US Interest Rates - BVI Property Guide

Rising US Interest Rates - BVI Property Guide
by Adam Stauffer, CFA, Chief Investment Officer at Offshore Investment Advisor

In the last months of 2010, US Treasury rates—or the interest on US government debt—started to climb from near historic lows.

The combination of a second round of quantitative easing by the Federal Reserve and an extension of former US President George W. Bush-era tax cuts sparked a rally in 10-year Treasury rates from a low of 2.45% in early October to around 3.5% at the time of this writing.

While the prospect of rising rates is welcome news for investors in CDs, many of whom have realised negative real rates of return over the last several years due to near zero percent interest rates, the impact on short-term CDs will be muted. In fact, the benchmark three-month CD rate only increased to 0.29% from 0.27%. Instead, the primary impact will be felt in mortgage rates and more generally across an investor’s portfolio.

When does 50 cents equal $5 million?

When you are a rapper named 50 Cent and you use Twitter to promote stocks in your portfolio: “Sales of the penny stock [ticker: HNHI] increased by 290 percent following the endorsement [by 50 Cent], resulting in a paper profit of almost $5.2 million for the rapper, who owns 7.5 million shares in the company...” To read the full article see “Is 50 Cent Using Twitter to 'Pump and Dump' Stock?”


Maybe James and I should hire 50 Cent to write this commentary …

Party Like Its 1999?

In some ways it sure seems like it. Equities appear to be unstoppable and some names like YOKU and DANG have had IPOs that have skyrocketed in their first several days of trading similar to dot-coms in ‘99. In reality, 1979 may be more like it. But let’s hope it is neither!


What is happening in Egypt has some similarities to Iran in the late 70’s. In 1979, amid massive protests in Iran, the Shah fled and the anti-western Ayatollah Khomeini took over leadership. This set up the Arab oil embargo of the US and its western allies and set off an inflationary cycle in everything oil-related, from gasoline to food. The price of Saudi crude more than doubled to around $34 a barrel at the end of 1980 from $14 two years earlier. A similar disruption in the Middle East could send WTI crude oil, which currently trades around $90, well above its previous high of $145 in 2008 (see chart).


However, it is unlikely that Egypt will be the cause of a massive spike (at least directly), since the country does not produce much oil. Egypt does control the Suez Canal, which sees more than 5% of the world's oil pass through it, however even this is unlikely to set off an inflationary spike.


In my opinion, the bigger concern is how quickly these disturbances are spreading from country to country. According to Business Insider, what started in Tunisia “partially due to food price inflation and unemployment, but also because of WikiLeaks,” has spread to Egypt, Morocco, and Algeria, among other countries. If a serious disruption were to spread to a significant producer of oil then runaway inflation—starting in oil-related products then spreading to other commodities—could be an issue.


Coincidently, if you have been reading our past couple of Commentaries there is a scary, albeit loose and lucky, similarity between what we spoke about and what is going on. Specifically, in November, we mentioned:

“To cap off the negative tone for the month, Wikileaks has thrown a wrench into closed door politics and, in my opinion, has turned a nearly impossible situation in the Middle East into an impossible one…” Read more here.

Then in December we spoke tongue in cheek about Armageddon and commodities inflation:

“I am not an “Armageddon is coming” type person, but It is easy to let your mind get carried away when you think of how much food, energy, water, etc. 7 billion people need…” Read more here.

Bottom line: The current turmoil in the Egypt is not Armageddon (although if you live in the region then it may feel like it). However, food prices have been rising dramatically in the Middle East, as well as other parts of the world. According to the UN, the food price index is at the highest level ever recorded. This food inflation has the possibility of creating global social unrest (particularly developing markets), which generally speaking will have negative implications for stocks which tend to decrease in value during times of uncertainty and positive implications for supply constrained things like commodities. Furthermore, it appears that risks are starting skew in favor of holding developed equities vs. developing.


For more information on the linkages between the Mid-East unrest and Wikileaks and Food Inflation see here and here.

Real Estate - BVI Property Guide

Real Estate and Asset Allocation

by Adam Stauffer, CFA, Chief Investment Officer at Offshore Investment Advisor

US home equity peaked in 2005 at $13.1 trillion when it accounted for over 22% of households’ net worth, according to the Federal Reserve. Now five years later it stands at $7 trillion and accounts for only 13%. The magnitude of this fall and its unprecedented global reach have left many investors breathless—questioning the role that real estate plays in maximizing long-term wealth.

Historically, real estate has been an excellent way for individuals to not only save but to build wealth. Despite this, many wealth managers do not include it in their asset allocation calculations. In fact, there is a relative dearth of research on how home equity fits into an individual’s overall portfolio. In my opinion, this is a mistake. Not only can real estate offer great diversification relative to other assets, such as stocks and bonds, but it also forces investors into a regimented savings plan.

A Peak Ahead At 2011

2011 is going to be a year of contrasts—developed vs. developing, stimulus vs. tightening, spending vs. austerity, and bubbles vs. ranges. Nearly everywhere we look we find opposing extremes. Same goes for our 2011 Outlook. Whether looking at the US, Developing Markets or Europe, there are frictions within each market as well as across markets that gives us cause for concern. While we are beginning the year fully invested in all of our Model Portfolios, we feel that markets particularly equities could be nearing a top.


Within the United States, equities ended the year at fresh 2-year highs and investor sentiment, as gauged by the Investors Intelligence Advisors Sentiment Survey, posted its highest reading of bullish sentiment in several years. However, despite these green lights we see red. Typically, sentiment extremes are a contrarian indicator and often signal the top or bottom. Furthermore, credit default swaps on US municipals debt, which are bonds issued by US cities or other local governments, are widening, which means that professional investors are starting to bet that some states may need to be bailed out by the federal government. But with what money? We are watching the situation closely as it will have a significant impact not only on Municipal Bonds and US Treasuries, but also on the US and Global economic outlook. For the time being however, it seems that the combination of Fed stimulus in the form of QE2 and the Bush tax cut extension will lift US growth expectations and the equities markets for the foreseeable future.


In stark contrast to the developed countries, many of the developing countries, particularly China, Chile and Brazil, are trying to cool growth and tame inflation by tightening their monetary policies. If done too quickly or in the wrong way (overly strict capital controls) then this could have a hugely negative impact on rising commodities prices, developing equities markets as well as commodity producing countries such-as Australia and Canada. With that said we continue to like developing markets, particularly some of the smaller countries, such-as Chile, Colombia, Egypt, Argentina, and Peru. We think these countries will benefit as investors chase returns.


And then there is Europe. Europe is following a completely different path. Where the US is applying the gas to in theory build escape velocity from the economic slowdown and the developing countries are applying the brakes to prevent overheating and runaway inflation, Europe is doing neither. Europe appears to be stuck in neutral, while representatives from different constituent countries argue over the best way to solve their sovereign debt issues. Europe has a serious dilemma in that the core of the region is relatively strong while the periphery is weak. This means that it will be nearly impossible to create a solution that addresses the growth issues in countries like Ireland and Spain, while at the same time maintains the fiscal discipline that Germany demands. As such, we are completely avoiding Europe until there is more clarity around the situation.


Bottom line: A lot of diverging and conflicting signals often mean that something big is around the corner. We are fully invested now but anticipate turbulence ahead and could easily see reducing exposure across the board (equities, fixed income and commodities) within the year. See Appendix A for a quick snapshot of our views on various markets.


On a lighter note (pun intended) there is an article in The Economist’s “The World In 2011” on the global population. In 2011 the population is expected to reach 7 billion up from 6.1 in 2000 and 1 in 1800. 7 billion! The main point of the article is that we shouldn’t worry because the rate of population growth is slowing. But 7 billion people seems like a lot to me. 7 billion of anything seems like a lot. 7 billion ants … no thanks! 7 billion pennies … yes please! (But wait where am I going to put them all?)


I am not an “Armageddon is coming” type person, but It is easy to let your mind get carried away when you think of how much food, energy, water, etc. 7 billion people need. For The Economist article please see “Another year, another billion”. For a not so educated spin on the same topic please see “Ashton Kutcher Preparing For Armageddon”.


Happy New Year (7 billion times)!


James & Adam

CD rates fall to all-time lows | Prism Money

CD rates fall to all-time lows | Prism Money

Interest rates on bank certificates of deposit are at their lowest levels ever, Market Rates Insight reports. “For the first time since 1952, the average rate for all CDs dipped below 1 percent,” Dan Geller, the firm’s executive vice president, told Reuters. 

That’s bad news for savers, but, as Geller points out, “what’s the alternative?”

Offshore Investment Advisor's Analysis: Offshore Investment Advisor uses MLPs, which generally tend to have high yields, to enhance the yields of our portfolios. However not all MLPs are the same and depending on your tax status, you will want to favor some and avoid others. For Offshore Investment Advisor's analysis please see "The Case For MLPs".

Whipsawed

November could have been a case study in why trading can be so difficult. It is easy to imagine how someone could have got caught in the euphoria at the beginning of the month, bought equities, gold, silver (everything!) just to get hammered midway through the month. Reverse their position just in time for a head fake of a rally and then get carried out at the end of the month. 

The first week of November saw the greatest concentration of monetary policy action since October 2008. As expected, the Fed announced QE2—$600B in purchases of medium-term Treasuries by the end of June or around $75B a month—and the markets were off to the races.

By November 5th, equities markets were hitting 2 year highs.



Gold soared past $1400 and silver (as well as other commodities) looked like they were all going to the moon.



All the while, the US dollar index continued to get clobbered. 

And the Australian Dollar broke parity with the USD.



All systems go. Right?

Not quite. Mid month, China signaled that is was tightening—requiring banks to set aside larger reserves (which in theory drains an overheating economy of fuel … cash)—and worries over the European sovereign debt crisis flared up again; this time with Ireland in the spotlight. Then North Korea bombed the South, and concerns over the success of Ireland’s bailout spread to Portugal, Italy and Spain. This all caused a flight to the US Dollar and reversed the trade that has worked so well over the last several months—USD down / everything else (equities, commodities, non-USD currencies) up.

To cap off the negative tone for the month, Wikileaks has thrown a wrench into closed door politics and, in my opinion, has turned a nearly impossible situation in the Middle East into an impossible one. What concerns me most are the documents that discuss King Abdullah of Saudi Arabia negative comments towards Iran. I do not know enough about the politics of the region to make an educated forecast of the repercussions, but it seems to me that in a region that is already so unstable these comments not only undermine relations at the political level but also create subversive tensions at the individual level within Saudi Arabia and across the region. 

Looking forward: In December investors will likely play defensive in an attempt to hold onto gains made over the year. The markets seem a little toppy, however we continue with the thesis that as long as the US Fed is printing easy money, the dollar will continue its slide down and nearly everything else will go up. However, now we have all of our positions on a shorter leash. China's monetary policy will have significant short-term implications on the commodity and commodity related markets. Meanwhile, the Euro is displaying a fairly negative chart pattern—making lower highs and lower lows—which could temporarily stall the USD’s fall.