Tag Archives: QE

Now Showing in Europe: Negative Yields – Next Stop the U.S.?

Posted February 26, 2015 by paragon. tags:Tags: , , , ,
World Globe

Yes folks, the condition where you actually have to pay someone to hold your money or you get back less than you deposited is now a reality in Europe. In anticipation of the start of the ECB’s asset purchase program yields in many European countries are now negative. Why would someone accept a negative yield? One reason is that you might expect deflation to continue to fall pushing the price up even further or giving you a positive real yield. Another reason could be regulations that force people or institutions to hold negative yielding instruments. Unless you’re using your mattress you pretty much have to put your cash in a bank/depository. Fear of an economic downturn or disaster could make getting most of your money back rather than losing it a relatively better prospect.

Due to the Fed’s zero interest rate policy and QE we in the U.S. have almost been there for years. I bet you are just loving that zero percent you basically get on your savings! In fact, after adjusting for inflation we’ve had negative real yield for some time on cash or near cash instruments. However, now the Fed is in a tough spot trying to raise rates to match the economy because most of the rest of the developed world is doing the opposite. Our relatively higher rates are causing the dollar to soar as foreigners buy our bonds.  As the dollar increases it creates stress on emerging markets and U.S. multinationals. This in turn gives the dovish Fed the excuse to put off the date for rate increases to begin.

Central banks however can only do so much and their actions to prop up assets prices don’t necessarily translate into economic growth. Overtime the marginal benefit from asset purchases decrease and then we are left with paying the price of trying to unwind them. The pain of trying to unwind then causes the Central Bankers to refrain altogether or even add more QE. The cycle never ends and we are trapped.

Let’s hope the world doesn’t end up being stuck in an infinite loop of QE and negative yields as they seem to be associated with subpar economic growth in the long run – just ask the Japanese.

Written by Nate White, Chief Investment Officer of Paragon Wealth Management

Disclaimer Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

Oh, What A Tangled Web We Weave….

Posted December 12, 2014 by admin. tags:Tags: , , , , , ,
Pick Pocket

Written by Nate White, Chief Investment Officer of Paragon Wealth Management
It looks like we are finally starting to see the consequences of the Fed’s great monetary easing experiment. Getting in was easy – getting out maybe not so much. The fear throughout the Fed’s great adventure was what type of unforeseen consequences could the happen as a result of QE and artificially low interest rates. Now we are starting to find out. Along with others, I have said for some time now that QE has distorted the markets. It has recapitalized the banks, which I believe was the main purpose, but the exceptionally low rates and asset purchases have supported asset prices and distorted credit markets as well. The need for yield has caused massive amounts of money to flow into the corporate bond space. Almost all corporations have been able to borrow with ease. Many projects that otherwise would not have been taken on had rates been more normal have received the green light. Due to lack of robust economic growth much of the borrowed corporate credit has gone into share repurchases rather than being used to expand business. It’s hard to blame the companies though for borrowing as much as they can at these low rates. The process of normalizing monetary policy (i.e. ending QE and raising interest rates) has caused the dollar to strengthen because our rates are higher relative to other developed nations. The other developed nations such as Europe and Japan are just beginning their QE programs which causes their currencies to weaken relative to the U.S. Since commodities like oil are priced in dollars a rising dollar pushes the effective oil price down. A stronger dollar can also encourage capital flight from developing nations and decreases the attractiveness of US products and services. The dangers of a credit bubble in high yield space and perhaps other corporate areas could be coming to light. (http://www.bloomberg.com/news/2014-12-11/fed-bubble-bursts-in-550-billion-of-energy-debt-credit-markets.html) The low level of interest rates has created a huge demand for anything with yield.  Junk rated companies have been able to borrow with ease.  Higher rates would have discouraged this.  Example: Much of the energy boom in the US has been financed with this cheap credit.  This caused production and supply to surge causing an oversupply situation with oil. Exacerbating the situation has been the aforementioned rise in the dollar. When the prices of anything goes down it is good for those who use or buy it – until a certain point. As oil drops it lowers consumers fuel costs and is good for all industries that use it as an input. However, at some point the positives from the drop in price become a negative. If the drop in energy prices gets so low that it causes the energy companies to fail on a massive scale it then affects the economy as a whole.  At some point the crash of an industry can become systemic and affect the economy as a whole – think the dot-com/tech and real estate bubbles. Whether this happen spill-over effect happens in relation to what is going on in the energy space remains to be seen. The same effect can be seen on a geo-political and global economic level. The dramatic drop in oil is now getting so low and causing tremendous pain for countries like Venezuela, Iran and Russia. At first we don’t shed a tear because these aren’t our Favs, but what if Putin and the Iranian clerics do something drastic if they feel they are backed into a no win situation?  Venezuela is getting close to default and that is having ripple effects on other emerging markets. I don’t mean to be so tough on the Fed as I don’t believe they are the cause of all our present or future troubles.  Nothing happens in isolation and they are one piece of the puzzle as there are many other factors at play (e.g. regulation, fiscal policy, etc.).  Let’s hope the adjustment back to a more normal monetary policy can be made without too much pain and disruption. Could what is currently happening with the energy markets be a sign of things to come? How far does the unraveling go?  Does it become systemic or not?  How much is already priced in?  No way to know until after the fact.  One thing for certain is that these type of events will create opportunities in the markets that we have been waiting for.
Written by Nate White, Chief Investment Officer of Paragon Wealth Management
 
Disclaimer Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject ffto change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

Adjustment Period

Posted October 22, 2014 by admin. tags:Tags: , , , , , , ,
Rolling hills and fall colors

The era of QE has been a difficult environment for active managers. The last five years have been a heyday for the passive investor, aided directly and indirectly by the Fed’s Quantitative Easing (QE) programs, stocks and bonds have moved up in an indiscriminate manner. All one had to do was simply show up. Bonds have been directly aided by the trillions the Fed has purchased while equities have indirectly benefitted from the implied “put” or backstop inferred by these Fed actions. The Fed’s actions to keep rates artificially low have created market distortions that have interfered with many of our quantitative indicators.

When all equities or bonds generally get rewarded the same regardless of their quality or differences, it’s hard for the skilled manager to outperform. A rising tide of liquidity has lifted all boats making it easy for anyone to navigate in the harbor. But once the tide starts to recede, experience and skill are what matters. We have seen improvement with our models over the last year coinciding with the gradual reduction of QE. As markets return to “normal” we are better able to assess the risk and rewards of certain moves and strategies. We are seeing a number of opportunities develop that haven’t been available for years.

In the short run the market is looking tired. We have rejected the doom and gloom scenarios that have been so prevalent since the financial crisis and have caused many investors to miss out on the bull market. However, fewer stocks are hitting new highs and the breadth has been getting weaker. The uncertainty surrounding the end of QE and the timing of rate increases next year are factors contributing to the hesitancy. This is only natural and healthy in the long-run. As previously mentioned it also creates opportunities for us that have not been available for the last four years. Over the last few years we have held a cash position which has been a drag on performance. Going forward, this cash position is an advantage as it helps to cushion the downside and provide flexibility to take advantage of opportunities provided by any volatility and uncertainty.

Although the risks have risen, this doesn’t mean investors should get out completely. The market has been overdue for a correction for some time but it doesn’t mean that everything is ready to fall apart. Getting completely out now could cause you to miss crucial gains if stocks continue to rally as they have. The last four years have shown the futility of trying to time the market in an all in or out manner. It is still a bull market until proven otherwise.

The current economic data has been stronger indicating that the economic growth is picking up instead of getting weaker. Ultimately that is a good sign as it will support earnings growth that has been the key foundation for the current bull market. Any correction that comes will probably be more short-term and establish the next leg up for the market. Therefore, a correction would be viewed by us as an opportunity rather than a harbinger of doom. It is only natural after five years of market advances and ahead of interest rates starting to move up to get some market hesitancy or disruption. Our current exposures are to technology, energy, and materials which are late-cycle stocks and tend to do well in rising rate environments. We also continue to favor various segments of the healthcare sector such as medical device and healthcare providers. Several emerging market opportunities are also looking more promising than in the past and we have started to act in a few of these areas such as Mexico and Brazil.

It is no secret that we have been cautious on the bond market for some time. As the sun sets on QE the angst over when the Fed will begin to raise rates and by how much is growing. Markets always like to price actions in ahead of time and right now it seems the equity market is being affected to some degree by this interest rate uncertainty. However, the bond market has not moved much yet. Many thought that bonds would have a difficult year as they began to price in rate increases. So far, bonds have done the opposite and surprised many by having a good year. The inevitable is coming though and the window for bond gains is closing as we creep toward June of next year which is the most accepted time for rate increase to begin. Any equity market weakness will give bonds more time to put off the reckoning.

Although the potential for a bloodbath in the bond market is high, that doesn’t mean it will happen. It will probably be more like death by a thousand cuts. The Fed will be very slow and steady in raising rates as to minimize market disruption. After all, they do hold about $4.5 trillion of bonds!  Even if interest rates rise in a slow and gradual manner (which is what I believe will happen) bonds will still produce negative or flat real returns at best.

For example, take a look at the interest rate sensitivity of a broad composite of investment grade bonds such as the Barclays US Aggregate Bond Index. If interest rates are a half to one percent higher a year from now, the index could be down 2.5 to over 5 percent respectively. The current yield of about two percent would still not offset the losses.

In preparation we have been making changes and getting ready for the coming environment. We have been early on this call which has caused us to underperform in Managed Income this year so far, but not by a lot and we are better positioned for what is to come. We believe this approach is the most effective from a risk/reward standpoint and will pay off in the environment to come. Now is the time to take a look at the risk in bond or fixed income holdings and make adjustments. The first one to two percent moves from the bottom will be the most painful.

Written by Nate White, Chief Investment Officer of Paragon Wealth Management

Disclaimer
Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

Backed against the wall….

Posted September 26, 2014 by admin. tags:Tags: , , ,
The chains

Hands chained up

We, along with many others, have been cautious about the bond market for some time.  As the sun sets on QE the angst over when the Fed will start to raise rates and by how much is rising.  Markets always like to price things in ahead of time and right now it seems the equity market’s recent nervousness could be due in some part to this interest rate uncertainty.   The bond market however has not moved much yet.  Many, including us, thought that the bonds would have a difficult year as they start to price in the rate increases.  Instead, bonds have (so far) have had a good year surprising many.  Alas, the inevitable is coming though and the window for bond gains is closing as we creep toward June of next year which is the most accepted time that the rate increases will begin.  Any equity market weakness will give bonds more time to put off the reckoning.

Any rally in bonds should be sold as their time is getting short.  I think you’re seeing the cracks appear in the high yield market right now.  Historically, high yield is more correlated with the equity market and not that sensitive to interest rate risk but at these low rates it now contains interest rate risk as well.  With yields still below six percent the reward is just not worth the risk for holding junk bonds.

Although we don’t find bonds attractive it doesn’t mean that a bloodbath is coming.  It will probably be more like death by a thousand cuts.  The Fed will be very slow and steady in raising rates as to minimize market disruption.  After all, they do hold about $4.5 trillion of bonds!  The first one to two percent moves from the bottom will be the most painful but in a gradual manner as mentioned.  A year from now interest rate could be a half to one percent higher.  Take a look at the duration of your bond holdings and compare it to your yield – you’ll be hard pressed to find anything that would come out positive…

Written by Nathan White, Chief Investment Officer of Paragon Wealth Management

 

Disclaimer Paragon Wealth Management is a provider of managed portfolios for individuals and institutions. Although the information included in this report has been obtained from sources Paragon believes to be reliable, we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Past performance is not a guarantee of future results.

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