Commentary - 8/26/2010
World equity markets have taken quite a tumble over the past month while fixed income of all kinds has rallied, dropping yields. The spreads (differences in yields) between high quality debt and junk bonds has narrowed significantly. Investors are simply looking for yield anywhere they can get it. We have ridden high yield (junk) bonds for a while now, getting in during the beginning of 2009 when fear drove the spreads to historic highs. It has taken the popular press and the everyday retail investor a long time to get on the high yield bandwagon so, to us, it is time to get off. There are a few other asset classes that look attractive such as foreign bonds and even large cap stocks, especially those that derive a significant portion of their revenue from overseas.
The decline in fixed income yields should continue to have positive consequences for the economy. Homeowners can refinance their homes even if they are underwater under new federal loan programs at incredibly low rates. Even if the real estate sector is still hurting, at least homeowners will have some extra money in their pockets to spend from lowering their mortgage payment. The headlines earlier this week related to housing were not positive but that shouldn’t have been a surprise. The expiration of the home buyer tax credit was sure to bring about a lower level of housing related activity. The credit simply crammed more sales into the months it was available. I doubt it actually did much for the long run trajectory of home sales. Would you buy a $250,000 home just because you were getting an $8,000 tax credit? I would contend you were buying anyway and just took advantage of a misguided government program. The bright spot in the data was that home prices didn’t really change.
There are silver linings in the negative data, which itself is flawed by things like the home buyer credit and census employment. Economic activity does not go up in a straight line and typically has a lull as government stimulus wears off and the economy must get used to standing on its own legs. While we took advantage of volatility to take some gains where it was appropriate, we don’t predict a double dip recession.