September 3, 2013

Spotlight’s still on the Fed, the recovery, bonds

August has traditionally been a slow month for Wall Street. Many take time off from daily routines and trading volume usually declines.  This year Treasury yields moved higher (prices lower) and stocks drifted lower in relatively uneventful trading.  The Dow Jones Industrial Average dropped 4.5% in August, while the broader Standard & Poor’s 500 stock index gave up 3.3%.  Commodity prices rose in August, and the ETF’s (Exchange Traded Funds) that are designed to follow gold and silver prices saw increases as well.  The silver ETF (SLV) saw an increase in price of 18% while the gold ETF (GLD) rose 5.2% for the month. (Google Finance)  We still hold the view that stocks could fall further from current levels, and that interest rates might ultimately come back down and commodity prices possibly continue to rise.  For this reason, we remain underweighted in stocks for all risk levels, and have kept our positions in the “alternatives” area which includes a commodities mutual fund, EFT’s in precious metals, and some real estate exposure through a real estate mutual fund.  We also generally hold above average exposure to fixed income/bonds in addition to cash/money markets.

A 2nd gear economic recovery

It’s no secret that the public’s confidence in the economy has yet to fully return (Conference Board – consumer confidence data).  The unemployment rate is at a still-troublesome 7.4% as of July (BLS), and the uncertainty is translating into lackluster consumer and business spending. Reasons include:

  • Weak income growth and sluggish job growth
  • Tight fiscal policy (depending on your political inclinations, recent declines in government spending, the sequester or a tax policy that does not encourage economic growth)
  • Tight bank lending standards.

And there’s one more: economic recoveries that follow a financial crisis have historically been a struggle – Kenneth Rogoff, Harvard economist and author of “This Time is Different – Eight Centuries of Financial Folly.”  A look at the latest recovery and how it compares to recent expansions can be summed up in Figure 1.


The current economic recovery is 16 quarters old (NBER). The chart above takes the average of the first 16 quarters of each respective recovery. 1980 is excluded as the economy slipped back into recession within one year.

But it’s not all gloomy and there have been pockets of strength.  Housing is well off the bottom but worries over higher mortgage rates are a concern.  The average 30 year fixed rate mortgage today is approximately 4.47%. (  Autos sales have also been strong (Bloomberg), and we can’t ignore the shale oil and gas revolution, which is creating wealth and spurring investment in infrastructure that’s needed to move surging U.S. oil production (Energy Information Administration, Wall Street Journal).

Fed muscle flexing

Still, much of the heavy lifting to get the economy out of its low orbit of growth is coming from the Federal Reserve.  There has been disagreement as to how much the Fed has helped growth, but most on the Street believe rock bottom interest rates and massive Fed bond purchases have been an important ingredient in the run-up in stocks.  But Federal Reserve officials have not been shy about publicly airing their concerns that low rates may be encouraging too much risk-taking (Illustration: Fed Gov. Sarah Bloom Raskin speech – Beyond Capital: The Case for a Harmonized Response to Asset Bubbles).

Fed taper talk

Though the Fed is committed to supporting the labor market, a recent paper presented by John Williams, who sits atop the influential Federal Reserve Bank of San Francisco, noted, “Policymakers are unsure of the future course of the economy and uncertain about the effects of their policy actions.”  Uncertainty about the effects of policies is especially acute in the case of unconventional policy instruments such as the Fed’s bond-buying programs. In the latest open-ended round, the Fed has committed to purchasing $85 billion in Treasury bonds and Mortgage Backed Securities each month until it believes the labor market has improved substantially (Fed press releases following each meeting).

Concerns about unintended consequences are one reason the Fed would like to get out of the bond-buying business and the focus on whether the Fed will begin to dial back on the purchases at its September 18-19 meeting has been under a bright spotlight.  Talk of tapering, along with market uncertainties as to how long the Fed might keep the Fed funds rate at near zero, have created an environment that has been less receptive in the bond market – see Fig 3.


Weaker-than-expected economic data, uncertainty tend to help Treasury bonds & push yields lower. Stronger-than-forecast economic data, talk of tighter Fed policy tend to encourage investors to move out of Treasury bonds, pushing yields higher.

As the month of August came to a close, a consensus seems to be forming around either a small reduction in the pace of bond buys at the next Fed gathering or a delay as Fed officials wait for more concrete evidence the economy is accelerating.

 What does September hold? Upcoming events include…

Who might replace Bernanke at the helm of the Fed when his second term expires at year-end? How will the upcoming debate over raising the U.S. debt ceiling play out? Will we see firmer evidence the economy is gaining steam? Will troubles in emerging markets fade? How might Europe’s nascent recovery proceed? The situation in the Middle East is fluid and complex. As we enter September, a showdown over Syria may create anxieties.  These are just some of the issues that may aid or hinder shares in the coming weeks.  We will keep you advised.

We hope all of you had a relaxing and enjoyable Labor Day weekend.  We are looking forward to moving into the fall months and happy to see football season arrive once again!  We appreciate the opportunity to be of service, and as always, please don’t hesitate to call or email if you ever have any questions or if we can be of further service in any way.

God Bless,

Your TEAM at F.I.G. Financial Advisory Services, Inc.

 1 The Dow Jones Industrial Average is an unmanaged index of 30 major companies which cannot be invested into directly.  Past performance does not guarantee future results.

3 The S&P 500 Index is an unmanaged index of 500 larger companies which cannot be invested into directly.  Past performance does not guarantee future results.

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