On the Money August 2013
by Stephen Memery
an old adage on Wall Street which says, “Sell in May and go away.” This is more than just a line about getting a jump on the beach traffic. The idea is that returns for the traditionally volatile May to October period historically underperform the November to April term. According to the Stock Trader’s Almanac, since 1950 returns for the Dow Jones Industrial Average have averaged a mere 0.3% during May-October while returns for November-April averaged 7.5%.
So far this year, it seems to have paid off to let your money skip the vacation and continue working. The DJIA ended April at 14,839.80, up nicely from the previous November. But it has continued to climb, finishing up July 15, at 499.54 or about 4.4%. True, we still have some months to go and of course we have experienced our share of volatility. But this is still a substantial gain given the tepid economic numbers and more than a dose of uncertainty.
In June, markets fixed their jaundiced gaze onto Chairman Bernanke and the possible unwinding of the cheap money policy known as Quantitative Easing. After the market choked on a few 100+ point down days amid speculation that the QE was about to end, the Fed settled things down by disclosing the parameters for an end to Easing – essentially as the economy continues to improve, bond buying would slow. When unemployment level reaches 7% the Fed would stop buying new bonds.
The unemployment rate for July came out at 7.4% with the country adding 162,000 jobs. It appears there is some time to go before we see the Fed stop buying bonds entirely. The Fed itself expects that we will reach that unemployment target midway through 2014. In the meantime, the June Consumer Price Index showed inflation at 1.8% during the previous 12 months. This is a pretty low level given the amount of cash that the Fed has been pumping into the economy, and it gives the Fed the luxury of time when it comes to wrapping up Quantitative Easing.
Simply put then, there is no reason to believe that Chairman Bernanke is poised to snatch the binky from our collective mouths and cut it up before our eyes. But eventually, higher interest yields will be a reality, not just a possibility. The risks to portfolios are just as real.
Bonds, particularly those with longer time to mature, risk loss to principal on a market to market basis. That is to say the bond values will decline on your monthly statement, and you will get less for a bond should you want to sell. Choose instead to keep your bonds until maturity, and you need to be comfortable knowing you are getting less interest income than you would with another investment.
Bond mutual funds are not exempt from this risk, and have an added complication; you have no say in whether to hold a bond to maturity. Many bond funds are managed for current income. As such they seek to maximize current interest yield. In a rising interest rate environment, a manager may choose to sell bonds purchased at lower yields in order to acquire newer bonds with higher yields. In doing so they may also achieve a capital loss and a drop in the Net Asset Value of the fund. The result can be a higher, more marketable current yield, but a loss in net asset value without achieving an appreciable increase in the interest income generated by the fund.
Investors have speculated that these risks will result in a “Great Rotation”, a mass movement out of bonds and into equities. Indications are that this movement is already under way. According to the Investment Company Institute (ICI), investors pulled $74.9 Billion out of bond mutual funds between June 1 and July 10. While some investors may have “sold in May”, but it definitely didn’t end there.
Yes, it’s summer. And everyone likes to “get away.” But if you really want to enjoy that vacation, and not worry that your investments will flounder, make sure you have a knowledgeable financial advisor to help you navigate the waters. Remember, there is opportunity in every difficulty, but you must Plan to Succeed.
Stephen D. Memery is a Chartered Portfolio Manager tm and Chartered Market Analyst tm with more than 20 years of experience in the financial industry, He is a Founding Partner of OV Capital, located in Old Town Alexandria, and on the web at www.OVCapital.Net.