Risk/Reward Vol. 258
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Over there/Over there
Send the word/Send the word over there
That the Yanks are coming/The Yanks are coming "---lyrics from "Over There" sung by George M. Cohan
"You have to learn to pace yourself
Pressure
You're just like everyone else
Pressure"---lyrics from "Pressure" sung by Billy Joel
"Can't let it get past me
You're far from plastic
Talk about getting blasted
I hate these blurred lines."---lyrics from "Blurred Lines" (apparently) written by Marvin Gaye
George M. Cohan wrote "Over There" when the US became embroiled in Europe's Great War. As described in Vol. 254 (www.riskrewardblog.blogspot.com ), the US is once again embroiled in a European war. This time it is a currency war. Since January, 2014 the Euro has dropped 25% against the dollar, falling over 12% in the past three months. It now sits at $1.04. Why is this important to US investors? It means that the profits earned by US companies with sales "Over There/Over there" are worth 25% less than a year ago. According to Thomson Reuters, this currency differential alone will cause the companies comprising the S&P 500 (which,combined, derive 35% of their total revenue from outside the US) to report 2.8% lower earnings in the first quarter of 2015 compared to last year. Lower earnings translates into lower valuations since the primary determinant of a stock's value is its earnings per share times a generally static market multiple. The converse is true for European companies, particularly those with a large presence in the US. "Send the word/send the word". Eurozone multinationals such as Luxottica, the eyewear manufacturer (e.g. Lenscrafters, Pearle Vision, RayBan, Oakley, etc.), are seeing their Euro denominated profits soar simply as a result of an appreciating dollar. One hundred dollars of profit earned from US sales translated into 69 Euros of profit one year ago. That same US profit today translates into 95 Euros of profit. With European companies booming as a result of the Euro's devaluation, "the Yanks are coming/The Yanks are coming." Or at least their investment dollars are. Several European stock indices including the broad based Stoxx Europe 600 are hitting multiyear highs.
The impact of the Euro's devaluation undoubtedly will put "Pressure" on the Federal Reserve's Open Market Committee (FOMC) when it meets next week. Any signal that the Fed is more resolute to raise interest rates in June will cause the dollar to appreciate even more against the Euro. This in turn will further depress US corporate profits. Several major US corporations such as Procter & Gamble, Apple, Intel and the auto manufactures already have warned that the strong dollar is impeding their ability to compete in the world market. With the US's recovery still very tenuous, any drop in sales by these and/or other US based multinationals could be deleterious to our economy. Add to this the deflationary effect of $45/bbl. oil and there is "Pressure", indeed, on the Fed not to act. As much as its hawkish members may want to raise rates, the entire FOMC may "have to learn to pace themselves." "Like everyone else", keep a close watch on the language of the FOMC's March 18th press release.
So what does all of this mean to an income investor like me? On the one hand, as demonstrated last week, the mere threat of an increase by the Fed can cause interest rate sensitive securities to tank. (Remember an increase in a security's interest rate means a decrease in its value). On the other hand, the major engine of the Euro's devaluation; to wit quantitative easing (bond purchasing) by the European Central Bank, has resulted in the yield on the bellwether US 10 Year Treasury Bond to fall despite the specter of the Fed moving rates up. After all, given a choice, with the German 10 Year Bund yielding only 0.26%, what rational investor wouldn't rather purchase a US 10Year yielding 2.11%? In short, I am seeing conflicting signals; signals which produced last week's volatility in both the stock and bond markets. "I hate these blurred lines." Wanting to avoid "getting blasted" by a precipitous rate hike (and price drop) which could come if the FOMC's communique next week bespeaks a June rate increase, I reduced my exposure to interest-rate-sensitive securities such as preferred stock closed end funds, real estate investment trusts and utilities. I may repurchase all that I sold this week as early as next week depending on the outcome of the FOMC meeting. I held most of these in tax deferred retirement accounts so the only costs associated with the sale were some modest trading fees ($7-9/transaction) and the off-chance of rapid capital appreciation.
With Marvin Gaye so prominent in the news this week, I sought inspiration from his song titles. The "Blurred Lines" described above make it nearly impossible to determine "What's Going On". Having "All I Need to Get By", I don't need to speculate. So instead of relying on what "I've Heard Through the Grapevine", I decided to "Give It Up"--for a short while at least.
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