February 21, 2014
By Steve Blumenthal
One of the upcoming challenges for the Fed, aside from tapering, will be the decision to raise interest rates. Keep in mind that the equity rally we have experienced has been largely fueled by the Fed (click here for a chart) and it is the end of this market presence (unnatural manipulation) that we should be thinking about.
It is important to note that the conversation at the Federal Reserve’s most recent policy meeting turned to something that hasn’t been a serious topic for years: the possibility of interest rate increases in the near future.
Yesterday, I was interviewed on WSJ Live and our short discussion centered on this possibility. I mentioned that I believe the Fed is, as my father used to say, trapped between a rock and a hard place. The link is provided below.
So what moves the Fed in a direction of higher interest rates? The bond market might just do it for them.
Today, I share a few interesting charts and links in this week’s On My Radar:
- Stanford’s John Taylor
- Foreign Purchases of U.S. Bonds and Stocks Fall to 20-Year Low
- Links to TheStreet.com and WSJ Live Interviews
- For now it is a “Don’t Fight The Fed or The Tape” environment
- What you can do today
- Trade Signals – Neutral Investor Sentiment
Stanford’s John Taylor
Stanford University professor John Taylor, creator of a rule for guiding monetary policy, said his framework suggests that Federal Reserve purchases of bonds are no longer needed to fuel economic growth.
We are nearing the end of extraordinary Fed intervention. So the next important thought is who is going to buy the bonds when the Fed steps away? Here is a look at the landscape of ownership and potential buyers.
Foreign Purchases of U.S. Bonds and Stocks Fall to 20-Year Low
The U.S. Treasury manages the U.S. debt through its Bureau of the Public Debt. The Bureau has broken out the debt into two main categories: Intra-governmental Holdings, at $4.995 trillion, and Debt Held by the Public, at $12.122 trillion (as of October 24, 2013). That is over $17 trillion in total. Social Security, Medicare and other unfunded liabilities are another larger problem to discuss on another day. Click here for total debt clock. Total debt owed to GDP is 107%.
Foreign governments and investors hold about half of the nation’s public debt. A little over one-fifth is held by other governmental entities, like the Federal Reserve and state and local governments. Fifteen percent is held by mutual funds, private pension funds, savings bonds or individual Treasury notes. The rest is held by businesses, like banks and insurance companies and a mish-mash of trusts, businesses and investors.
Here’s the breakout (as of March 2013):
- Foreign – $5.724 trillion
- Federal Reserve – $1.794 trillion (this balance is actually higher today due to QE since March 2013)
- State and Local Government, including their pension funds – $703.5 billion
- Mutual Funds – $946.4 billion
- Private Pension Funds – $457.7 billion
- Banks – $341.4 billion
- Insurance Companies – $263.3 billion
- U.S. Savings Bonds – $181.7 billion
- Other (individuals, government-sponsored enterprises, brokers and dealers, bank personal trusts and estates, corporate and non-corporate businesses and other investors) – $1.497 trillion. (Sources: Federal Reserve, Factors Affecting Reserve Balance, March 28, 2013; Treasury Bulletin, Ownership of Federal Securities, Table OFS-2, as of March 2013)
This debt is not only Treasury bills, notes and bonds but also TIPS, savings bonds, and state and local government series securities.
Just under one-third of the Federal debt is owed to about 230 other Federal agencies. How does this happen? Some agencies, like the Social Security Trust Fund, take in more revenue from taxes than they need right now. Rather than stick this cash under a giant mattress, these agencies buy U.S. Treasuries with it.
This effectively transfers their excess cash to the general fund, where it can be spent. Of course, one day they will redeem their Treasury notes for cash. The Federal government will either need to raise taxes, or issue more debt, to give the agencies the cash they will need.
Source: http://useconomy.about.com/od/monetarypolicy/f/Who-Owns-US-National-Debt.htm
One of the charts I follow is the year-over-year change in Net Foreign Purchases of U.S. Bonds and Stocks (12-Month Total).
The chart shows Foreign Purchases at 20-year lows. Concerning to say the least. Lacking sufficient buyers to support our debt addiction, the trillion dollar question is: who will be the big buyer, at such low rates, when the Fed steps away?
This is why the Fed finds itself somewhere “Between a Rock and a Hard Place”. A loss of confidence and a spike in rates may just prick the great bond bubble. This remains high on my worry list.
Links to TheStreet.com and WSJ Live Interviews
Don’t Fight The Fed or The Tape
This, along with the cyclical trend charts provided in Trade Signals below, continues to support the current cyclical bull market trend for now. Watch this chart along with the cyclical trend charts. Caution is advised today as the cyclical bull is aged.
What you can do today
Overall, with equity valuations stretched, profit margins peaking and a Fed closer to the end of its steroid stimulus vs. the beginning, broaden your portfolio exposure.
Shift away from 60/40 and add tactical strategies to your portfolios and find a proactive way to risk protect your long equity exposure. Also shorten and diversify your bond exposure and consider tactically managed bond strategies.
- 30% Equities,
- 30% Fixed Income and
- 40% to Tactical (for more on Understanding Tactical Investment Strategies, click here)
Here is a short description of Tactical:
Tactical Investment Strategies are investment strategies that seek to identify and profit from price momentum. Some combine price momentum with broad economic factors such as interest rates and yield spreads. Others combine price momentum with fundamental factors such as P/E and price-to-book and earnings growth.
They respond proactively to market movements, seeking to take advantage of rising asset classes and avoiding falling ones. Tactical Investment Strategies analyze data over shorter time horizons. While the goal, of course, is to generate return, they may also work within a strategic framework to stabilize your client’s overall portfolio.
It is important to know that price momentum has excellent long-term reliability. It is well studied and supported by hundreds of academic papers.
Price momentum-based Tactical Investment Strategies attempt to lock onto major leadership trends, allowing profits to run, and losses to be cut short – it is the losses to be cut short part that adds a diversifying element within your longer-term strategic investment plan.
Trade Signals: Neutral Investor Sentiment
Click here for a link to Wednesday’s Trade Signals.
Trade Signals identifies the equity and fixed income markets’ cyclical trend and suggests ways to hedge your long-term focused equity exposure tied to periods of excessive investor optimism. Charts are posted weekly on Wednesdays.
The great gift of a new child
New York City was a rainy mess this week but nothing like the snow/ice/rain nightmare here in Philadelphia. I hope you weathered the recent storms well.
Post my meetings at Barron’s and Forbes, I found myself catching up with an old friend on Wednesday night. It was lucky and by chance. What a wonderful dinner it turned out to be. I reflected on how little time we spend together and how much I like who he is as a person. My 53 year old friend, Doug, has a beautiful five month old boy. Changing diapers came to mind. Ugh – diapers. I smiled and told him if we don’t fix this debt mess your new son won’t be changing your diapers in 30 years. Something I’m sure we didn’t spend as much time thinking about in our early 30’s.
I’m heading to San Diego next Wednesday for Gemini’s NorthStar Summit and a few additional advisor client meetings. I present in Arkansas on March 6 and 7 followed by meetings in Virginia Beach on March 10. I’ll be in Chicago on March 19 and 20 to meet with our friends at Brookstone Capital Management. Let me know if you are in the area.
Have a great weekend!
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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