The Cloud of Interest Rate Uncertainty
Thursday, June 20, 2013
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 37.5%, up 4.5 points
  Neutral: 32.6%, up 0.2 points
  Bearish: 30.0%, down 4.6 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »




Uncertainty over interest rates remains a short-term problem for the financial markets.

Yesterday’s Federal Open Market Committee (FOMC) statement failed to calm the nerves of traders. Though traders were looking for more clarity, the June meeting statement only contained two notable changes from the May meeting statement. The committee altered its assessment of economic and labor market downside risks to “having diminished,” from continuing to see those risks. The second change was the dissension of St. Louis Fed president James Bullard. Bullard thought a stronger defense of the committee’s willingness to defend its inflation target was needed.

The immediate reaction by the bond markets was to push yields higher. The benchmark 10-year Treasury note now yields 2.42% versus 1.94% a month ago (May 21, 2013, close). Higher yields mean lower bond prices and there is already a knee-jerk reaction occurring in mutual funds. During the past two weeks, $24.3 billion has been pulled out of domestic bond funds according to the Investment Company Institute (ICI). The proceeds are not going into equities, however, with domestic stock funds incurring $4.8 billion in outflows over the past two weeks. Retail money money market funds, conversely, have seen their assets increase by $15.5 billion over the past two weeks.

This said, I did observe more interest in dividend stocks than other income-producing instruments while I was at the Morningstar Investor Conference last week, a conference that attracts many money managers and financial advisers. It’s admittedly an unscientific observation, but the dividend panel I sat in on was more crowded than the sessions about using a multi-asset approach for income and closed-end funds. I also noticed fewer attendees at a keynote session on bonds than there were at the opening session.

We do appear to be in a period of volatility marked by uncertainty and worry. This is hardly surprising given that we’ve enjoyed several months of relative calm in both the bond and the stock markets. Plus, I have yet to see downside volatility surface without uncertainty and worry accompanying it. Mr. Market is acting in a manner that is normal for him.

What is unknown is how much of the recent rise in bond yields reflects last year’s overshot to the downside. It is possible that bond traders went too far in pricing in a continuation of loose monetary policy. To the extent they did, yields should rise. We also do not know how much interest rates will rise over the short term, much less over the long term. Bernanke emphasized yesterday that changes in the Federal Reserve’s bond buying program will be dependent on how the FOMC’s outlook for economic growth evolves.

It can be difficult to ignore the headlines and short-term market trends, but this is exactly what you should do. If money management firms and hedge funds staffed with economists, strategists and bond traders can’t figure out the timing or magnitude of the next change in monetary policy, you should question your own ability to do so. And if you don’t know the timing or the magnitude of the change, the best bet is to diversify. Not only can you hold a mix of domestic stocks and bonds, with funds, you can easily go overseas as well. There are currency risks and potential tax issues, but doing so can help you reduce the impact of U.S. monetary policy uncertainty.


AAII Model Portfolios

One change was made to the Model Shadow Stock portfolio. Sterling Construction (STRL) was deleted because it violated earnings probation. Taking its place is new addition International Shipholding Corp. (ISH).

For May, the Model Shadow Stock Portfolio gained 6.5%, outperforming the Vanguard Small Cap Index fund (NAESX), which gained 3.6%, and bettering the DFA US Micro Cap Index fund (DFSCX), which was up 5.2%. Year-to-date, the Model Shadow Stock Portfolio has gained 32.8%, beating the Vanguard Small Cap Index fund, which has gained 17.1%, and the DFA US Micro Cap Index fund, which is up 16.9%. The Model Shadow Stock Portfolio has a compound annual return of 17.7% from its inception in 1993, while the Vanguard Total Stock Market Index fund (VTSMX) has gained 8.8% annually over the same period.

The Model Fund Portfolio was up 2.1% for May and the newly implemented Conservative Portfolio (75% Model Fund Portfolio and 25% iShares Barclays 1-3 Year Treasury Bond ETF) was up 1.5%. This compares to a 2.3% gain for the Vanguard Total Stock Market Index fund (VTSMX). Year-to-date, the Model Fund Portfolio has now gained 13.6% and the Conservative Portfolio is up 10.1%, compared to 15.5% for the Vanguard Total Stock Market Index fund. The Model Fund Portfolio has a compound annual return of 9.0% from its inception in June of 2003, while the Vanguard Total Stock Market Index fund has gained 8.2% annually over the same time period.



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The Week Ahead

AAII President John Bajkowski and MarketWatch’s Mark Hulbert will speak to the AAII Washington D.C. Metro Area Chapter on Monday, June 24. Not in the D.C. metro area? Visit our local chapter page to find a meeting near you and come to our Investor Conference this November.

Speaking of presentations, I will be speaking at the American Library Association’s annual conference on July 1, 2013.

Another batch of early reporters will announce quarterly earnings next week, including 11 S&P 500 members. Those companies are Apollo Group (APOL), Carnival Corp. (CCL), Lennar Corp. (LEN) and Walgreen Company (WAG) on Tuesday; Bed Bath & Beyond (BBBY), General Mills (GIS), Monsanto Company (MON) and Paychex (PAYX) on Wednesday; and ConAgra Foods (CAG), McCormick & Company (MKC) and Nike (NKE) on Thursday.

The week’s first economic data will be May durable goods orders, May new home sales, the April Case-Shiller home price index and the Conference Board's June consumer confidence index. All of these will be released on Tueday. Wednesday will feature the final estimate of first-quarter GDP. May personal income and spending and May pending home sales will be released on Thursday. Friday will feature the final University of Michigan consumer sentiment survey and the June Chicago PMI.

Several Federal Reserve officials will make public appearances. Dallas President Richard Fisher will speak on Monday, Minneapolis President Narayana Kocherlakota will speak on Wednesday, Governor Jerome Powell and Atlanta President Dennis Lockhart will speak on Thursday, and San Francisco President John Williams will speak on Friday.

The Treasury Department will auction $35 billion of two-year notes on Tuesday, $35 billion of five-year notes on Wednesday and $29 billion of seven-year notes on Thursday.

AAII Sentiment Survey

Optimism rose for the second consecutive week, while pessimism declined in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 4.5 percentage points to 37.5. Even with the increase, optimism is below its historical average of 39.0% for the fourth consecutive week and the 14th out of the last 17 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, increased by a modest 0.2 percentage points to 32.6%. This is the fourth consecutive week and the 10th in the past 13 weeks that neutral sentiment is above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, dropped by 4.6 percentage points 30.0%. The historical average is 30.5%.

The changes in bullish and bearish sentiment over the most recent three weeks are nearly mirror images of each other. Bullish sentiment is up by a cumulative 8.0 percentage points, while bearish sentiment is down by a cumulative 8.9 percentage points. The swap reflects the ongoing volatility we have seen in the survey results since the start of March.

Since the survey period runs from Thursday through Wednesday, any reaction to yesterday’s Federal Open Market Committee's meeting statement and Federal Reserve Chairman Ben Bernanke’s press conference would have had only a small impact on the results. Rather, this week’s results reflect the tug of war between concerns about prevailing valuations, the slow pace of economic growth, interest rate uncertainty, and a lack of progress on key issues by Washington politicians and optimism about the length of the current rally and signs of continued economic growth.

This week’s special question asked AAII members which sectors and industries they like right now. Energy was the most popular, named by 31% of respondents. Technology came in second, picked by 25% of respondents. Health care and industrials came in third and fourth, listed by 19% and 10% of respondents, respectively. When we asked the same question in early April, respondents named energy, health care and technology as their favorite industries and sectors.

» Take the sentiment survey