THIS IS NOT INVESTMENT OR TAX ADVISE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Yield curve, risk premium, QE2, risk tolerance---fancy words bantered about on Kudlow. Do they mean anything to me? Yes. Here are a few facts.
1) The difference between the interest rate (yield) paid on a 2 year United States Treasury note (0.85%) and a 10 year US Treasury bond (3.6%) is now 2.79% which when plotted on a graph presents an historically high "yield curve".
2) The difference between the yield on the average "junk" bond (considered below investment grade and therefore very risky) which is now 6.99% and the yield on the 10 yr. Treasury bond (3.6%) is currently 2.35%. In December 2008, that difference or "risk premium" was (22%-2%) was 20%.
3) The Federal Reserve is expanding the money supply (literally printing more money) in order to bid on short term Treasury securities and thus to artificially keep the interest rate down and otherwise making money available to banks at near zero interest (discount rate). This is the second phase of what economists call quantitative easing (QE2). The philosophy is that by making money available cheaply and keeping short term interest rates low, banks will lend cheaply and companies and individuals will borrow to purchase assets (e.g. homes) and goods thus spurring economic growth and creating jobs. Creating jobs (more properly "full employment") is one of two mandates of the Federal Reserve which at times like now seems exactly opposite to its other mandate--to control inflation.
Some view the above and the recent rise in the stock market as signs that a recovery is afoot. They see this as evidence that the collective "risk tolerance" of the investing world is increasing--that is that investors are bullish on private enterprise and thus willing to forego the safety of the presumably ever constant US securities (e.g. 2yr and 10 yr notes and bonds) for more speculative ventures. I take a different view. Like most people, my risk tolerance is a constant. I want a 7% return if inflation is 3% or lower. In normal times, this should be a free throw. But, when the Fed artificially keeps interest rates low (believe me there is a direct correlation between 2 year Treasuries and CD's) I have to travel well up the risk ladder to get the 7% (or 4-5% "spread to inflation") that I seek. I own very few Treasuries or CD's. I have achieved my goal by investing heavily in the exchange traded debt (etd's) and preferred stock of companies such as GE, American Airlines, Bank of America and at the heretofore risky end AIG. But as the investing world begins to awaken to what the Fed is doing, it is leaving US securities and betting that these companies (as well as gold, copper, wheat, oil, etc.) are frankly less risky than the 2.35% risk premium described above.
Stated alternatively, in a remarkable turn of events, since December 2008, investors have come to view the safety of the US Treasury (measured in absolute terms or relative to inflation) only slightly more secure than junk bonds and frankly considerably less secure than oil, gold and copper.
I am no different. I am grabbing yield as fast as I can. I replaced some GE etd's for that of First Industrial (FRpJ). One of my readers will cringe at this revelation. I cashed out some bonds and bought two commodity based exchange trade funds, DBA and DBB. These moves took my eye off of my more speculative moves into the smartphone tsunami, but I did manage to buy some Acme Packet (APKT).
In editing the above, I detect an overly negative voice. How ironic. Due to the plethora of etd's and preferred stocks in my holdings, I have enjoyed 2 incredible weeks of principal appreciation in a row.
Was this too esoteric?
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