April 29, 2017 Q1

Risk/Reward Vol. 391

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN

Corporate America is well on its way to a record earnings season. Profits are up on average 25% over Q1 2017, and more than 80% of reporting companies have beaten forecasts. Some market leaders such as Boeing and Amazon have dazzled. Moreover, the economy grew at a respectable 2.3% in the first quarter, and peace on the Korean peninsula seems possible for the first time in nearly 70 years. Nonetheless, all three averages finished the week lower than last. How can this be? Perhaps what John Authers saw a few weeks ago is coming to pass: to wit, the favorable impact of tax reform has already been baked into stock prices. Whatever the reason, one is at a loss as to what if anything can spur this market.

Meanwhile, Mr. Market seems to be warming to a 3% yield on the US Ten Year Bond and a nearly 2.5% yield on the 2Year. Although I never thought Barb and I would find such paltry returns attractive, we have decided to park some cash in one year CD's yielding 2.2%. We are not alone. I have it on good authority that some other subscribers are making similar moves. Rumor has it one has started a short bond ladder. Frankly the older I get the more attractive these meager returns look. Moreover for a host of reasons including the differential between domestic and ECB rates and the futures market now pricing a 50% probability of four Fed hikes this year, I don't see yields increasing much more in the near term.

One factoid in Friday's Financial Times I found troubling. According to Gillian Tett (whose reporting I find credible), the quality of commercial loans in the United States is deteriorating. She noted that in 2007 Single B (risky) loans represented 25% of US lending portfolios. Now more than 65% of loans are rated Single B. Moreover, over 75% of loans have "lite" covenants which means that lenders have limited tools with which to collect. This is a natural byproduct of a decade of easy money and subsidized rates. Fortunately the percentage of these risky loans held by non traditional lenders (not banks) has also increased which should lessen the effect should defaults increase. Nevertheless, this is something to watch.