Out of the Box: Out on the Income Stream
The Fed stated, last Friday, in a surprise announcement, said that they will now use payments, from their current holdings, to reinvest in Treasury Bills and Mortgage Backed Securities, along with Treasuries. They will also be increasing the size of their balance sheet, they stated. In doing so, the Fed engaged in Quantitative Easing, once again, regardless of their protestations, and this, in my opinion, will change the Yield Curve and end all of the speculation that some form of an inverted curve is signaling a Recession.
This was a very significant statement, in my view, because it means that Agency securities, will likely widen to Treasuries, as the Fed is no longer concentrating on this segment of the market. For those of you that are Agency buyers I would be taking a hard look at your portfolios as they are going to drop in price, in my estimation, as they widen to Treasuries, regardless of the market’s fluctuations.
Your free lunch is over.
Personally, I believe that the Fed’s recent interest rate cut is just the beginning of their reversal. My opinion, here, is not based upon anything that President Trump exclaims, or anything that is American centric. One of the biggest errors in judgment, when assessing the Fed, is to assume that it is a stand-alone institution that is somehow above and beyond the other central banks of the world. This is just not the case. In fact, Chairman Powell intoned, several times, recently, about the notion of protecting American interests and our economic expansion.
It is my viewpoint that what is happening globally will force the Fed’s hand. In fact, there is now not one country, in the European Union, with yields as high as American yields including Italy and Greece. The Greek 10 year now stands at 1.38% while America’s 10 year is now 1.77%, according to Bloomberg data. The ECB is on the move, once again, and it is apparent, at least to me, that the “Fix is in.” That is my honest opinion.
It is fair to say that the United States is now under assault, from many other governments in the world, and that our central bank, the Fed, is going to be forced to respond to protect American interests, regardless of what anyone says. There is just no real choice, in my estimation. The Fed has to stand-up for the United States.
We continue to live in “Wonderland,” I tell you. Alice is pratting about.
For American borrowers, I say, take what advantage that you can, because lower rates will mean more stock buy-backs, more refinancing of both Investment Grade and High Yield debt, lower mortgage rates, lower rates on student loans, and it will be a boon for the REIT’s, and other holders of commercial property, as you will be able to borrow for less and less and less.
This is step-one of a protracted process, in my view. We will eventually get to the point where lower yields will no longer move the needle and then, “Watch Out.” However, we are not there yet. We are still in a “Borrower’s Paradise” where those needing money, for any purpose, are standing inside “Heaven’s Gates.”
“I suppose I ought to eat or drink something or other; but the great question is what?”
The flip side of this coin is that it is becoming increasingly difficult to find yield, anywhere, for investors. This is a decided negative for insurance companies, banks, pension funds, savers and retirees, who depend upon yield, and cash flow payments, for their profits and lifestyles and even their existence. It will be equities “up,” Real Estate prices “up,” other hard assets “up,” initially, as both people and institutions alike are forced into riskier assets, in an attempt to cover their expenses.
I do point to one of the last segments, in the markets, that still offers some double digit yields and that is Closed-End Funds. These securities are complicated and a lot of homework has to be done to separate the wheat from the chaff but, in opinion, it is well worth the time, or, perhaps more realistically, find someone that is experienced in this part of the markets. Double digit yields can be found here, even now, in the MLP space, in the energy and pipeline space, in some High Yield bond portfolios, in some mostly Investment Grade bond portfolios, in some REIT and Real Estate funds, and in some hedged dividend plays. Yes, many Closed-End Funds have leverage but I also point out that the leverage is theirs, and not yours.
I also point out another huge advantage, in this sector, and that is that some of the closed-end funds pay monthly dividends. Here you get compounding of interest, the opportunity to have money for your monthly expenses or to re-invest some, or part of it, and grow your principal value, upon which the dividends are based. While it is certainly true that some dividends can be cut, they can also be increased and some funds have paid out special year-end dividends. The monthly payments also let you assess your portfolios, and what looks attractive, each month, so that decisions can be made every 30 days, or so, on what will benefit your portfolios the most.
“When I used to read fairy tales, I fancied that kind of thing never happened, and now here I am in the middle of one!”
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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