Wednesday, November 30, 2011

November Ends with a Bang

Isn't it amazing what a little perceived bank liquidity will do to the stock markets? Central banks all over the world agreed to lower the cost of funds by 50 basis points and that concerted effort was recognized as a strong positive. The Dow closed on November 30 at slightly over 12,000 for a 4.23% return on the day, with some of the biggest gains being made in the financial sector.

This week, Standard & Poor's announced downgrades on 37 global banks, including Bank of America, Citigroup, Credit Suisse, JP Morgan Chase, RBS, and UBS. In true market fashion, the combination of Central Bank action and the fact that most banks were downgraded only half a notch (from "A" to "A-" for example) led to a strong rally.

Less bad news (the downgrades COULD have been worse) is interpreted these days as extremely GOOD news...and the markets reacted accordingly.

On the bond side, the US Treasury 30 year bond was all over the place today, ending the day down around 2 points for a yield of 3.06. The 10 year was down 3/4 of a point and ended at 2.08%, a 10 basis point change in yield.

Other numbers out this week look good, but we are a long way from being out of the woods. In the bond markets, credit risk rather than interest rate risk is still the thing to watch out for. The street is pumping out floating rate to fixed rate paper along with a fair amount of absurdly low coupon step-coupon bonds. We continue to monitor credit situations, buy premium coupon callable paper, and try not to get overly enthusiastic on the big up-days in stocks.

Wednesday, November 2, 2011

Big Rally in Stock Market

What a month it was for stocks! The last 4 weeks has seen an almost 12% rise in the Dow Jones Industrial Average, yet the year-to-date performance is only slightly ahead of the various bond indices. We continue to believe that stock performance over the next 5 years will be only marginally higher than bond performance, yet the stock market volatility will be dramatically higher. For those who have had a reluctance to take on stock market volatility, fear not. If stocks and bonds perform as expected, your bond results should not be too different than the stock market's results.

As interest rates eventually begin to rise, Blue Haven Capital is poised to take advantage of the opportunity for our client accounts. We continue to recommend a balance between short and longer term bonds and an emphasis on higher coupons. Why higher coupon bonds? See this post from 2009 for a quick explanation.

Credit Spreads and Perceived Risk

The US fixed income markets trade in relation to the US Treasury market. If McDonald's has a 10 year bond, and McDonald's is perceived as riskier than the US Treasury 10 Year Note, then McDonald's will trade at the 10 year Treasury yield PLUS some extra yield spread. In trade lingo, one might hear someone say they have "McDonald's of 2021 at +100 to Tens" meaning they are offering McDonald's 10 year bonds at 100 basis points (1%) higher yield than the US Treasury 1o Year Note.

As the bond buying public perceives more risk in the US economy, spreads widen. In other words, that same McDonald's bond might trade at "+150 to Tens" when corporate profits and the US economy is suspect. Likewise, in a stronger economy with higher confidence, that bond may trade at +60 to Tens.

Over the last 12 months, corporate spreads on Industrial bonds in general have tightened. For example, on average a non-bank 10-year bond was trading at +103 a year ago and is now trading at +86. Consumer confidence is higher and the public's perception of risk is a bit lower. The one area that has widened over the last 12 months has been bank and finance paper. Some weeks ago when the future of Greece and perhaps all of Western Europe was in question, bank and finance paper widened out to +200 in the 10-year part of the curve. Over the last week, as the EU came to some agreement about how to help Greece, those spreads have tightened to +190, but bank and finance paper still has the highest yields available in the market.

As industries fall in and out of favor, and as corporations go through various events (HP deciding to stay in the computer business or Apple's death of Steve Jobs) Blue Haven Capital looks for opportunities to capture the incremental yield increases that such events generate.

Update: Latest Bank Failures Versus Previous Years

The latest numbers from the FDIC's Failed Bank List show that bank failures are decreasing.  The last time Blue Haven Capital discussed banks going into receivership was September 2009 at which time the number of banks failing had been doubling every six months for the previous 4 years. The first half of 2010 saw the first decrease in the number of failed banks since 2005, and we have seen a steady decline for each of the last three semi-annual periods. One might logically argue that there are fewer banks around to fail, but tightened lending standards and increased FDIC oversight also have much to do with the better numbers.

Here is an updated list of annual bank failures:
2000: 2
2001: 4
2002: 11
2003: 3
2004: 4
2005: 0
2006: 0
2007: 3
2008: 26
2009: 140
2010: 157

From January 2011 through June 30, 2011 there were 48 bank failures. 
Between July 1 and October 30, 2011 there have been 37 bank failures. 
We should see fewer than 100 bank failures for 2011, which would be a decrease of more than 33% versus 2010.

Again, we encourage those who are buying CDs from a brokerage firm to be suspect of premium CDs. If a bank fails, the FDIC will NOT refund the premium you paid for that CD and you could easily end up losing money. We would welcome your questions regarding this little known fact of the brokered CD market.