Cracks surface in US economic outlook

The Chicago Purchasing Manager’s Index contracted in February and the extreme weather this winter is probably responsible for a minor disappointment in consumer spending.

A labor dispute at West Coast ports hasn’t helped either. So there are reasons why the economy appears to be slowing a bit.

Fed Policy

What this all means for US Federal Reserve policy and the timing of an interest rate hike is unclear.

With inflation under control and an improving labor picture, my own opinion is that the markets will not be derailed when the Fed finally acts.

That said, valuations are not as attractive as they have been. Investor sentiment is running pretty high so the overall picture is a bit more mixed.

Time to Sell?

A client recently asked if it is time to sell. His wife recently sold all her equities and bought bonds to be more conservative.

Having spent eight years of my life as a bond trader, my first comment is that no one has any idea where interest rates (and therefore bond prices) are going.

Who would’ve thought that they would get this low, and stay this low for so long?

Who would’ve thought that interest rates would be negative in several countries around the world?

Parts Unknown

Eventually, and by that I mean sometime in the future, rates will “normalize.” I have no idea when that will happen nor how quickly it will advance once it starts.

As rates rise, bond prices drop, so any portfolio owning them will drop in value.

That’s not exactly what most people expect from a “conservative” portfolio with fixed income investments.

A Borrow Be?

However, anyone holding those bonds until maturity (assuming the borrower doesn’t go belly up) will get back 100 cents on the dollar. Investors will also be collecting coupons along the way.

Unfortunately, those coupons are very low, barely 2% for 10-year US Government bonds.

In short, it’s a very good time to be a borrower, and a very difficult time to be an investor in bonds.

Right Price

My own bias is to find the right stocks, given how low the returns are in bonds and the potential for the principle value to drop when rates rise.

Regardless, I believe that paying the right prices to own the right stocks is a good approach to the market.

Photo Credit: Quinn Dombrowski via Flickr Creative Commons