Keeping It Interesting

Some lines from a movie never leave your mind; I don't remember the context always, but I do recall the dialog. "The Big Chill" is one of the few movies I own (VHS). At dinner, William Hurt, Jeff Goldbloom, and Tom Berenger argue about their past like dogs growling for a turkey leg at Thanksgiving. JoBeth Williams brings calm by chastising the men, and to that Hurt replies with a smirk, "Just trying to keep the conversation lively." It's one of those "had to be there" moments.

Bond traders "keep the conversation lively" . Have you noticed that long-term rates have fallen while short-term rates have risen? Low long-term rates keep the housing market active (a positive, maybe), with the implicit suggestion of a slowing economy (a drop in long-term borrowing by corporations suggests a slow down in the economy). All of this is happening as the Federal Reserve torques rates higher!

An interest rate anomaly occurs when short-term rates get close to exceeding long-term rates. This is known as an "inverted yield curve". Inverted yield curves preceded the past five recessions. "Something strange has been going on in the bond market", writes E.S. Browning (Wall Street Journal, May 31, 2005). Markets get long-term trends right, usually.

Low interest rates recommend positive stock returns; however, market volatility seems to defy such optimism. One day stocks are up, and the next down. Someone said, "When interest rates are low equities grow." Many stock analysts get slap-happy moments with low interest rates. Optimism does not move markets; pessimism does. Browning wisely observes "...the prevailing view in the stock market is one of celebration..." when it ought to be fear. (WSJ, May 31, 2005)

Some economists do expect worsening economic conditions. "Over the past 35 years, the skeptics say, Fed rate increases have tended to end with trouble." (WSJ, May 31, 2005) Most recently, the bubble gum stock market popped during 2000 left stocks looking like pink bubble gum on a child's cheeks.

No simple resolution keeps investors from the dangers of an inverted yield curve. Every analyst, economist, and pundit has an opinion. What matters is the reaction of the bond market, and the current short and long-term yields are "keeping it interesting".

My point? There is no way to predict every asset class move (up or down). Broad diversification within the bond universe provides aggregate benefit to your portfolio. This does not mean owning every conceivable bond; it does mean integrating bond management consistent to reach your goals within the context of your risk tolerance.

* These are the major bond (fixed income)asset classes U.S. Government

* International Fixed Income

* Municipals (tax efficient accounts)

* High Yield

* Emerging Market Debt

"When a thing ceases to be a subject of controversy, it ceases to be a subject of interest." - William Hazlitt, English essayist (1778 - 1830)

Ray Randall serves clients as a registered investment advisor with his firm, Ethos Advisory Services, Essex, Massachusetts http://www.ethosadvisory.com. He has wide experience within the financial services industry, writes a weekly newsletter for Ethos Advisory Services, and coordinates the developments at Echievements http://www.echievements.com. Ray holds a Masters Degree from Gordon-Conwell Theological Seminary, Hamilton, MA. You may email him or call (877-895-3756).