Taking Action on Low Yields
Thursday, November 14, 2013
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

Tug of War in the Bond Market
Worried about yields? Consider variable-rate bonds.

Money Funds and the Regulators
Regulators are considering changes such as floating net asset values.

AAII Discussion Boards
What you are doing to get a higher yield?

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 39.2%, down 6.3 points
  Neutral: 33.3%, up 0.6 points
  Bearish: 27.5%, up 5.7 points

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

Take the AAII Sentiment Survey »

I invited a special guest for this week’s Investor Update: PIMCO’s Tony Crescenzi. Tony will give his outlook for the U.S. and global economy and the financial markets this Saturday at our Investor Conference. Ahead of his presentation, Tony wrote the following suggestions for coping with the current low-yield environment.

I remember well the excitement of opening my first savings account and receiving a passbook as a youth in the 1970s. As a novice yet eager saver, I took pride in seeing the numbers move ever higher, both from my deposits and from the “free” money that the bank was crediting my passbook with in the smudgy blue ink they used.

Today, amid the lowest interest rates since the 1950s, I shudder to look in my passbook because the numbers don’t move on their own anymore. If anything I am falling behind, because inflation is eating away at my savings and it likely is yours, too.

Today’s savers are earning next to nothing on their commercial bank deposits, which at the end of October stood at $9.6 trillion outstanding, money that every day is losing ground to price inflation. There is another $2.5 trillion sitting in money market funds, also earning next to nothing.

To be sure, investors who place money in a bank or mutual fund do so with good reason: To preserve their capital and to keep it liquid. The older we get the more we elevate these priorities. Today, for the 80 million Americans who are aged 55 and older, these are high priorities.

Yet investors are not captive to these low-yielding investments. So, how is an investor to break free? First, grasp that today’s low savings and money market rates will likely persist for a long time - for years. The Federal Reserve has made this clear, projecting that its policy rate, that rate by which so many short-term interest rates are set, will be at just 2% at the end of 2016. It might be until 2018 or beyond before the Fed returns its policy rate to its long-run historical norm of 4%.

Should you believe the Fed? Yes. Its credibility rests in large part on keeping its word, and it is currently providing clear guidance on the likely path for its policy rate, providing markets with economic conditions that the Fed wants to see before it raises interest rates. By most expert opinions, these conditions will not be in place for at least two years.

So, once you have cried “uncle” and given in to the likelihood of persistently low rates, you can take action. Here are a few ideas:

  • Consider moving money out of bank deposits to short- and low-duration mutual funds and ETFs. Stay mindful, however, of your cash needs, allocating money that you believe will stay invested under most circumstances. Yields are not high and there’s some market movement, but the return prospects are favorable given the outlook for monetary policy.
  • Consult with your financial advisor and ask about the many income funds that have been developed in recent years with the aim of boosting incomes in non-traditional ways, including by investing in dividend-yielding equities and mortgage-backed securities, among other instruments.
  • Consider “absolute return” strategies, whereby active managers utilize their skills and select investments on the merits rather than because they are tied to an index. These fall into the bucket of so-called “liquid alternatives.”
  • Avoid longer-dated maturities (beyond 10 years) where slowly rising interest rates put your capital at risk.

In sum, ever mindful of safety and liquidity, note that there are $100 trillion of bonds in the global supermarket of bonds. Go shopping! The days of growing your capital through passbook savings are of a bygone era.

Tony Crescenzi,
Executive Vice President, PIMCO

AAII Model Portfolios Updated

There were no transactions for either the Model Shadow Stock Portfolio or the Model Fund Portfolio last month.

For October, the Model Shadow Stock Portfolio pulled back slightly after its strong recent gains, losing 0.6% and underperforming the Vanguard Small Cap Index fund (NAESX), which gained 3.3%, and the DFA US Micro Cap Index fund (DFSCX), which was up 3.5%. Year-to-date, the Model Shadow Stock Portfolio has now gained 46.7%, well ahead of the Vanguard Small Cap Index fund, which has gained 30.7%, and the DFA US Micro Cap Index fund, which is up 34.9%. The Model Shadow Stock Portfolio has a compound annual return of 17.9% from its inception in 1993, while the Vanguard Total Stock Market Index fund (VTSMX) has gained 9.1% annually over the same period.

The Model Fund Portfolio was up 3.4% for October and the Conservative Portfolio (75% Model Fund Portfolio and 25% iShares Barclays 1-3 Year Treasury Bond ETF) was up 2.6%. This compares to a 4.2% gain for the Vanguard Total Stock Market Index fund (VTSMX). Year-to-date, the Model Fund Portfolio has gained 21.5% and the Conservative Portfolio is up 15.9%, compared to 26.3% for the Vanguard Total Stock Market Index fund. The Model Fund Portfolio has a compound annual return of 9.3% from its inception in June of 2003, while the Vanguard Total Stock Market Index fund has gained 8.8% annually over the same time period.

More on AAII.com

The Week Ahead

Fewer than 30 members of the S&P 500 will report earnings next week. Included in this group is Dow component The Home Depot (HD), which will report on Tuesday.

The National Association of Home Builders November housing market index will be the week’s first economic report of note, with a Monday release date. Wednesday will feature the minutes from the October Federal Open Market Committee meeting, the October Consumer Price Index (CPI), October retail sales, October existing home sales and September business inventories. The October Producer Price Index (PPI) and the November Philadelphia Federal Reserve survey will be released on Thursday.

The Treasury Department will auction 10-year inflation-protected securities (TIPS) on Thursday.

Several Federal Reserve officials will make public appearances next week. Philadelphia president Charles Plosser and Minneapolis president Narayana Kocherlakota will speak on Monday. Chicago president Charles Evans and Chairman Ben Bernanke will speak on Tuesday. St. Louis president James Bullard will speak on both Wednesday and Thursday.

AAII Sentiment Survey

Optimism about the short-term direction of stock prices was tempered this week, according to the latest AAII Sentiment Survey. Pessimism rose notably higher, but still remains below its historical average.

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 6.3 percentage points to 39.2%. This is the first time in six weeks optimism is below 40%. The historical average is 39.0%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged, rose 0.6 percentage points to 33.3%. This is the fourth consecutive week that neutral sentiment is above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, jumped 5.7 percentage points to 27.5%. Although pessimism is at a five-week high, it remains below its historical average of 30.5% for the eighth time in the past 10 weeks.

A reversion to the mean in both bullish and bearish sentiment occurred this week. Though optimism is still slightly above and pessimism is still somewhat below their respective historical averages, upside expectations for the short-term direction of stock prices were tempered following last Thursday’s 1.3% decline in the S&P 500.

Individual investors, in aggregate, continue to be encouraged by the market’s upward momentum as well as by earnings and economic growth. Tempering this optimism are concerns about the pace of economic growth, elevated stock valuations and the lack of a long-term fiscal solution.

Since we are holding the AAII Investor Conference in Orlando, FL, this weekend, this week’s special question asked AAII members what their favorite Disney movie is. “Fantasia” and “Snow White and the Seven Dwarfs” tied as the favorites, with each named by more than 10% of respondents. “Davy Crockett: King of the Wild Frontier” and “The Lion King” tied for second, with each movie picked by 8% of respondents.

» Take the sentiment survey