BOND MARKET PERSPECTIVES Week of June 1, 2015 BT Wealth Advisors 601 Bayshore Boulevard Suite 960 Tampa, Florida 33606 813.998.2791 In This Issue Kids & Money: Important Lessons Start Early in Life The first step in teaching children responsible money management skills is to start early and set a strong example. A Net Worth Statement Helps Keep Retirees on Track Your net worth is more than just your income. A net worth statement presents a composite picture "in time" of your overall financial health. Bond Market Perspectives Week of June 1, 2015 Lingering uncertainty over Greece, U.S. economic growth, and the Fed may continue to create a tug-of-war on bond prices that will likely continue to lead to a low-return environment. Weekly Market Commentary Week of June 1, 2015 Greece is unlikely to maintain its debt repayment schedule without a resolution. Weekly Economic Commentary Week of June 1, 2015 We give the Fed partial credit on equity and bond market impact.
2 Kids & Money: Important Lessons Start Early in Life To ensure that important life goals remain at the forefront of your children's -- and likely heirs' -- priorities throughout their lifetimes, incorporate the use of incentives in your estate plan. Today many affluent families are concerned about the potentially adverse effect of wealth on younger generations. As a result, the goals that many high-net-worth parents and grandparents have set for their children or grandchildren reflect core values, an honest work ethic, and a desire to give back to the greater community. Walking the Talk The skills and knowledge needed to help children achieve these goals should be developed early in life and continue well into adulthood. The following strategies can assist older family members in becoming positive financial role models for children. Start early -- Parents can start talking to children about money at as young as age three. Between four and five, you can explain the importance of good spending habits, and by age six or seven, you can help children open a bank savings account. By the time children reach their mid-teens, they should start seeking after-school and summer employment. Support education -- Personal finance education helps instill such pragmatic money management skills as setting a budget, balancing a checkbook, understanding the role of debit/credit cards, and developing strategies for funding college. Encourage your child's school to offer personal finance as an elective "life skills" course, send your teen to a community college/adult education class, or tap the many educational resources available online. Lead by example -- Your children will learn the most valuable lessons about money from examples you set. A few simple rules: Enjoy the fruits of your labor -- but don't go overboard. Set a healthy example regarding credit card use. Pay your bills on time. Save and review your savings plan on a regular basis. Above all, be consistent. Use incentives -- To ensure that important life goals remain at the forefront of your children's -- and likely heirs' -- priorities throughout their lifetimes, incorporate the use of incentives in your estate plan. What exactly is an incentive trust? It is an estate planning tool designed to reward desired behaviors or impose appropriate penalties for undesirable behaviors. It also provides a way to address the needs of beneficiaries who require special assistance. Common themes guiding incentive trusts are education, moral and family values, and business/vocational choices, as well as charitable and religious interests. Encourage philanthropy -- Affluent families often use philanthropy to convey the message that their success has been the result of hard work and good fortune, and that success comes with the responsibility to give something back. If you want to ensure future generations of volunteers and donors, you must model for children various ways to give of their time, their talents, and their money. Once children understand the scope of their contributions, philanthropy often becomes a real and meaningful part of their lives. If you are interested in developing a legacy plan that incorporates some of the ideas mentioned here, consider seeking the guidance of a financial and estate planning professional. Together you can create a plan that instills financial responsibility in children for generations to come. This communication is not intended to be tax or legal advice and should not be treated as such. Each individual's situation is different. You should contact your tax/legal professional to discuss your personal situation. 2015 Wealth Management Systems Inc. All rights reserved. 1-331502
3 A Net Worth Statement Helps Keep Retirees on Track Taking stock of your assets and liabilities may require a bit of research at first, but the process will get easier each time you do it. A number of planning tools can help retirees monitor their cash flow and make appropriate adjustments in response to changes in income and expenses. Not the least of these is a net worth statement. By calculating your net worth, you are essentially taking a snapshot of your current financial status. That snapshot can then provide you with the information you need to make important financial decisions. What is net worth? It is more than just your income -- it's your overall wealth. To determine your net worth, just add up your assets and subtract your liabilities. Your assets are everything you own, including the money in your bank accounts, retirement plans, and investments accounts as well as real estate and even possessions such as your car(s) or a boat. Your liabilities are what you owe. This may include the balance on your home mortgage, credit card debt, car payments, and even unpaid taxes. Taking stock of your assets and liabilities may require a bit of research at first, but the process will get easier each time you do it. It's a good idea to review the calculation each year to make sure you stay on the right track. Whether your net worth is higher or lower than you expected really should not be of concern. The main purpose of identifying your net worth is to give you a reference point for assessing your overall financial health. The following worksheet will help you break down your assets and liabilities so you can reach your bottom line. YOUR ASSETS Cash/bank accounts, CDs, etc. 1 $ Vested share of retirement accounts (employer plans, pensions, profit-sharing plans, etc.) $ Market value of investments (stocks, bonds, mutual funds, IRAs, annuities, etc.) 2 $ Market value of real estate (home, other property) $ Market value of vehicles (car, boat) $ Cash value of insurance policies $ Other (valuables, furnishings, etc.) $ TOTAL ASSETS $ YOUR LIABILITIES Balance due on home or real estate mortgage(s) $ Balance due on loans (car, student, real estate) $ Balance due on rental properties $ Balance due on credit cards $ Fixed monthly payments $ Unpaid taxes $ Other $ TOTAL LIABILITIES $ YOUR NET WORTH (Subtract liabilities from $
4 assets) 1 CDs are FDIC insured and offer a fixed rate of return if held to maturity. 2 Investing in stocks involves risks, including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. Investing in mutual funds involves risk, including loss of principal. Mutual funds are offered and sold by prospectus only. You should carefully consider the investment objectives, risks, expenses and charges of the investment company before you invest. For more complete information about any mutual fund, including risks, charges and expenses, please contact your financial professional to obtain a prospectus. The prospectus contains this and other information. Read it carefully before you invest. An annuity is a long-term, tax-deferred investment vehicle designed for investment purposes and contains both an investment and an insurance component. They are sold only by prospectus. Guarantees are based on the claims-paying ability of the issuer and do not apply to an annuity's separate account or its underlying investments. The investment returns and principal value of the available subportfolios will fluctuate so that the value of an investor's unit, when redeemed, may be worth more or less than their original value. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. 2015 Wealth Management Systems Inc. All rights reserved. 1-331501
5 Bond Market Perspectives Week of June 1, 2015 KEY TAKEAWAYS Lingering uncertainty over Greece, U.S. economic growth, and the Fed may continue to create a tug-of-war on bond prices that will likely continue to lead to a low-return environment. We believe additional bond market strength is likely limited. BOND TUG-OF-WAR The bond market tried to end the month of May on a high note but did not quite make the mark. The last 10 days of May 2015 witnessed fairly steady improvement in high-quality bond prices after a difficult five weeks, but it was still not enough to offset losses for the month. The broad Barclays Aggregate Bond Index still finished 0.24% lower in May and posted consecutive monthly declines for the first time since the last two months of 2013. However, unlike late 2013, we do not expect a repeat of the 2014 bond rally that followed, but rather a continuation of the tug-of-war on prices that has been evident so far in 2015. The first day of June 2015 was a reminder of the push-and-pull on bond prices as the Institute for Supply Management's (ISM) Manufacturing Survey report was stronger than expected. The ISM result appeared to contrast with growing fears about second quarter 2015 economic growth and led some Wall Street economists to boost their expectations of growth for the second quarter. Focus now shifts to the employment report due out Friday, June 5, 2015, as the next clue to the extent of a second quarter bounce back. The monthly employment report and bond prices and yields have moved in sync over the past several months [Figure 1]. While far from an exact relationship, bond yields and monthly total payrolls have, directionally, moved together, with stronger monthly payrolls corresponding with higher yields and vice versa. For the December 2014 jobs report, which was released in early January, the 10-year Treasury yield may have overshot to the downside but the directional relationship still held. Current bond yields already reflect an anticipated gain of just over 200,000 in total payrolls. Bond prices and yields may take their cues from monthly payrolls, either surging notably above or falling substantially below the consensus forecast of 227,000. Despite bond yields and monthly jobs gains moving in tandem, changes to bond yields have been relatively limited. The 10-year Treasury yield has fluctuated within a range of approximately 1.7% to 2.3% since late 2014. Friday's jobs report is just one factor in the push and pull on bond prices. Others include: Greece. Friday, June 5, 2015, also marks the date of a key Greek payment to the International Monetary Fund (IMF) (see our Weekly Market Commentary, "The Greek Drama," June 1, 2015).
6 Without a resolution between the Greek government and Eurozone and International Monetary Fund (IMF) officials before then, Greece may default, as it likely does not have sufficient cash to make the payment. An agreement will pave the way for additional bailout payments and alleviate a cash crunch. Throughout 2015, Treasury prices have been both pressured and supported by the progress of Greek negotiations, as a default may boost demand for high-quality assets such as Treasuries. Even if a last minute deal is reached, an agreement is likely to merely postpone potential default risks and challenges to the European financial system. On a positive note, the European economy and financial system is much better prepared to handle a Greek default now, and Greek creditors consist almost exclusively of central banks and the IMF, not private investors. Economic growth. Just as expectations for second quarter growth were beginning to fall below 2% for the second quarter, a strong ISM report on manufacturing activity, released Monday, June 1, 2015, led to forecasts being revised higher. While we continue to believe the economy could grow at a 3% pace over the remainder of 2015, data remain inconclusive on the extent of a bounce back from a depressed first quarter. Federal Reserve (Fed) rate hikes. Much of the good news about a delay and slower pace of rate hikes is largely priced into the bond market, as measured by fed fund futures. A first rate hike is almost fully priced in for December 2015, but a first rate increase is still a coin flip probability for September. Lingering uncertainty over the above-mentioned issues may continue to create a tug-of-war on bond prices that will likely continue to lead to a low-return environment [Figure 2]. High-quality bond prices declined in May but year-to-date performance is still positive. Lower-rated bonds may continue to benefit from their higher yields and less sensitivity to interest rates. Inflation expectations, both domestically and in Europe, trended lower in May, but the year-to-date trend is clearly higher [Figure 3]. Wage data in the May employment report may dictate whether inflation expectations rebound. A fourth consecutive higher than expected reading on core consumer prices (which exclude food and energy) and an increase in the prices paid component of the ISM survey appear to have halted the decline, but they do not explain the notable drop in inflation expectations during May.
7 A continued decline in inflation expectations, which would support bond prices, would likely require weaker economic data, starting with Friday's jobs report, indications the Fed will wait beyond the start of 2016 to raise interest rates, or contagion risks from a potential Greek default. We view each as unlikely and therefore believe additional bond strength is likely limited, leading to a continued tug-of-war on bond prices and a low-return environment. IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. Investing in foreign fixed income securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with foreign market settlement. Investing in emerging markets may accentuate these risks. High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors. INDEX DESCRIPTIONS The Standard & Poor's 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non-agency).
8 Barclays U.S. High-Yield Loan Index tracks the market for dollar-denominated floating-rate leveraged loans. Instead of individual securities, the U.S. High-Yield Loan Index is composed of loan tranches that may contain multiple contracts at the borrower level. The Barclays U.S. Corporate High-Yield Index measures the market of USD-denominated, noninvestment-grade, fixed-rate, taxable corporate bonds. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below, excluding emerging market debt. The Barclays U.S. Corporate Index is a broad-based benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate, taxable corporate bond market. The Barclays U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC) The Barclays U.S. Municipal Index covers the USD-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. The Barclays Municipal High Yield Bond Index is comprised of bonds with maturities greater than one-year, having a par value of at least $3 million issued as part of a transaction size greater than $20 million, and rated no higher than 'BB+' or equivalent by any of the three principal rating agencies. The Barclays U.S. Treasury Index is an unmanaged index of public debt obligations of the U.S. Treasury with a remaining maturity of one year or more. The index does not include T-bills (due to the maturity constraint), zero coupon bonds (strips), or Treasury Inflation-Protected Securities (TIPS). The Citi World Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The WGBI is a widely used benchmark that currently comprises sovereign debt from over 20 countries, denominated in a variety of currencies, and has more than 25 years of history available. The WGBI provides a broad benchmark for the global sovereign fixed income market. Sub-indexes are available in any combination of currency, maturity, or rating. The JP Morgan Emerging Markets Bond Index is a benchmark index for measuring the total return performance of international government bonds issued by emerging markets countries that are considered sovereign (issued in something other than local currency) and that meet specific liquidity and structural requirements. This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Not FDIC or NCUA/NCUSIF Insured No Bank or Credit Union Guarantee May Lose Value Not Guaranteed by Any Government Agency Not a Bank/Credit Union Deposit Tracking #1-388030 (Exp. 06/16)
9 Weekly Market Commentary Week of June 1, 2015 KEY TAKEAWAYS Greece is unlikely to maintain its debt repayment schedule without a resolution. A default and a Greek exit may add volatility to the equity markets, but do not appear to present a systemic risk at this point. THE GREEK DRAMA There is no question that Greece is tangled economically and politically in Europe. This was by design--the adoption of the euro was intended to be permanent, as was membership in the European Union (EU).* These entanglements are being tested by the ongoing crisis regarding Greece, its debt, and its ability to continue to use the euro as its currency. Though much has been--and will continue to be--written about this situation, we can reduce the problem to three basic issues. Will Greece default on its debt? Should Greece default, is the financial system at risk? Can Greece stay in the Eurozone? Does it matter? *Article 50 of the Treaty on European Union does provide a right to withdraw from the EU, though the process is largely undefined. WILL GREECE DEFAULT ON ITS DEBT? It's hard to gauge the current progress of discussions. Even as the current round of negotiations approaches the next deadline (June 5), the picture is muddled: the Greek government says a deal is at hand, but that claim is rejected by some international officials. Greece is running out of money; and without a resolution in coming days, it will likely be unable to make its scheduled June payments, the first of which is due Friday, June 5, 2015. There have been short-term fixes for these deadlines, including the Greek government transferring cash from local governments, delaying pension payments, and borrowing additional funds. The issue appears to have reached a critical point [Figure 1]. Greece has no realistic way to fulfill these obligations without substantial concessions from its creditors. It is possible that there will be a solution requiring Greece to enact a severe austerity program in exchange for further funding from the international community. However, it seems unlikely that this is a viable long-term solution. Ultimately, we believe Greece will need to restructure its debt, which qualifies as a default. It would not be the first time. In 2012, Greece reached agreements with private holders of its bonds to restructure its debt, effectively reducing the par value of its bonds by 100 billion euros ($130 billion given the exchange rate at that time). When all factors are considered (the change in face value, interest rates, and extension of maturity), private debt holders saw a reduction in value of approximately 70%. THE DIFFERENCE BETWEEN THE EU AND THE EUROZONE The European Union (EU) is an association of 28 countries that have created a common market, with free movement of goods and people across national borders. These countries have harmonized many laws regarding labor, environmental, and other social policies. The euro is the currency used by 19 of those 28, a currency created by the European Central Bank (ECB) rather than a national monetary authority. The countries that use the euro as their currency are referred to collectively as the Eurozone.
10 SHOULD GREECE DEFAULT, IS THE FINANCIAL SYSTEM AT RISK? One of the concerns about Greek default is its potential impact on broader financial institutions. To monitor the risks created by Greece, LPL Research reviews a set of indicators that signal stresses in the financial markets. These include absolute and relative performance of the bonds from other highly indebted nations (Spain, Portugal, and Italy), several indicators measuring European interbank lending, credit default swaps (essentially insurance contracts against government defaults), and the performance of European banks relative to the broader market. Taken together, we believe these indicators should provide a good early warning signal should the markets fear broader financial risk from a potential Greek default. At this point, we are not seeing signs of strain. The global financial system is far less entangled with Greece than it was during prior crises. Currently, over 80% of Greek government debt is held by governmental and central bank agencies. Given how little debt private investors hold, we believe the global financial system can weather a second Greek default. CAN GREECE STAY IN THE EUROZONE? DOES IT MATTER? It appears that a Greek default is inevitable; whether Greece stays in the Eurozone is less certain. Greece can default and retain the euro. The converse is not true; leaving the euro would guarantee default. It seems to LPL Research that Greece should leave the euro, the so-called "Grexit." Leaving would allow Greece's currency to devalue. As a more independent country, it would also allow Greece to do the basic economic restructuring necessary, such as improving tax collection. The fact is, Greece was not ready to join the euro when it did and would not be considered ready now. Politicians and central bankers in Europe had been adamant on the commitment of countries to retain the euro. In the past few days, several officials, most notably International Monetary Fund (IMF) Managing Director Christine Lagarde, have acknowledged that Greece might leave the euro. The fact that "Grexit" is being openly discussed indicates that it is more probable than would have been the case a few months ago. The biggest risk of a Greek default and possible exit from the Eurozone is the impact it would have on other countries and their markets. We can see the fear created by this "contagion" effect in 2011. Figures 2, 3, and 4 show the stress on the bond markets in many highly indebted countries in Europe, including Spain, Portugal, Greece, and Italy. Though Greek yields spiked the highest, reflecting fears of a default, all four countries felt the impact. When we examine these statistics today, we see the market reacting to Greece, but only to Greece, at this point. The European economy has also been getting stronger. One key measure of European economic health, loans from banks to the private sector, recently turned positive. This measure indicates increased economic activity in the region. However, it is difficult to gauge the impact of Greece leaving the euro on market psychology. Click here for Figure 2, Except for Greece, Yields in Europe Remain Low. Click here for Figure 3, Eurozone Stress Is Confined to Greece, but Worth Watching. Click here for Figure 4, European Financials May Potentially Be Attractive. CONCLUSION After years of discussion, the final end to the Greek debt issue may be in sight. The result seems likely to be a significant, but organized, default and a Greece that is less entangled in Europe, regardless of the decision to remain in the Eurozone. A default and Grexit may add volatility to the equity markets, but do not appear to present a systemic risk at this point. IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market. Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks. Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.
11 Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged. INDEX DESCRIPTIONS The MSCI Europe Index is a free float-adjusted, market capitalization-weighted index that is designed to measure the equity market performance of the developed markets in Europe. This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Not FDIC or NCUA/NCUSIF Insured No Bank or Credit Union Guarantee May Lose Value Not Guaranteed by Any Government Agency Not a Bank/Credit Union Deposit Tracking #1-387556 (Exp. 06/16)
12 Weekly Economic Commentary Week of June 1, 2015 KEY TAKEAWAYS We give the Fed partial credit on equity and bond market impact. The U.S. equity market performed exceptionally well during all three QE rounds, with the broad stock market increasing by 164%, as measured by the Russell 3000. The Fed partially helped lower bond yields (and boost bond returns) during its QE program. GRADING THE FED'S QE PROGRAM: WEEK 3 This week's Weekly Economic Commentary is the third in a series looking back at the Federal Reserve's (Fed) quantitative easing (QE) programs and evaluating how well they achieved their goals. Why grade the Fed now? We have just passed the six-month mark from the last purchase of QE3, which began in September 2012 and ended in October 2014. Also this time of year, colleges, universities, and high schools pass out report cards and hand out diplomas. In the week ahead (June 1-5, 2015), we'll hear from all four major central banks that have enacted QE: The European Central Bank (ECB), which meets on Wednesday, June 3, 2015 The Bank of England (BOE), which meets on Thursday, June 4, 2015 The Bank of Japan (BOJ ), as the governor of the BOJ delivers a key policy speech on Wednesday, June 3, 2015 The Fed itself, with the release of its Beige Book--a qualitative assessment of economic, business and banking conditions in each of the 12 regional Fed districts--on Wednesday, June 3, 2015, ahead of the next Federal Open Market Committee (FOMC) meeting on June 16-17, 2015 Having already graded the Fed on financial stress and its dual mandate, we'll grade the Fed's QE program on how it impacted financial markets, one of the Fed's key transmission mechanisms to achieve its dual mandate. This week we are looking at domestic stock and bond market performance, and will grade the Fed on the other asset classes in a future commentary. We'll compare the performance of U.S. equities (as measured by the Russell 3000 Index) and U.S. bond market (as measured by the Barclay's Aggregate Bond Index) before, during, and notably, six months after the end of QE3. We will also review the period before, during, and after the Fed's first two forays into QE: QE1 (November 2008 through March 2010) and QE2 (November 2010 through June 2011). OUR SCORECARD: FINANCIAL MARKETS As we assess the Fed, we point out that Operation Twist came between QE2 and QE3, making it much more difficult to grade either program on its own merits. Operation Twist was aimed at putting downward pressure on long-term Treasury yields without the Fed buying any additional net Treasures. It sold existing holdings of short-term Treasuries (less than a 3-year maturity) and bought longer-term Treasuries (6-30 years in maturity). The Fed cannot control any of the financial markets listed above directly of course, and can only use its policy tools to foster a policy environment that will lead to low and stable inflation and maximum employment. For most of its history, the Fed used some combination of the money supply, reserve requirements (money the Fed requires banks to hold against their deposits), and interest rates to nudge the economy toward the goals of the Fed's dual mandate. However, in December 2008--in the aftermath of the collapse of Lehman Brothers and the near freeze-up of the global credit markets--the Fed cut its fed funds rate to zero and began pursuing bond purchases, or QE, to achieve its goals. One asset not listed above is cash, and the nation's savers were severely impacted by the Fed's decision to take rates to zero in late 2008 and keep them there to this day. Prior to the onset of the Great Recession in late 2007, a five-year certificate of deposit paid around 5% per year. Today, that same five-year CD pays just under 1.5%. Although the Fed didn't directly target individual savers, one of the aims of QE was to encourage investors--mainly large institutional investors--to take risks, and by keeping the rate on cash near zero, motivated these investors to move further out the risk spectrum. By encouraging "risk taking" the Fed was hoping that lower rates on Treasury yields and high-yield bonds would encourage businesses (small and large) to refinance existing debt at lower rates and use the savings to reinvest in their businesses via hiring, capital spending, etc. The Fed also hoped that lower rates would help the housing market get back on its feet by allowing existing homeowners to refinance at lower rates and use the savings to pay down debt, save more, and spend more, and to entice prospective homeowners into the market by making owning a home more affordable. PARTIAL CREDIT ON EQUITY AND BOND MARKET IMPACT
13 During all three rounds of QE--from November 2008 through the end of October 2014--the U.S. equity market performed exceptionally well, with the broad stock market, as measured by the Russell 3000, increasing by 164%, or an annualized rate of gain of nearly 18%, well above the long-term (1979-2007) average gain of 13% [Figure 1]. In general, equity markets like lower interest rates over higher rates, economic growth over recession, and certainty over uncertainty. The Fed's QE program provided lower rates, which in turn fostered better economic growth and provided some certainty in an uncertain world. The U.S. equity market rose in each of the three rounds of QE, and in each case the gains were an improvement versus the six months prior to QE. This improvement was especially notable in QE1, when stocks fell more than 36% in the six months leading up to the start of QE1 in November 2008, and then posted a 39% gain during QE1 itself. Equity market performance turned negative in the six months following the end of QE1 and QE2 ended; however, in the six months after the end of QE3 (October 2014 through April 2015) equities prices eked out a small gain. The external environment (European debt crisis, the U.S. debt ceiling debacle, etc.) had a major influence on equities at the end of QE1 and QE2. The Greek debt crisis has heated up again over the past six months; however, the overall stability of the Eurozone--and the health of the U.S. economy itself--was much better at the end of QE3 than it was at the end of QE1 or QE2. (For more on Greece, see this week's Weekly Market Commentary, "The Greek Drama.") Although many factors played a role in driving equity prices higher during QE1, QE2, and QE3, we'll give the Fed partial credit for the rise in equity prices. SUPPORTING ASSIGNMENTS One of the main goals of QE from the Fed's perspective was to lower rates, which, in turn, would foster a more favorable environment for borrowing by households and consumers--leading to a rebound in economic activity. To evaluate this goal, we look at total returns for the Barclay's Aggregate Bond Index, which benefits from falling yields. Of the three QE programs, QE1 had the biggest impact on yields and bond returns: during QE1, yields fell sharply, leading to an 11.8% total return for the Barclays Aggregate. Bond total returns were also positive during both QE2 and QE3. But unlike the equity market, where performance was better during QE than during the six prior months for all three rounds, bond performance only improved in QE1, as bond total returns in QE2 and QE3 were lower than in the six months prior to the start of QE [Figure 1]. Click here for Figure 1, The Fed's QE Program Was Largely Successful in Driving Stock and Bond Prices Higher. Notably, bond yields generally moved lower--and total returns higher--in the six months after QE ended, and in two of three cases the performance was worse. The exception was in the six months after QE2, when the 5.0% total return on bonds was an improvement over the 1.6% gain seen during QE2. Recall that the latter half of 2011 saw the U.S. debt ceiling and debt downgrade debacle as well as a sharp escalation in the European debt crisis, which pushed investors into the relative safety of U.S. Treasuries, driving bond yields lower. During the entire QE program (November 2008 to October 2014) the 10-year Treasury yield fell from 2.75% to as low as 1.5% in mid-2012, before ending QE3 at 2.50%. Would yields have been higher without QE, or perhaps lower? Were the factors that pushed yields lower during QE caused by QE, or would they have occurred anyway? Given that Fed policy does not occur in a vacuum, it is difficult to say with any certainty what impact the Fed had, let alone what would have happened had the Fed not done QE at all. In addition, we must consider what the Fed said--for example, promising in mid-2011 to keep rates low until at least the middle of 2013--in addition to the actions they took (QE, Operation Twist) as we consider the Fed's grade. On balance, as with the Fed's influence on equities, we will give the Fed partial credit for helping to lower bond yields (and boost bond returns) during its QE program. IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for your clients. Any economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All performance referenced is historical and is no guarantee of future results. All indexes are unmanaged and cannot be invested into directly. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price. DEFINITIONS Quantitative easing (QE) refers to the Federal Reserve s (Fed) current and/or past programs whereby the
14 Fed purchases a set amount of Treasury and/or mortgage-backed securities each month from banks. This inserts more money in the economy (known as easing), which is intended to encourage economic growth. The Beige Book is a commonly used name for the Federal Reserve's (Fed) report called the Summary of Commentary on Current Economic Conditions by Federal Reserve District. It is published just before the Federal Open Market Committee (FOMC) meeting on interest rates and is used to inform the members on changes in the economy since the last meeting. The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. The Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non-agency). This research material has been prepared by LPL Financial. To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity. Not FDIC or NCUA/NCUSIF Insured No Bank or Credit Union Guarantee May Lose Value Not Guaranteed by Any Government Agency Not a Bank/Credit Union Deposit Tracking #1-387639 (Exp. 06/16)
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Scott Fleming is a Registered Representative with and Securities are offered through LPL Financial, member FINRA/SIPC. Insurance products offered through LPL Financial or its licensed affiliates. BT Wealth Advisors is not a registered Broker/Dealer and is not affiliated with LPL Financial Not Bank/Credit Union Not FDIC/NCUA Insured Guaranteed Not Insured by any Federal Government Agency May Lose Value Not a Bank Deposit This newsletter was created using Newsletter OnDemand, powered by Wealth Management Systems Inc.