Are we always at the end of
the beginning? Or are we always at the beginning of the end?
T.S. Eliak said in Burnt Norton, “The end precedes the
beginning, and the end and the beginning were always there
before the beginning and after the end, and all is always
now.” Confusing? Welcome to the investment scene.
Last year every investor in the world knew Alan Greenspan
was going to raise interest rates, after he told us in advance.
So bond investors shunned long term (5 years and out) fixed
rate bonds. Well, rates did rise on the short end of the yield
curve (good for adjustable rate securities). However, yields
on long fixed rate bonds barely budged, meaning those that
held or bought these bonds actually performed well last year.
The consensus was that rates on the long end of the yield
curve would rise with short rates, and bond prices on the
long end of the curve would drop, resulting in a loss for
bond holders. Now, it’s 2005, and we are faced with
the same scenario. Greenspan has hinted in so many words that
he is somewhat concerned about near-term inflation, and that
he would like to see short-term rates at least up to the level
of inflation (3.3% in 2004). That could mean four more quarter
point increases in the Fed Funds rate by this fall. If long
rates do not rise, the yield curve will continue to flatten.
Last May, the spread between the three-month Treasury bill
and the ten-year Treasury note was 3.78 percentage points.
Today, the spread between the two-year Treasury bill and the
ten-year Treasury note is 75 basis points. That’s the
lowest spread since March 2001. Typically, a flattening yield
curve portends slower economic growth and a negative yield
curve can precede a recession. The yield curve turned negative
in 2000, and we had a recession in 2001. We do not expect
the yield curve to go negative at this time. Greenspan is
apparently trying to temper near-term inflation concerns (rising
oil and other commodity prices) with “measured”
short-term interest rate concerns. The market is saying that
it is not concerned about longer-term inflation or a marked
slow down in economic growth. So we would expect short-term
rates to continue their climb and long-term rates to remain
stable but with periods of volatility. We continue to recommend
investments in pools of adjustable rate mortgages as their
coupons will rise with short-term rates. Most of our investments
in these mortgage pools are adjusting to the one year CMT
(constant maturity treasury) and this rate is now at 3% and
rising. Remember, this index was as low as 1.25% at one time.
OPEC met last week and said they were comfortable with oil
at $50 a barrel. Of course they are. It was not long ago that
they were comfortable at $40 a barrel. A funny thing happened
on the way to the gas pump though. Last summer when oil prices
initially jumped to $50 a barrel, gas prices were over $3
a gallon in many parts of the country. Now, with oil prices
approaching $50 a barrel once again, prices at the pump are
$2 a gallon and lower. We will survive with $50 a barrel for
oil because much of the price uncertainty has been removed
- less confusion.
How about that job report? Only 146,000 new jobs created
last month, and the stock market jumps over 100 points. Now
that the election is over, the media will look for other things
to worry about.
Take the deficit and trade imbalance for example, not to
mention the $2.568 trillion budget President Bush just sent
to Congress. Remember, however, that we have an $11 trillion
economy, and it is growing. This year government outlays will
equal 20.3% of GDP or exactly where they were in 1996. The
budget deficit is actually slightly over 3% of GDP. It has
been higher in the past. The trade deficit is somewhat more
confusing, but in simple terms we buy products from foreign
countries. They accept payment in dollars from us. They do
not store these dollars in a bank vault somewhere. They invest
them either in US Treasury bills or direct investment in the
US (Lenoro, a Chinese PC manufacturer, is buying the personal
computer business from IBM). We have said before that it is
an accounting issue. Every credit has to be matched by a debit.
We went down this road in the 1980s and eventually supply/demand
factors evened everything out. It will happen again.
Confusion in China. The Chinese new year started February
8. This new year will not contain the traditional start of
spring known as li chun. That means the Chinese year 4702
will be cursed. Many Chinese couples opted to marry before
February 8 to avoid the curse of the “widows year.”
Random thought for February 2005:
“The bedrock of reality is a world of disequilibrium.
Educate yourself for ambiguity instead of certainty.”
James Fraser – investment author
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