So it’s a good thing when people such as Federal Reserve Vice Chairman Donald Kohn say that the Fed will keep interest rates near zero “for an extended period” as he did in a September 30 speech in Washington.
As long as interest rates are so low, bond yields on the 5-year Treasury note of 2.3% and on the 10-year note of 3.3% don’t provide much competition to stocks. Those low yields push investors to consider buying stocks since they’re the only game in town offering a decent return.
Sure stocks are riskier than bonds but with traditional blue chips like Pepsico (PEP) paying a dividend yield of 3.1%, Verizon (VZ) paying 6.3%, and Chevron (CVX) paying 3.8%, you’ve got to admit that stocks look relatively appealing.
So every time a Federal Reserve official speaks about jacking up interest rates fast and hard, as Fed governor Kevin Warsh did on September 25, investors shudder. Warsh said that rates may need to be increased “with greater force than is customary.”
And every time an official like Kohn or the Federal Reserve’s Open Market Committee itself says that rates are staying low for a long while, investors breathe a sigh of relief. That relief may not translate immediately into a move up in stock prices but it does put a general floor under stock values.
One caveat in all this talk of interest rates. Rates right now are so low because the Federal Reserve is trying to rescue the economy from a recession by making credit cheap. The rally in stocks that began on March 9, 2009 is based on a belief that interest rates are going to stay low but that the economy is recovering.
If interest rates go up before anyone expected that could sink stocks. If the recovery is further off than anyone now expects that too will sink stocks–no matter where interest rates are.
ehg, I’ll try to answer in the order that you asked. I tend to be more long-term in general than the Jubak’s Picks portfolio. Most of my investment is for retirement. I own about 40 stocks and ETFs and funds in my portfolio. Not all of those are full positions–some are what I call focus money where I’ve bought 50 shares or so of a stock that I might want to buy. I find having some skin in the game foscuses the mind. I don’t think you ned more than a dozen stocks to get good diversification–if you really do picks diversified stocks. I do own ETFs and funds in areas where I either want to build quick and cheap exposure to a whole sector or economy. (So I own ETFs invested in South Africa, Brazil, and Australia.) Or where I think I’ve found a manager who is spending more time on the ground in a hard to research market than I am. So I own the Matthews China Fund. Hope that helps.
danshib, I listen to all those guys and take them with a grain of salt. In a boom, the guys who are always bullish sound like geniuses. In a bust, the guys who are always bearish sound like geniuses. My problem is that listening to the perma bears would have kept you out the recent nearly 60% rally. One test that I like to use is to look at what they actually suggest I buy to take advantage of their gloom. Does the recommendation make any sense? (Buy gold to hedge against inflation? When do they see any inflation arriving?) This isn’t an easy market but the money to be made is in the ground betwen the gloom and the boom.
sigli, great reasoning on prospects for Annaly (NLY). I also like it that they were nimble enough to get a new REIT IPO (Crexus) through the very narrow window for raising new money.
Talk about prescience, Jim.
Barnanke hinted at being at least a little concerned about the strength of the dollar and the market takes a dive on worries over higher interest rates.
Nice timing. heh!
Adamadamek,
My suggestion is to dig in to the financing aspect of companies like Capstead and really understand how it all works together (follow the repo’s and swaps out on both party sides). Learn how they hedge book value and how they lock in a spread.
I follow Annaly and like the management there. NLY is going to make a killing for some time because of the steep yield curve and US government guaranteed payments (now implicit instead of implied).
I see two huge downsides: 1) interest rates skyrocketing (which I don’t think is very likely for at least a couple of years), which will cause huge mark-to-market losses. 2) Fannie and Freddie are bankrupt. Congress may decide the GSE’s will have to stop making interest payments on MBS’s rather than shoveling another hundred or two billion dollars into them. I think there is a good chance of this in such extreme times.
If I remember correctly, Capstead buys a lot of adjustable rate securities. That’ll hedge against interest rate hikes as long as they’re guaranteed by the GSE’s and the GSE’s pay. If they’re buying adjustables from banks then I wouldn’t give them a second look.
You can add Jim Rogers, Nouriel Roubini to that list also.
Hello, Jim? I’m happy that you are back writing. I have one question for you. What do you think about guys like Mark Faber and Peter Schiff? They talk about impending US doom/depression that is really scary. Unfortunately they seem to have lots of good reasons for this. Does US dollar have any hope? Can US govt do anything about dollar?
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I’m shaking my head. This economy cannot recover without jobs, and the jobs went to China. This nation has been living on greater and greater amounts of credit for the last 20 years. Now the jobs are gone, the credit card is charged up, and no one wants to lend us more money.
And the S&P500 is selling for over 20 times earnings, in a depression. And the only way out of the depression, is to borrow more money, so to stimulate more jobs ……jobs in China, ..so we can get jobs at Wallmart to sell each other the stuff.
And as long as the market is being held up by a fake earnings rally in the banks, the rally will never fail.
It just keeps marching up the 10 day….
Jim, your columns include some of the best information I have ever read ( I graduated college 5 years ago with little knowledge of investment strategy or general understanding of the economy so take the compliment however you please). I am interested in your views on the extremely high yield of CMO. At almost 16%, I would assume you wouldn’t be interested in something like this due to the risk of the housing market? Thanks again for breaking it all down into leyman’s terms.
Jim,
Thank you very much for all your guidance and hard work.
I am trying to develop a new portfolio and I have a couple of doubts:
How much of your own personal equity portfolio is divided between the short term Jubak Picks and the longer term 50 portfolio?
In your comments you mention many stocks that are part of your personal portfolio. How many stocks do you include in order to diversify the risk without making it too complex to manage? You recently recommended the BRF ETF. Do you make use of ETFs and mutual funds to help diversify your own portfolio?
Thanks for your help