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10
.5
ISSUE
13.2
Harvey’s Investment Review
June
2013
SECOND QUARTER
2013 STATISTICS
Gross Domestic Product
(GDP)
4th Qtr 2012 +0.4%
1st Qtr 2013 +1.8%
Consumer Price Index
(CPI) / Core
Apr: -0.1%
May: 0.2%
Oil (light crude)
June 30: $96.56 bbl
3-Month T-bill: 0.02%
10-year T-bond: 2.52%
(June 30)
Gold
May 31: $1,394.50/oz
Jun 30: $1,235.00/oz
$/Euro at 1.3036
Yen/$ at 98.476
(June 30)
Unemployment:
Apr: 7.5%
May: 7.6%
**Sources provided on the
Explanation Page. Please note
that past performance is no
guarantee of future results
Harvey A. Wartosky
A Financial Representative
offering advisory services and
securities through Lincoln
Investment Planning, Inc.
Tel: 800 251 1995
A fixed income bubble is inflating that could
appreciably deteriorate portfolio values.
Retail investors (you) traditionally use bonds to
provide income and assure portfolio safety. Right now,
the Federal funds rate is only 0.25% and the 30-day
Treasury Bill is at a multi-generation low. With
current inflation at less than 2%, investors holding
certificates of deposit, money market accounts and
other short-term fixed income instruments are
actually losing real money.
Income is no longer a good reason to own bonds.
Usually bonds are a buffer against the brunt of a
declining stock market, because the price of bonds
tends to rise when the price of stocks declines. But,
this is not a hard and fast rule, because sometimes
bonds have suffered extreme losses and have
contributed to a substantial loss of portfolio value.
Institutions are the culprits for bond market debacles,
since financial behemoths seek short-term capital
growth. They make risky bets on the direction of
interest rates and sometimes earn twenty times their
original capital outlay. A bad bet can lead to losses
and bankruptcy. The battlefield of financial wagering
is littered with the corpses of failed institutions like
Bear Stearns, Countrywide Credit, Long-Term Capital
Management and all the banks in Cyprus. A cascade
of failures can even crash markets as in 2008 and even
upset the entire financial system.
Many retail investors saving for retirement or seeking
modest capital growth harbor the false notion that
bonds are always a safe investment. Nothing could be
further from the truth. The following is a list of fixed
income calamities during the past 100 years triggered
by the confluence of inflation, declining credit quality,
excessive leveraging and out-of-control speculation:
1. When Germany went off the gold standard in 1914
to finance WWI, interest rates began to rise and never
stopped. In the 1920s hyper-inflation destroyed 90% of
the value of German bonds in a matter of months.
Valuable investments turned into massive liabilities.
2. From 1955-1959, during the "Eisenhower Bond
Recession," the post-WWII economy boomed from low
taxes, a balanced budget and public spending. The
stock market rose during this period, but the bond
market declined 4 times between 1955-1959. Over
this 5-year period long-term Treasury bonds suffered
an annualized loss of -8.11%. The culprit was the
explosion of consumer debt fueled by the introduction
of credit cards. Buying on credit may have stimulated
demand and retail consumption, but a massive buildup of debt took its toll on the bond market.
3. In 1969 there was rampant inflation in the US,
propelled, in part, by the Vietnam War, race riots and
the beginning of a 14-year long stagnant stock market.
That year the average long-term Treasury bond lost a
devastating -18.1% of its value and corporate bonds lost
-6.8%. Investors who bought bonds for income were
crushed by the loss of capital value. Time Magazine
estimated that "The value of long-term Treasuries
dropped from $1,000 to $714".
4. Fortune Magazine called 1994 the year of "The Bond
Market Massacre" when over $1 trillion disappeared
from fixed income markets. The trigger for the sell-off
was a modest 0.25% hike of the Federal Funds rate to
stifle inflation unleashed by economic growth. During
1994, the average long-term Treasury bond declined by 11.1%. The villains were fund managers who ignored
the consequences of a Fed tightening of interest rates.
Managers had become inebriated by the drop in rates
from 8% in 1992 to 3% in 1994 to juice GDP growth and
lower unemployment. Today’s economic environment
and Fed policy are strikingly similar to Pre-1994 when
the Fed dropped rates to near zero, also in an attempt to
stimulate the economy and reduce unemployment. The
combination of lowering rates to provide liquidity and
then raising rates to curb inflation proved to be a mortal
blow to the bond market in 1994. Some Fed governors
at the Federal Open Market Committee (FOMC)
meeting in February warned that even a small increase
in rates would tank the fixed income market.
They were right.
Today's economic environment mirrors those of previous
years, particularly 1994. This similarity is instructive,
because it provides insights to investors about how to
allocate bonds in their portfolios.
For the moment, bonds yield close to nothing, but they
remain relatively safe investments. The case for an
imminent explosion of the inflating bubble in bonds is
weak right now, since GDP growth is anemic,
unemployment is high and inflation is low.
Today, the Fed is pumping $85 billion each month into
the economy to jump-start GDP growth, and they intend
to keep rates near zero until 2015 to encourage
investors to sell low-yielding bonds.
Bonds may be in a bubble that is just beginning to
inflate. Before the Fed begins to raise rates and bond
prices begin to tick down, investors need to determine
how much cash they plan to withdraw from their
portfolio each year and how much volatility they can
withstand. Then they can begin to reduce the fixed
income allocation of their portfolios.
Benjamin Franklin said, "Great haste makes great
waste," but he also said, "You may delay, but time will
not." The bond time bomb is ticking.
ISSUE
13.2
Harvey’s Investment Review
June
2013
S&P 500: is a value-weighted index of 500 widely held stocks often used as a proxy for the stock market. The S&P
500 index includes 500 of the largest stocks (in terms of stock market value) in the United States and represents a
sample of top companies in leading industries in the U.S. economy.
Dow Jones Industrial Average: is a price-weighted average of 30 significant stocks traded on the New York
Stock Exchange and the NASDAQ. The DJIA was invented by Charles Dow back in 1896.
New York Stock Exchange (NYSE): is the world’s largest stock exchange by market capitalization (with listed
companies at $12.25 trillion as of May 2010), located on Wall Street in lower Manhattan, New York City, USA.
Gross Domestic Product (GDP): is a measure of output from U.S. factories and related consumption in the
United States. It does not include products made by U.S. companies in foreign markets.
Consumer Price Index (CPI): measures prices of a fixed basket of goods bought by a typical consumer, it is
widely used as a cost-of-living benchmark and uses January 1982 as the base year.
Oil (light crude): Crude oil is the world’s most actively traded commodity. Oil is considered light if it has a low
density and low wax content and may be considered sweet if it contains relatively little sulfur. Light crude oil is
more desirable than heavy oil since it produces a higher yield of gasoline. Sweet oil commands a higher price than
sour oil because it has fewer environmental problems and requires less refining to meet consumption standards.
Treasury bills (T-bills): are short-term securities with maturities of one year or less issued at a discount from face
value. Treasury bills are the primary instrument used by the Federal Reserve in its regulation of money supply
through open market operations.
Sources and ideas for information in this newsletter: The Economist, The Wall Street Journal, The
Financial Times, Investor Business Daily, Bloomberg, Market Watch, Reuters, US government web sites, Morningstar,
CNBC, James Surowicki, Niall Ferguson, Heather Wagner, BNP, private foundation reports, Peter Bernstein, Goldman
Sachs Research and Ned Davis.
*Sources of Statistics listed on front page:
Statistic
GDP
CPI
Oil
T-bill & T-bond
Website name
Bureau of Econ. Analysis
US Dept. of Labor
CNN Money
US Dept. of the Treasury
URL
Gold
Exchange Rates
Kitco Bullion Dealers
Yahoo! Finance
http://www.kitco.com/
Unemployment
US Dept. of Labor
http://data.bls.gov/timeseries/LNS14000000
http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
http://data.bls.gov/timeseries/CUUR0000SA0?output_view=pct_1mth
http://money.cnn.com/data/commodities/
http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.as
px?data=yield
http://finance.yahoo.com/currency-converter/?amt=1&from=USD&to=JPY&submit=Convert
#from=EUR;to=USD; amt=1
Advisory Service and Securities offered through Lincoln Investment Planning, Inc. Associates of The Wartosky Group, LLC are financial
representatives of Lincoln Investment Planning, Inc. Lincoln Investment Planning, Inc. is a Registered Investment Advisor, Broker Dealer,
Member FINRA/SIPC. The Wartosky Group, LLC and Lincoln Investment are independently owned and each is responsible for its own
business. Lincoln Investment supervising office: 218 Glenside Avenue, Wyncote, PA 19095 (800) 242-1421.
Harvey A. Wartosky
A Financial Representative
offering advisory services and
securities through Lincoln
Investment Planning, Inc.
The Wartosky Group, LLC. 84 State Street, Boston, MA 02109
Phone: (800) 251-1995, Fax: (617) 227-1993