The Financial Earth Shook
May marked the turning point of what financial people label as the great inflection: the time when interest rates would begin to ascend.
Over the past two months, interest rates on the US Treasury ten year bond rose from 1.7% to 2.7%. This is one of the steepest and swiftest rises in the ten year yield that we have seen since 2010. Investment portfolios absorbed the impact of this substantial rise in interest rates during May and June. Any fixed income investment suffered (since bond values decline when interest rates increase). By the end of June, the stock market had gained almost 14% for the first half of the year. A portfolio invested in bonds is likely to have lost 8% over the same period, even after accounting for the income that bonds pay. This would heavily impact an investment portfolio that holds any fixed income investments along with stocks. A hypothetical $100,000 portfolio invested 50%-50% in each asset class would only have a total return for this year of about 3% taking into account the gain in stocks with the loss on bonds. Any portfolio that is more heavily invested in bonds would have fared even worse over the past six months.
Higher interest rates are usually caused by a stronger economy but conclusive evidence of a strengthening economy is still proving elusive. For this reason, we did not make any material change in our bond holdings in the second quarter. The cause of the recent interest rate shift was not because of an improving economy. Instead, it was the anticipation of a reduction in the Federal Reserve quantitative easing program. This pending reduction in the program is referred to as “the taper”. Interest rates moved higher on speculation that the taper will cause interest rates to return to higher levels.
It’s funny that for many years, radio commercials for mortgage companies loudly pronounced locking in on a “once in a lifetime opportunity” for low mortgage rates. For years, these guys have been wrong. Are they finally going to finally be right?
Managing investments in a rising interest rate environment is a dangerous process. The core issue to bear in mind, regardless of the reports of the analysts, is higher rates ultimately dampen economic activity. If rates continue to ratchet higher, they would reach a point at which their impact will be so economically detrimental as to cause them to come back down. Ultimately, higher interest rates create an attractive investment opportunity to lock in on higher yields.
What do we learn from Apple and Steve Jobs?
Last year, Apple was the star of the stock market. Surging sales of the ipad and the iphone revved investor enthusiasm. Apple shares rose over 400 points between June 2011 and July 2012. Today, Apple shares are alomost 300 points lower than last July. Even though Apple shares are much lower today than last year, we acknowledge Apple to be an epic company that has served to change the world with its simple, usable technology products.
Despite the legendary status of Steve Jobs and Apple, it is possible that many companies reach the same status and growth as Apple. In the future, we might look back on today and conclude that Apple spawned a new era of breakthroughs in American business. Many companies are making a monumental impact to industry. The innovation that comes from these companies can actually contribute to making our world a better and more friendly place. These products and services of these companies make us more efficient at our jobs, produce education, entertain us, save our energy and resources, and, of course, cure disease. Examples of these companies are Linkedin, Google, Three D Systems, GrandCanyon Education, Netflix,Tesla, First Solar, Celgene, and Pharmacyclics. Even more provocatively, it is likely that the best is yet to come from this group. The work of Apple and Steve Jobs to make practical and useful solutions has ushered in a great ecosystem (in keeping with popular lexicon) of investment opportunity.
Peregrine Returns and Strategy
Keeping with the TINA Principle (see 2013 1st quarter Market Overview), the stock market continued its winning ways in the second quarter. We did see a brief interruption in the form of a June swoon that took the S&P down 5% over a two week period. The talk of the “taper” by Fed Chair Ben Bernanke preceded this decline. In spite of this pullback, the index finished with a modest gain of 2.91% for the quarter. The Dow climbed to an all-time record, over 15400 at mid May and in the early weeks of July; it has returned to that level.
Our Equity Composite gained 1.23% for the quarter and is up 8.29% for the first half of the year. Our Balanced Composite finished the quarter with a small loss and is only up 2.85% in the six months. Like I covered above, the decline in the value of our bonds caused our balanced accounts to tread water in the quarter.
The threat of higher interest rates poses a considerable problem for our balanced accounts since the drop in bond values would offset any stock market gains. In this third quarter, if interest rates move higher, it would be most beneficial to sell some of our fixed income assets.
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.