Last week, the U.S. Department of Commerce
delivered news that was about as welcome as a report of a great white shark sighting
off a popular beach during the Fourth of July holiday. The Commerce Department’s
third revision of its estimate for economic growth in the United States during
the first quarter of 2014 was revised downward – by a lot. Instead of contracting
by 1 percent, the economy shrank by 2.9 percent. It was the worst
single-quarter contraction in five years.
According to Barron’s, “The number was so bad… it suggested that something more
than the weather was to blame for the plunge in economic activity – and that a
recession could be in the offing.” Other factors did contribute to the economy’s
first-quarter reversal including a reduction in healthcare spending sparked by
the Affordable Care Act and the end of emergency unemployment benefits in
January.
However, experts warned against making
too much of backward-looking data. ING economist James Knightley told The Guardian reaction to the news should
be fairly muted as many economists expect second quarter numbers to show
significant improvement. PNC Financial Services senior economist Gus Faucher,
who was also quoted in the article, concurred:
“The contraction
in the first quarter is old news, and things are looking much better for the
rest of this year. Most importantly the labour market remains solid… Job gains
are allowing households to increase their spending, with higher stock prices and
home values also helping. Recent data have been solid, with big jumps in new
and existing home sales in May, and consumer confidence recovering after it
took a hit in the winter. An expanding global economy will help boost exports...”
Comments from St.
Louis Federal Reserve President James Bullard reinforced the view that economic
growth remains steady. Last Thursday, he predicted the Fed would raise interest
rates early in 2015. Bloomberg.com
reported Bullard expects the jobless rate to drop below 6 percent and inflation
to close in on 2 percent by the end of 2014.
the bull market in bonds has persisted
for more than 30 years. It began when The Cosby Show was in
its heyday, when the first Apple Macintosh computers arrived in homes, and when
Clara Peller famously asked, “Where’s the beef?” in a popular television
commercial. The bull market began late in 1981 when 30-year U.S. Treasury bond rates
hit an all time high of 15.2 percent and 10-year Treasuries topped out at 15.8
percent. Thirty-three years later, in mid-2014, 30-year Treasuries and their
10-year brethren offered rates in the low single digits.
MarketWatch.com says the lengthy
bull market in bonds has important implications:
“…
Assuming the typical investor doesn’t seriously start thinking about investing
until he is 25 or 30 years old, especially about investing in bonds, that means
that anyone today not in, or very close to, retirement has only known a bond
bull market. That’s an amazing historical and psychological fact, the
significance of which cannot be overstated. It means that very few investors
today have
the
long-term perspective with which to properly assess whether bonds are likely to
suffer major declines in coming years.”
After
30-odd years of declining interest rates, some experts believe investors should
prepare for a period of rising rates. Since there is an inverse relationship
between bond prices and interest rates, higher rates could mean declining bond
prices. How much could the price of a bond decline? It all depends on the bond’s
duration. Duration is expressed as a number of years and measures the
sensitivity of a bond to interest rate movements. The longer the duration of a
bond, the more sensitive it is to changing rates, and vice-versa. Investopedia.com
describes duration like this:
“The duration number is a complicated
calculation involving present value, yield, coupon, final maturity, and call
features. Fortunately, for investors, this indicator is a standard data point
provided in the presentation of comprehensive bond and bond mutual fund information.
The bigger the duration number, the greater the interest-rate risk or reward
for bond prices.”
If
rates move higher, a portfolio with long-term, long-duration bonds may
experience a significant reduction in value.
Weekly Focus – Think About It
“Hard work
spotlights the character of people: some turn up their sleeves, some turn up
their noses, and some don't turn up at all.”
--Sam Ewing, American baseball player
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