Home sales stunk, and the Fed Governors are squabbling. Ergo: markets sold off. This strikes us more than casual market noise and that there has been a very significant shift in Fed Policy. Throughout the fall 2009 and spring 2010, the Fed had been on course to measuredly terminate various types of monetary accommodation. They were well on course with their stealthy tightening until last week when they announced that they would be reinvesting principal payments from their $2.3 trillion portfolio. That’s a big deal. It is a major about-face. It seems they tried to temper the severity of their move by disclosing that there were dissenters among their ranks. It looked like a way to try to make their dovish shift a bit edgy.
They may have sent the wrong message or at least their message may have unintended consequences. Wall Street has conferred upon the Fed mystical powers of solomonesque omniscience. Squabbling undermines that perspective. It makes them appear downright mortal and perhaps even fallible. Steve Roach said on CNBC that he thought that this Fed was being reactionary and not strategic. He may be right, or this shift may be strategic and indicate a more severe economic condition than most expect. Whether reaction or strategy, the Fed has ceased its contraction and reversed to an expansive posture.
We know that jobs aren’t being added and that consumers have their saving hats on. Neither offers much encouragement for speedy recovery. But pay attention to stocks.
As investor flows have been removed from all things equity and invested in bonds, rates are making record lows. The 2year Treasury Note auction wrought yields of less than one half percent. The 10year Treasury Note traded at and below 2.5%. This message of concern for a return of capital as opposed to a return on capital is deafening. Stocks look ever more reasonable.
Big blue-chip multinational corporations are selling at 11 times earnings, have huge amounts of cash on their balance sheets, and dividends largely in the 2-4% range. If you believe that America’s future will continue to grow and flourish over the years and decades ahead, then this period of contraction will pass as all of the others have passed, and these levels will be remembered as laughably cheap.
There are always exceptions, and individual municipal bonds are quite interesting right now. Many deals of the past ten years were issued with insurance that garnered a AAA rating and did not apply for an underlying rating. Insurance is considered of questionable worth, and smaller issues (less than $200 million) don’t have much of a following and tend to trade inefficiently. Farr, Miller & Washington Fixed Income Manager, Glenn Ryhanych, CFA, CFP said he’s never seen such wide spreads among similar securities.
DC Ballpark Revenue Bonds are interesting to us. On their face they carry an A rating and were a huge issuance. Revenues from a stadium might raise questions about cash flow necessary for debt service, but a little research tells a different story. The primary source of the debt service fund is a business tax on all DC businesses over $5 million in revenues. The secondary source of debt service income is a utility tax for commercial, not residential, subscribers, and thirdly is a tax on revenues generated by stadium vendors, ticket and merchandise sales. These broad based revenue supports give us greater comfort in considering these bonds for client accounts. Please note that this is not a recommendation to buy or sell. We may be buying or selling these and other issues for clients’ accounts at any time as we deem appropriate.
With diligent research and optimism for the future, we continue to research several stocks and bonds that appear to represent compelling value at current levels. It has gotten tougher to invest, but don’t give up, buckle down and do your homework; it will be worth it.
Hang in there.
Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.