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| August 06, 2014
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There’s one major difference between James Bond and me.     He is able to sort out problems!

Sean Connery

The past month was a rough one for the markets.  Last week the Dow Jones Industrial Average (DJIA) fell over 467 points which equates to about 2.75% while the Standard & Poor’s (S&P) 500 fell 2.69%.  The S&P 500 is now about 3.15% off from the high set earlier this year.  When you look into the other sectors of the markets, you can see everything was down last week and there was nowhere to hide as far as stocks were concerned.

We had been slowly reducing our equity positions starting with the most volatile small companies in April and now have increased our allocation to bonds, bond alternatives and equity alternatives to levels that we plan on maintaining until after the election or the markets offer us compelling reasons to buy again.  If we are able to get equities at 20 to 25% off July retail prices we will be happy to pick up some bargains.

Currently the Dow is slightly negative for the year, the S&P 500 up around 4% and the smaller companies in the Russell 2000 down almost 4%.  For those investors who are a little more diversified, inflation hedges like commodities and REITS and MLPs are doing relatively well this year and non-US investments are performing better than U.S. investments this year to date. 

 


AN UNFORGIVING MONTH FOR STOCKS

If we are to look at the U.S. market as a whole, the chart above from Bespoke shows that 33% of all stocks in the Russell 3000 are down 10% or more over the past month.  The Russell 3000 comprises 99% of the market capitalization of all stocks traded in the U.S.

Last year everyone wanted to own the Dow and the S&P 500. Owning a diversified portfolio with REITS, commodities, MLPs and other inflation hedges was not very popular.  This year, many portfolios would be flat or down without them.

The markets have been trading within a range for the most part this year.  For those types of investors who follow short to intermediate trends, it has been hard to find a trend that sticks.  For the most part, this year has been a great year for those people who rode the speculative stocks to the end of 2013, sold on the first day of the new year to allow capital gains to spill over into the 2014 tax year and bought stocks that had done the most poorly in 2013. 

If you look at the following chart, we have been increasing our exposure in emerging market bonds, MLPs, BDCs, bank loans, tax free bonds, high yield bonds and REITs over the last few months.  Most all of these types of investments are outperforming equities year to date and all pay relatively strong rates of interest.


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What types of bonds will typically perform better in a rising interest rate environment?

Last year high yield bonds, convertible bonds, ultra -short term bonds and bank loans held their value.  In a more normalized environment where interest rates creep up slowly these bonds will definitely be better to own than treasuries and investment grade corporate bonds.  Non-US bonds will usually not be affected by changes in U.S. interest rates in most cases.  The central banks of various countries and world regions have much more power to influence interest rates in those areas than the U.S. 

Again, the best performing fixed income holdings this year have been those that suffered the most last year.  Municipal bonds and emerging market bonds still look relatively attractive, but not near as attractive as they were a few months back. 

  

What happens when the Federal Reserve starts to hike the short term rate, and when should we be expecting this to happen?

Some analysts are telling us that Janet Yellen and her crew could be looking at raising the fed funds rate as early as the first quarter of next year.  Others feel that rates could stay low for the next few years.

Very few fixed income investments will not be affected by a bond panic.  These panics happen much less frequently than stock selloffs, however.  Whereas stocks can and do lose 10% to 30% or more when they suffer, the Barclays Bond Aggregate lost a little over 2% last year (which was the worst year for bonds since 1994).  

We see another bond panic like we saw last year as relatively unlikely although the mechanisms that allowed the selloff to extend as far as it did do not seem to have been rectified.  Institutional investors are much less involved in the bond markets today and less likely to provide ballast in the event of a panic.  They are not looking to purchase bonds for their inventories.  Rates are lower and capital requirements are much more stringent these days.

Because of this, there is more opportunity for investors to find fixed income investments at good prices if they see a selloff as an opportunity rather than something to be fearful of.



Data as of August 4th, 2014


Important Disclosure Information for the "Backstage Pass" Blog

Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Franklin Wealth Management), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Franklin Wealth Management.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Franklin Wealth Management is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of Franklin Wealth Management’s current written disclosure statement discussing our advisory services and fees is available for review upon request.  


Joe D. Franklin is President and Founder of Franklin Wealth Management.

He is the writer of the Franklin Wealth Management "Backstage Pass" Blog and former host of the Financial Focus radio show on Ruby, WDOD (1310 AM)

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