Ray Bradbury’s 1952 short story, A Sound of Thunder, explored the implications of time travel and the impact one small decision could have on the future of the world. The concept is one that many have considered over the years with the same question in mind: could we change history? The challenge of this mindset is that it is impossible to know what the true outcome would be with even the most insignificant of changes. As Edward Lorenz noted in his research on chaos theory, even a small butterfly flapping its wings over Brazil could seemingly cause a tornado in the state of Texas.
The Federal Reserve and central bankers around the world are convinced that taking a different approach to fighting a deep recession will affect a better outcome and restore stability to the markets and the global economy. In his famous “Helicopter Drop” speech in November 2002 to the National Economists Club (http://www.federalreserve.gov/boarddocs/speeches/2002/20021121/default.htm), Federal Reserve Chairman Ben Bernanke noted that had central bankers in the Great Depression in the 1930s and in Japan in the 1990s utilized every monetary policy tool available to them, they could have mitigated the ensuing financial distress. Chairman Bernanke felt that “the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation…to ensure financial stability in the economy.
“Fixed income should be considered more risky today than it has been at almost any other time in the past 30 years.
Thus, the Federal Reserve and central bankers around the world are availing themselves of these monetary tools in an effort to right the economic ship and effectively “change history”. According to ISI Research:
- There have been over 293 easing programs instituted by central banks around the world in the past 4 years; and
- Our Federal Reserve has paralleled these efforts with three substantive quantitative easing programs (QE1, QE2, and QE3) in that same time period.
The visible implications of these policy decisions are dramatic:
- The US Treasury ten year bond has fallen from a yield of over 4% in 2008 to approximately 1.7% today.
- US Thirty year fixed conforming mortgage rates are at 3.5% from over 6.5% during the 2008 crisis;
- Spreads in domestic high yield bonds are now at multi year lows;
- Investor sentiment has continued to support the demand for income despite negative real Treasury yields; and
- The ECB has managed to put a ceiling on spread widening with commentary on their support of all peripheral Eurozone countries.
These facts lead us to one assessment: fixed income should be considered more risky today than it has been at almost any other time in the past 30 years. Thus, we have maintained a neutral or underweight to fixed income assets across portfolios. Our position is ironically informed by uncertainty. The unknowns of when rates will rise or when the global economy will be able to stand on firm footing without intervention pose too great a threat to treat the fixed income markets as though they will behave according to historical norms.
The single known is that, when rates do rise, it will be a sharp reversal that will come when investors least expect it. Nevertheless, institutional investors continue to search for less volatility in their portfolios and yield to cover spending needs, but the fixed income market fails to deliver the security and consistency it once offered. It is our goal to help clients minimize the impact of this reversal and, in the meantime, leverage large cap domestic stocks to generate greater income through above average dividend yields and alternative strategies to manage volatility. We have also chosen to pursue greater diversification within the fixed income space.