ends meet that may not sound all bad. In fact, it’s not always bad. According to the Federal Reserve Bank of St. Louis, between 1876 and 1879, prices in the United States fell by about 5 percent per year, on average, while the economy grew at a 7.6 percent clip.

Of course, deflation is not always good either. Financial crises in the United States during 1890, 1893, 1907, and the early 1930s were followed by periods of lower economic growth and deflation. The Economist described the harmful effects of deflation like this:

“It is a pernicious threat, all the more so because, at its onset, it seems almost benign… The belief that money made tomorrow will be worth less than money today stymies investment; the belief that goods bought tomorrow will be cheaper than goods bought today chokes consumption… Wages, incomes, and tax revenue all stall, undermining the ability of households, businesses, and governments to pay their debts – debts which, in real terms, will grow more burdensome under deflation.”

Deflation is a greater threat in Europe than in the United States. The European Central Bank’s most recent bulletin distinguished between deflation (a significant and persistent decline in prices that becomes entrenched in expectations) and disinflation (a process of decelerating inflation that may lead to negative inflation rates but is a temporary state of affairs). Italy, Spain, Greece, Sweden, and Israel experienced negative inflation in September, according to The Economist. It reported, “The IMF [International Monetary Fund] recently put the odds of deflation in the euro zone – defined as two quarters of falling prices in a 12-month span – at 30 percent in the coming year.”

Weekly Focus – Think About It

“And so it began: a growing realization that the vampire genre is positively swollen with economic questions. And the zombie genre? Maybe more so. Economic issues take center stage in many undead narratives – and when they don’t, they’re still lurking in the shadows.”
--Economics of the Undead, A collection of essays

Best regards,

Lee R Barczak, RIA
President