What has this meant to long-term bond investors during this time span?  Obviously, it has most often resulted in lower yields when their bonds matured and they reinvested the proceeds in new bonds.  But while they owned their bonds, they have frequently seen an increase in their bond holdings’ current market value.  (Remember, when rates fall, the market value of long-term bonds rise.) 

     For a generation of investors, I believe this has given them “interest-rate-risk amnesia”, and they have come to see even long-term bonds as very “safe” investments.   I believe that there is a good chance that long-term bond investors are about to be reminded that the bond market is not a one-way street, and that when rates rise, bond prices fall, perhaps dramatically.

      The chart above comes courtesy of Scott Grannis at Calafia Beach Pundit.  It chronicles the relationship between stock prices and bond yields since the beginning of 2010.  As you can see, when worries about the economy grabbed the headlines, as they did between May and September of 2010, the market declined and so did bond yields.  Conversely, when the gloom receded, as it did from September 2010 to May of 2011, stock prices and bond yields rose.

        Since last fall, this relationship seems to have ended.  We’ve had one good economic report after another, the S&P 500 has risen 25% from its October low, but the yield on the 30-year Treasury has only inched up from 2.6% to 3.1%.  Stocks are trumpeting an economic turnaround, while the bond market is moaning about a double-dip recession.  If the stock market proves to be the more accurate seer, long-term bond investors could see significant declines in the market value of their bond holdings.

         To receive the Raymond James report “Managing Fixed Income Risks”, which has an excellent chart that will allow you to quantify the potential decline in the value of your bonds, click here and type “Bonds” in the Comments section.

Don Harrison                                                                                                                                                     President,CIS                                                                                                                                    Br. Mgr., RJFS

 The information contained in this report does not purport to be a complete description of the markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Don Harrison and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is an inverse relationship between interest rate movements and fixed income prices. Generally, when the interest rates rise, fixed income prices fall and when interest rates fall, fixed income prices generally rise. The S&P 500 is (an unmanaged index of 500 widely held stocks.) Indexes don’t accommodate direct investment. Past Performance is not indicative of future results.

1) underinvested portfolio managers playing “catchup” (read: performance anxiety)
2) the upside seasonal bias
3) low stock valuations
4) improving economic trends;
5) still depressed sentiment readings;
6) the knowledge that we have now entered the best performing six months of the year for stocks.

     I think points 1, 3 and 4 deserve some further elaboration.
In his October 31st commentary, Jeff furnished some numbers regarding the underinvestment in U.S. equities of portfolio managers all over the world and its implications:
The world remains profoundly underinvested in U.S. stocks. Underinvested indeed, for as repeatedly stated, I could not find one European PM that had more than a 15% weighting in U.S. equities despite the fact their benchmark index has a ~43% weighting. Even here in this country most endowment funds have less than a 10% weighting in U.S. stocks. Ladies and gentlemen, there is no way an endowment fund can achieve its mandated return of 6% – 9% per year using 2.3%-yielding 10-year Treasuries. Manifestly, all we need is for PMs to realize this, and decide it’s time to reallocate money by switching out of fixed income and into equities, for the SPX to do better than most expect. To be sure, that’s what we expect, which should cause professional money to chase stocks higher driven by performance anxiety. Therefore, we continue to favor the strategy of buying “dips.”
It’s not only individual investors who are shunning the market and staying on the sidelines. Professionals have also run for cover which means there is an enormous amount of buying power on the sidelines that could come in and drive stock prices higher.
Investors are fleeing from an historically undervalued market.  The chart below is a version of one that I have kept for many years.  It tracks the yield on corporate bonds (Moody’s Baa Yield) and the Standard & Poor’s 500 Earnings Yield, which in this case is the expected earnings for the next 12 months on all the stocks in the S&P 500 divided by the current price of the S&P 500.  It is the yield you would receive if

JP Morgan Guide To The Markets Q3

you had enough money to buy all of these companies at their current total market value and put the earnings in your pocket.  Currently, the S&P has an earning’s yield of 9.5% and corporate bonds pay 5.2%.  Treasury bond yields are even lower. Normally, bonds have a higher yield than stocks because the yield on stocks can grow as earnings increase while bond yields are fixed.  You have to go back to the late 1970′s to find a stock market that is this undervalued.
Not only is the market undervalued, it is undervalued in the face of mostly underreported good economic news.  Certainly, we have problems — Europe, housing, unemployment and government spending.  But there are also many positive notes playing in the economy right now.  As you can see here, both Corporate Profits

 and GDP are at an all-time high.  My guess is that not 1 in 100 people on the street know this.
Viewed from a businessman’s perspective, you almost have the best of all possible stock-market situations right now: an historically undervalued market where companies are earning record profits that is being ignored by all classes of investors.

To receive a copy of Jeff Saut’s latest commentary, click here  and type “Market Outlook” in the Comments section.

Don Harrison

President/Capitalist Investment Services
Branch Mgr./Raymond James Financial Services

The information contained in this report does not purport to be a complete description of the markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Don Harrison and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is an inverse relationship between interest rate movements and fixedincome prices. Generally, when interest rates rise, fixed income prices fall and when interest rates fall, fixed income pricesgenerally rise. The S&P 500 is (an unmanaged index of 500 widely held stocks). Indexes don’t accommodate direct investment. Past Performance is not indicative of future results.

Which leads me – being the contrarian that I am – to wonder if we might be pretty close to the bottom.

     Our investment decisions here at Capitalist Investment Services center around a very simple question: if we could buy all of the asset we are considering for investment, and pocket all of its present and future earnings, would it make business sense at its current price?  Right now, when you apply that logic to homes, I think the answer is “yes.” 

     Since the late 1980s, the Census Bureau has asked owners of vacant properties trying to rent or sell their property, what they are asking for rent or asking as a sale price.  Assuming a 20% down payment and prevailing 30-year mortgage rates, this allows us  to calculate  the monthly mortgage payment necessary to buy the median vacant home and compare it to the cost of renting the median house or apartment.

     As you can see from the chart below, from 1988 to 2005 the two numbers tracked each other very closely.  But from 2005-2007, with the sharp increase in home prices,

the cost of a monthly mortgage payment jumped well above the monthly rent number.  Today, after an almost four-year decline in housing prices, we see the opposite situation.  The monthly cost of renting a home is significantly higher than the cost of owning one.

            In other words, if you could obtain 100% financing for all the vacant homes in the U.S. at today’s asking price, and rent them out at prevailing rental rates, you would have essentially no net monthly cost.  You would have a free ride on any appreciation.  It has been my experience in the investment business over the years that when dollar bills are lying free in the street, even if they are wet, bedraggled and floating in the gutter, people  eventually recognize them for what they are, pick them up, clean them off, and put them in their pocket.  I believe housing today has the smell and feel of those dollar bills.

     To receive two excellent, more detailed reports on the possibility of a bottom in housing, click here and type “Housing” in the Comments section.

                                                                                                Don Harrison

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Any opinions are those of Don Harrison and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.

                                                      Julius Caesar

The airwaves today are certainly filled with “portentous” commentary warning of the imminent arrival of the second leg of a double-dip recession.  (Shakespeare used “portentous” to mean “ominous, foreboding some calamity”)  Real Clear Markets, a popular website that aggregates financial commentary from major news sources and blogs, is now “howling and shrieking” with the following headlines: Is Another Financial Panic On the Way?, Is a Repeat of 2008 Coming?, The Alarming Decline in Productivity, Why Investors Can’t Trust Anything From Europe, Is Smart $$ Right?  Europe’s Too Big, MUST Fail? ( To be fair to Real Clear, they also have a headline titled Bears Outnumber Bulls, and that May Be Good.)

    Though many things are possible, and Europe’s well-publicized troubles could ripple into the U.S. and cause another recession, it will be the first time in the last 50 years that the economy has tipped into recession when interest rates and Federal Reserve policy look like they do now.  The chart below details the last 8 recessions (green bars), the Real Fed Funds Rate ( blue line, Fed Funds Rate minus inflation) and the 1-10 Treasury Yield Slope (red line, the difference in yield between 1 and 10 year Treasury Bonds).

Right now Federal Reserve policy is very accommodative, as evidenced by the negative Real Fed Funds Rate and the very steep 1-10 Slope.  The Federal Reserve is currently holding short term rates below the Fed Funds Rate and well below the yield on the 10-year Treasury.  As you can see, since 1960 we have never had a recession under these conditions, where the Real Fed Funds rate is negative and the 1-10 Slope is this positive.  In fact, recessions have usually been preceded by the exact opposite conditions.

Raymond James Chief Investment Strategist Jeff Saut has an excellent commentary this week with his thoughts on the stock market’s possible direction.  To receive a copy, click here and type “Jeff Saut” in the comments section.

Don Harrison