War – What is it good for? Absolutely Nothing Except
Markets this past week • S&P 500 + 7.5% • DJIA +8.4% • 10 Year Note +.40% yield 4.10% • Oil -$6.45 $26.70/barrel • Gold -$10.00 spot $326.00 • Dollar 121.5 ¥ +3 ¥ 1.050 € +2 €
Where do we go from here? No guidance from the FOMC
Thanks for the help • In light of the unusually large uncertainties clouding the geopolitical situation in the short run and their apparent effects on the economic decision making, the committee does not believe it can usefully characterize the current balance of risk with respect to the prospects for its long run goals…..
Or as Yogi Berra said “You can observe a lot by watching” Fed Fund futures now put the chances of a ¼ point cut by the Fed at 45% by the next FOMC meeting on May 6th.
Some Historical Perspective • Dow’s rise in the largest percentage gain since the start of the bull market in 1982 • In 1991, the Dow gained 20% within 3 months of the start of the conflict • Since March 12th, the Dow is up 13.25% • Oil prices in 1991 went from $40 a barrel to $20 a barrel within 100 days
Stocks are not cheap by historical measures 1991 2003 S&P 500 P/E 15.5x 27.7X S&P 500 yield 3.75% 1.91% Mutual fund cash 11.4% 4.4%
But interest rates and inflation are lower 1991 2003 10 year yield 8.20% 4.10% 2 year yield 7.13% 1.78% CPI 3.0% 1.7%
Moving Forward • Short covering helped markets rally • Economic calendar light last week -CPI up .6% mainly on higher energy prices -Philly Fed survey -8.0 from 2.3 in February
Now it gets difficult • Most expected the initial stages to go well • Fighting closer to Baghdad could be more intense • Relationship with allies and rest of the World • Corporate scandals still a factor
Implications for the Fixed Income Fund Impending Doom?
Rates, Rates, Rates • The 10 year Treasury Note remains near an all time low from a historical perspective. • However, the yield jumped from 3.57% to 4.09% in the past two weeks. • The stock market rally last week demonstrates the vulnerability of interest rates, and thus fixed income performance. • Areas for potential weakness include economic recovery and budget deficits. • In the case of the latter, where the treasury issues debt (short end, long end, or even distribution) will be a key determinant of the shape of the yield curve and thus investment decisions.
Duration, Convexity Considerations • Slightly long duration relative to index reflects current overweight to Corporate sector • Negative convexity of Mortgages suggests eventual decrease in weight.
Actions taken so far: • Agreed to change index from 5 yr Treasures + 100 bp, as this did not match our portfolio objectives. Interim index is Vanguard Bond Index, and may be changed if more suitable index can be found. • Agreed to change target allocation to reduce weight in Corporates and Mortgages, add Treasury / Agency exposure. Actions to be taken: • Reallocate $50,000 of Corporates and $25,000 of Mortgages into a new Treasury / Agency Fund. • Determine if Vanguard Bond Index is best Index for our investment objectives. • Find a Mortgage fund that invests mostly in Mortgages. Current fund invests in both Mortgages and Agencies, making it difficult to estimate exposure to negative convexity.