Investment Implications of a Rising-Rate Environment. David C. Wright Managing Director and Co-Portfolio Manager May 2015

Transcription

1 Investment Implications of a Rising-Rate Environment David C. Wright Managing Director and Co-Portfolio Manager May 2015

2 What Dave will cover:» What are the issues as to a shift toward rising rates and why do we care?» What is Sierra s outlook which has proven correct over the past few years?» What factors might allow yields to move even lower?» But when yields do begin a sustained rising cycle, what will be productive?

3 A KEY MISCONCEPTION: Many advisors think that investors need income that is, interest and dividends from portfolio holdings. The truth is that investors need cash flow, which can include small liquidations of some holdings. See our White Paper on the benefits to you and your clients of this paradigm.

4 THE FIVE BIG QUESTIONS:» When will interest rates begin a sustained rising cycle?» How fast will the rise be, and how far will rates rise?» What will be the impacts on the U.S. and global economies?» What investments will be hurt by such a shift?» What asset classes will benefit, or at least be productive, in a rising-rate environment?

5 STOCKS vs. LONG-TERM BONDS Data to 2/25/15 Latest two years S&P Long-Term Treasury Bonds (TLT) Unlike 2013, long-term bonds performed better than stocks in 2014.

6 Yields Have Been in a Downtrend for Years Despite the occasional fakeouts, the main trend has never changed

7 THE FED S UNPRECEDENTED & MASSIVE STIMULUS POLICIES WERE INTENDED TO BENEFIT THE STOCK AND BOND MARKETS (AMONG OTHER GOALS)

8 ONGOING INFUSION The Fed has the economy on life support 24/7 Since late 2008 the Fed has made cash constantly available to the banking system at virtually zero interest 8

9 PLUS REPEATED MASSIVE PULSES Quantitative Easing surges as needed Each time the Fed has feared the worst, it has acted fast to resuscitate the patient 9

10 THE FIVE BIG QUESTIONS:» When will interest rates begin a sustained rising cycle?» How fast will the rise be, and how far will rates rise?» What will be the impacts on the U.S. and global economies?» What investments will be hurt by such a shift?» What asset classes will benefit, or at least be productive, in a rising-rate environment?

11 SIERRA S OUTLOOK: We believe that rates are likely to continue to decline, generally, for at least two more years. Thus bonds and bond funds will benefit. We ve proved correct on this for the past three-plus years, when the consensus has worried that the massive Fed interventions would cause rates and inflation to soar, and the dollar to plummet.

12 WHAT MIGHT SUSTAIN FURTHER GAINS IN BONDS?» Slowdown in global economic growth» Policies of the Fed, ECB and other central banks» Sluggish growth in household incomes» Low inflation, verging toward outright deflation in some economies

13 High Directional Correlation of Rates to Wages, Growth and Inflation Data to 8/14

14 Real GDP Growth Worst Ever for USA in Recovery Data to 6/14 Recoveries: 1790 to Present

15 CHINA S GROWTH IS SLOWING Data to 1/13/15 Latest 4.8 years Hong Kong s Hang Seng Index Physical Copper Demand from China has dominated the global commodity markets and that is a two-way street

16 RECENT SHIFT IN SENTIMENT 110- Data to 2/25/15 Latest two years Hong Kong s Hang Seng Index Physical Copper Down -31.7% in 30 weeks! Over recent months, weaker data points from China have led global investors to become quite pessimistic

17 CHINA SLOWS AND Latest 12 months - Data to 2/25/15 Copper Crude Oil Down -52.6% in 36 weeks Formerly hailed as the locomotive for a stagnant global economy, what if China continues to slow?

18 Euro Area near outright Deflation Data to 6/14

19 Bloomberg: Monday, June 16, 2014

20 Completing the Japanification of Europe Deflation Taking Control? Data to 10/14

21 THE FIVE BIG QUESTIONS:» When will interest rates begin a sustained rising cycle?» How fast will the rise be, and how far will rates rise?» What will be the impacts on the U.S. and global economies?» What investments will be hurt by such a shift?» What asset classes will benefit, or at least be productive, in a rising-rate environment?

22 THE FIVE BIG QUESTIONS:» How fast will the rise be, and how far will rates rise? Your guess is as good as mine» What will be the impacts on the U.S. and global economies? Too lengthy to discuss today

23 THE FIVE BIG QUESTIONS:» When will interest rates begin a sustained rising cycle?» How fast will the rise be, and how far will rates rise?» What will be the impacts on the U.S. and global economies?» What investments will be hurt by such a shift?» What asset classes will benefit, or at least be productive, in a rising-rate environment?

24 RISK-OFF ASSET CATEGORIES:» U.S. Treasury bonds» TIPS» The U.S. dollar» High-grade corporate bonds» Municipal bonds» High-grade European bonds» Money market funds» Bank CDs

25 THE FIVE BIG QUESTIONS:» When will interest rates begin a sustained rising cycle?» How fast will the rise be, and how far will rates rise?» What will be the impacts on the U.S. and global economies?» What investments will be hurt by such a shift?» What asset classes will benefit, or at least be productive, in a rising-rate environment?

26 U.S. STOCKS & RISING RATES Latest five sustained episodes of rising rates Date of the Low TNX-X, 10-Year Notes Yield Index Reading Low: Yield Date of the High Reading High: Yield Basis Pt Change in Yield Length of Episode, Days S&P with dividends % Change Annualize d Gain 1 1/12/ % 11/7/ % % 0.0% 2 10/5/ % 1/21/ % % 35.4% 3 6/13/ % 6/28/ % % 10.9% 4 12/18/ % 4/5/ % % 29.5% 5 7/24/ % 9/5/ % % 23.9% Stocks have usually been VERY productive during sustained periods of rising rates!

27 JUNK BONDS & RISING RATES Latest five sustained episodes of rising rates Date of the Low TNX-X, 10-Year Notes Yield Index Reading Low: Yield Date of the High Reading High: Yield Basis Pt Change in Yield Length of Episode, Days Junk Bd Average % Change Annualize d Gain 1 1/12/ % 11/7/ % % -9.5% 2 10/5/ % 1/21/ % % 3.8% 3 6/13/ % 6/28/ % % 6.6% 4 12/18/ % 4/5/ % % 51.1% 5 7/24/ % 9/5/ % % 6.6% High-yield corporate bonds have been quite productive during sustained periods of rising rates

28 EMD & RISING RATES Latest five sustained episodes of rising rates Date of the Low TNX-X, 10-Year Notes Yield Index Reading Low: Yield Date of the High Reading High: Yield Basis Pt Change in Yield Length of Episode, Days Emerging Markets Debt % Change Annualize d Gain 1 1/12/ % 11/7/ % % -19.2% 2 10/5/ % 1/21/ % % 37.2% 3 6/13/ % 6/28/ % % 10.8% 4 12/18/ % 4/5/ % % 38.3% 5 7/24/ % 9/5/ % % -4.2% Emerging-markets bonds have often been productive during sustained periods of rising rates

29 RISK-ON ASSET CATEGORIES:» Small-cap stocks» NASDAQ Indices» Emerging market stocks» Physical commodities» Emerging market bonds» High Yield Corporate Bonds» REIT securities» Preferred stocks

30 SUMMARY

31 FOR MORE THAN THREE YEARS, MOST HAVE PREDICTED RISING RATES BUT SIERRA S CONTRARY VIEW HAS PROVED CORRECT

32 MASSIVE INTERVENTION BY THE FED, AND BY THE ECB, HAS PURPOSELY SUPPORTED THE U.S. AND EUROPEAN BOND MARKETS KEEPING YIELDS MUCH LOWER THAN NORMAL

33 DURING ANY SUBSTANTIAL DECLINE IN THE GLOBAL STOCK MARKETS, THE LARGEST GLOBAL INVESTORS TURN TO U.S. TREASURY BONDS AND THE U.S. DOLLAR

34 IF THE MAJOR TREND IN STOCKS TURNS DOWN, AS WE EXPECT, OUR PORTFOLIOS WILL BENEFIT BY OUR CURRENT LARGE ALLOCATIONS TO HIGH- GRADE BONDS

35 Our goal is to smooth your clients financial road while helping them achieve financial objectives THANK YOU!

36 Keep posted on our outlook via SierraMutualFunds.com and OceanParkAM.com

37 [TRANSITIONS]

38 WHAT IS THIS CHART? (template) Latest Data to 10/14 Line 1, of What does this chart mean? Line 2

39 TEMPLATE FOR BULLETS» Since WWII the economy has tended to have rather regular cycles of roughly four years, thus known as the Presidential Cycle» Unprecedented and massive Fed interventions starting in 2008 have artificially extended the current cycle

40 TEMPLATE FOR BULLETS [TEXT LINE TWO]» A» A» A» A» A