• The Federal Reserve decided to lessen monthly purchases to $75 billion from $85 billion.
  • They said further measured steps are possible on tapering.
  • They said exceptionally low rates until jobless rate well below 6.5%.

            We sense that they gave a very token reduction in the pace of purchases since $75 billion worth of debt purchases is going to continue to grow the Fed’s balance sheet.

           They likely did this for a few reasons and most importantly to foster a sense of credibility. Data dependency is their mantra for the decisions they make and a better jobless number apparently warranted a slight taper. If they seriously thought the economy had full wind in its sail, they would have taken $20-$25billion off of the table.

            The big key is the last of the three statements in terms of what we feel is a bargain with the market. To mitigate the risk of a tantrum such as the one in Spring when bonds sold off significantly, they are anchoring rate expectations for quite some time while they take their foot off the accelerator ever so slightly. Bonds are broadly softer this morning although a massive unwinding is unlikely at least for now.

            This Fed action simply let some air out of the ever growing “anticipation balloon”. Now we know they can taper based in part on improving data. Here is a thought. What if in their tapering campaign, data comes out that is both deflationary and recessionary sometime in late 2014 for instance?   Will they begin to ramp up again?

            While some believe this is the first in a series of measured reductions, we feel that the path and direction of the Fed’s purchase program is not likely to be a linear move. The data both for inflation and labor markets is too uncertain to predict such an exact policy change.

            Bonds continue to be one of the most difficult areas of the capital markets to invest in as investors are “forced” into credit products that are in many cases overvalued and into reasonably unknown areas such as Emerging Market debt where clarity of policy is even more uncertain and less studied.  

            A small bit of evidence with regard to the difficulty that bond investors face came to us as we examined a few ETFs.  Here are two brief examples.

AGG-I-Shares US Total Bond Market

  • 2.21%  SEC yield
  • 5.06 duration
  • 60% weight to Treasuries and Mortgage Backed securities
  • AUM $15 Billion

            This is evidence of either a strong belief in this ETF with 60% of the portfolio highly influence by Fed policy or or a degree of discomfort with more robust options. Even if this $15 Billion of investor money liked mortgage backed debt, why not utilize an adept active manager in this space? That 2.21% is wiped out with that duration as high as it is if rates move up.

IGOV-I-Shares International Treasury Bond

  • 1.41%  SEC yield
  • 6.76 duration
  • 18% weight to Japanese debt and 37% in “other”
  • AUM $603 Million

         This is even more vexing as I am not sure how $603 Million worth of investor money can hold any conviction on a product where 37% is other and 18% is Japanese Debt. Possibly a move is proving difficult in a market where spreads have come in and EM Debt is perceived as too precarious.

            We would absolutely sell these products as soon as your team is able to formulate a well vetted alternative solution. They do not in our opinion represent a solid risk to reward scenario.

            This is our last blog of the year and while that is a relief for some who are weary of Zenith’s insight;), we will be back in the new year identifying solidly good situations as well as the poor ones such as the two listed above.

            Our closing thoughts are as disparate as the markets we cover. As the year comes to a close we wish for a few things.

  • A solid resolution to the Ukrainian revolutionary storm so that the people can develop as a nation free and prosperous.
  • The projected global wine shortage does not occur.
  • That every and all ski resorts continue to receive regular and heavy snowfall through spring.
  • The US Ski Team dials it up and does well in Sochi. This holds for all of our athletes.

 

Sincerely,

 

Tom Koehler-CIO

 

 

“Bond markets represent a complex asset class and while we covered a small amount, there is a lot more information needed prior to making an investment decision. Let us know if we can provide more information to help in that process.”

 

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