July 12, 2014 Woman To Blame

Risk/Reward Vol. 228

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

“Come Monday
It'll be alright
Come Monday
I'll be holding you tight”---lyrics from “Come Monday” sung by Jimmy Buffett

“Portuguese love
Won’t you say it to me
Say it to me
You love me baby.”---lyrics from “Portuguese Love” sung by Teena Marie

“No need to be complacent
There’s chaos across the border
And one day it could happen to us.”---lyrics from “Blood on the World’s Hands” sung by
Iron Maiden

When last I wrote, I was giving consideration to paring my holdings this week in interest rate sensitive securities due to a spike in the yield on (and concomitantly a drop in the price of) the US 10 Year Treasury Bond (10Year). In Vol. 221 www.riskrewardblog.blogspot.com , I explained the correlation between these securities and the 10Year. But one thing that I have learned over the past few years is the value of patience. Before making a significant purchase or sale, I re-read previous editions of Risk/Reward that discuss similar moves in the past. I do so as a double check against what could be an emotional as opposed to a studied decision. This time I found Vols. 80, 99 and 174 www.riskrewardblog.blogspot.com instructive. Another thing I have learned is to avoid large moves “Come Monday.” Monday markets reflect an entire weekend’s worth of euphoria and/or anxiety and in my experience overshoot, to the positive and to the negative, actual market sentiment. “Come this past Monday”, I decided to “hold tight”---and I am glad that I did.

In addition to my reticence to act on Monday’s in general, my review this past Monday of the world bond market influenced me to stand pat. As also discussed in Vol. 221 www.riskrewardblog.blogspot.com, bond markets are global and interconnected. As such, the prevailing rates last Monday for the 10Year bonds of France (1.585%), Germany (1.264%), Italy (2.698%) and Spain (2.673%) led me to conclude that the rate on the US10Year would not move much higher than the previous Friday’s close of 2.65%. Why would a rational investor buy Italian bonds with their inherent risk of default at a yield of 2.698% when one can purchase the safest bonds in the world at a yield of 2.65%? I was proven right as the US10Year yield moderated to 2.62% on Monday and fell steadily through Wednesday’s close of 2.55%. Due to the correlation between my portfolio and the 10Year, that movement translated into some excellent gains for me. And as Thursday dawned, I received even more positive vibes; this time in the form of “Portuguese love.” News of possible financial trouble from that small nation sent tremors throughout the Eurozone. The resulting flight to safety by bond buyers caused the price of the US 10Year (and those securities priced in relation thereto) to rise as its yield dropped to 2.53% by that day’s close and to 2.52% at week's end.. It was like Europe was ‘saying to me/love me baby.”

For those who pay attention to financial news, investor “complacency” and its cohort, the lack of volatility, continue to be hot topics. Commentators warn that the steady upward momentum in asset prices, nurtured by highly accommodative monetary policies, has created asset bubbles in every financial market. The ”q and a” session last week between Fed Chair Janet Yellen and IMF President Christine Lagarde has heightened this concern. In that session, Chair Yellen stated that tightening monetary policy was NOT the first line of defense against “financial excesses” (bubbles); macroprudential policy was; in the form of capital and lending requirements imposed on regulated institutions as coordinated by and between central banks. Good luck with that one, Janet. Very recent history has shown that there can be “chaos across the border.” Just look at the Eurozone sovereign debt crisis of 2011 which at the time was chronicled each week in this publication. (See May through December, 2011 editions). And as interconnected as the financial world has become, that chaos “one day could happen to us.” In the meantime, the ECB contemplates more accommodation in the form of its own quantitative easing; our zero bound policies keep our rates at historic lows; and investors the world round continue to venture further out the risk curve in search of yield. Someday the resultant bubbles will burst, and there will be no doubt this time as to who has “blood on their hands.”

Unlike Jimmy Buffett, I “know the reason” I stayed invested this week. I am not sure I will remain so “all season.” Any type of “pop top” could cause me to “blow out my flip flop” and sell, most notably a rise in interest rates. One thing is for sure. If I fail to preserve my year to date profits, “some people could claim that there’s a woman (Janet Yellen) to blame”, but “I know it will be my own damned fault.”