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|Index||Month / Year to Date|
10yr UST began the month at 2.68% and finished at a yield of 2.62%
We had a partial swap and sold AmTrust preferred securities AFSI 7.5% 9/15/55 (BB+) and purchased Best Buy bonds- BBT 4.55% 10/01/28 (Baa1/BBB). While the yield is lower on the Best Buy bonds this was a credit “up-grade” trade to lower the risk in the portfolio on a credit basis and a duration or interest rate basis.
In January, big investors seemed to shift their focus mainly to positive and hopeful financial news. As a result, the stock market remained relatively stable, and both the Dow Jones Industrial Average and S&P 500 increased by just over 7% (although the market overall is still down from its peak highs).* This was a dramatic change from 2018, when Wall Street suffered its worst year since the Financial Crisis, and its worst December since the Great Depression.
One of the main drivers for the new cautious optimism in January was the more dovish language coming from the Federal Reserve about short-term interest rates. In its January meeting, the Fed said it would be “patient” with further interest rate hikes, and removed language about “further gradual increases” from its policy statement.**
This came as welcome news to Wall Street given that long-term interest rates continued to exhibit a strong resistance level throughout January, with the yield on the 10-Year Treasury rate ending the month almost exactly where it started it, at around 2.7%. With short-term rates now 2.5%, that means the yield curve is perilously close to being completely flat. It has been partially flat ever since December 3rd when yields on the 2-Year Treasury rate rose higher than yields on 5-Year Treasuries. As I’ve pointed out before, a flat yield curve preceded both of the last two market crashes and is widely regarded as a red flag of a coming recession.
Even if a recession doesn’t hit this year, most economists are forecasting a significant economic slowdown. As for now, what we’re seeing with the markets is fairly common. Investors typically fall into
a trend of shaking off bad news toward the end of a cyclical bull market period. I believe we’re in just such a period, as further evidenced by the bond market’s ongoing resistance level. Remember, the bond market is often said to be “smarter” than the stock market when it comes to forecasting economic trends.
So, just how long can investors continue shaking off bad news and ignoring warning signs near the end of a cyclical bull rally? Well, remember that in 2007, it was widely known in February and March that the subprime mortgage crisis was coming, but it wasn’t until November that the markets started to drop. So, this “shaking off” period might continue for a while… or it might not.
When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:
- Pay Me Now – Enhancing current yield
- Pay Me Later – Enhancing yield to worst
- Cover My Assets I. – Managing interest rate risk
- Cover My Assets II. – Managing default risk
We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.
*“Stocks Wrap Up Best January in 30 Years,” CNN Business, Jan. 31, 2019
**“Treasury Yields Fall Further After Fed Vows Patience,” CNBC, Jan. 31, 2019
*Note: The above trades were recent block trades and do not reflect all trades done on an individual specific basis. Sound Income Strategies, LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Past performance is not an indication of future results. Be sure to first consult with a qualified financial advisor or tax professional about your specific financial situation before implementing any strategy discussed herein.You are advised to give independent consideration to, and conduct independent investigation with regards to, the information above in accordance with your individual investment objectives. Use of the Information is at the reader’s risk, is strictly intended for informational purposes in conjunction with the recipient’s due diligence, and should not be construed as a solicitation by Sound Income Strategies, LLC. Past performance will never indicate or guarantee future behavior. Sound Income Strategies, LLC does not represent or warrant that the contents of the document are suitable for you from compliance, regulatory, legal, or any other perspective. We shall have no responsibility or liability for your use or non-use of the document or any portion thereof. Sound Income Strategies, LLC is registered as an investment advisor under the Investment Advisors Act of 1940 and is regulated by the SEC. Sound Income Strategies, LLC and its affiliates may only transact business or render personalized investment advice in those states and jurisdictions where we are registered or otherwise qualified to do so.