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Business Week recently ran a story with some astonishing facts about bond issuance and interest rates around the world, Bonds, Bonds Everywhere and Not a Drop to Yield.

A few of those facts:

“…yields on almost $20 trillion of government securities are below 1 percent, according to Bank of America (BAC) data.”

“The average yield to maturity for the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index fell to a record low 1.34 percent last week, compared to 3.28 percent five years ago.”

“Indeed, corporate bond yields fell to 3.15 percent on average on April 25, from almost 5 percent at the start of 2012, according to the Bank of America Merrill Lynch Global Corporate & High Yield Index.”

Unthinkable back in the depths of the financial crisis of 2008/2009 where high yield bonds were yielding double digits and you could get over 5% in a muni money market (this was a short term quirk).

Interest rates have steadily fallen since their peak in 1981.  Some US Government bonds actually trade with negative yields (they are inflation-protected).

This must be the end though, right?  Interest rates surely can’t fall any further and they have to go up soon, right?

I’ve listened to the prognosticators predict higher rates now for almost four years…and rates instead went lower.  Are interest rates going to turn around and go up anytime soon?  I doubt it.

I decided to do some digging on rates in the United States (and for the fun of it, Japan) to give you an idea of the possibilities.  This is not a prediction, I just want to demonstrate  that something which is said cannot happen…has happened before.

In 1933 the one year rate on a government issued bond went below 2%.

In 1941 the one year rate on a government issued bond hit its low, .53%.

In 1951 the one year rate on a government issued bond finally broke back above the 2% mark hitting 2.12%, in 1952 it hit 2.39% and in 1953 it was 2.58%.  The rate then dropped below 2% again in 1954 for two years before finally climbing above 2% in 1956 (3.21%) and not looking back until 2009.

For 23 years interest rates were essentially 2% or below stretching from 1933 – 1956.

But that is for 1 year rates, what about longer term rates.  I use the 3% level for the ten year, though currently our ten year is under 2%.

The ten year rate on government issued bonds fell below 3% for the first time in 1935, but keep in mind it had been in the 3% range for ten years prior.  The rate proceeded to stay under 3% for 22 years straight.  From 1935 – 1956 the ten year rate remained under 3% and from 1925 – 1963 the rate remained under 4% with the exception of just a few years.

For comparison, we are in our 5th year of sub-2% one-year yields and only in our 2nd straight year of sub 3% ten-year yields.  We did have a three year stretch between 2002 and 2004 of sub 2% one-year yields and the ten-year has been below the 4% level since 2008.

In Japan, the benchmark interest (the discount rate) will have been below 2% for twenty-years come this September.

This is not an exhaustive study of interest rates, nor is it my prediction of what interest rates are going to do.  This is a refutation of what many market prognosticators state MUST happen soon.  Rates may rise soon, I doubt it, but they DO NOT have to rise.

Again, this is not an opinion about the lower interest rate policy.

While I was writing this post, Cullen Roche over at the Pragmatic Capitalist blog posted an interview by Lance Roberts with Doubline CEO Jeffrey Gundlach.  Gundlach, along with Bill Gross and Daniel Fuss (some would also say Kathleen Gafney) are the current bond guru’s (this means they’ve achieved great returns trading bonds in the past, whether they were skilled or lucky is a different observation).  Gundlach does make predictions on rates and I thought his comments were intriguing, as follows:

“Let me reiterate….bond yields are not going to rise. QE drives yields lower as it goes straight to the heart of the bond market.”

Rates will not rise with real HIGH unemployment. The unemployment (U-3) rates is a false measure of employment due to the high level of dropouts. All that really matters for the economy, and ultimately the bond market, is the labor force participation rate which is at the lowest level since the 80’s.

Rates will not rise with median household incomes at the lowest level in 19 years.

Rates will not rise as QE is all about funding the federal budget. if rates rise the budget will be blown and deficits will explode.

Rates will not rise as it will kill any economic growth.   Housing, private investment and consumer borrowing all rely on low interest rates. If rates rise it is the end game for the economy.

Despite what you may have heard – the reality is that rates will not rise any time soon. This is the liquidity trap the Fed has gotten itself into.

Furthermore, Bond indexing makes no sense into today’s market.   However, emerging market bonds, on a very selective basis, will likely be lucrative as the global economic malaise continues in their developed counterparts.

If the current financial experiment fails – the only place to be will be long US Treasuries. A decent hedge in the event of an economic disruption will be long US Treasuries and short French Bonds. As all European bonds converge toward 1% the reversion due to economic disruption could be hugely profitable.

Own bonds? You bet. With corporate profits in the U.S. at all-time highs as a percent of GDP the repayment probability for bond holders is extremely high. However, this is also bad for holders of corporate stocks because the reversion of profits to GDP will be brutal.

I could go out and find you all sorts of quotes from other money managers who think the opposite, but that is the mainstream view – so it’s boring.

Just remember, when someone tells you that rates can’t stay this low for much longer, they haven’t done much historical analysis.  Heck, I spent less than an hour finding the little bit of information above.  The information was provided by Robert Shiller’s data project.

This post is already to long, but for another great article loosely related to this topic, see Business Week’s The “Rising Bubble in Bond Bubble Chatter.”

Scott Dauenhauer CFP, MSFP, AIF

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As the stock market continues its seemingly unstoppable rise, many have forgotten that it doesn’t always go up.  Other than the Great Depression, I can’t recall a generation that has endured so much market volatility – but memories are short these days.

We’ve experienced two U.S. stock market drops of at least 50% in just the past 13 years and John Bogle the other day predicted two more in the coming decade.  Using the Shiller CAPE measurement to value stocks, they appear quite overvalued.  At a minimum they are not cheap, yet each and every day the market moves higher.  There has not been a three day losing streak in 2013.

Many investors are asking themselves why they are not in the market, not in the market with more of their assets or if they should borrow to put money into this market (I kid you not, I get these calls).  Instead of getting into valuation measurements, mean reversion and profits in relations to GDP, I thought I’d just provide a simple chart showing how much a person would have lost from the top of a market to the bottom of a market with different stock exposures during the past two market downturns, 2000 and 2007.

I’ve added a label to each portfolio of Conservative, Moderate and Aggressive to give you an idea of what the industry would consider each portfolio in terms of its risk profile.

The “months” at the bottom indicate how many months between the top and the bottom, in other words, how long did it take for the market to go from peak to trough.

In the 2000 – 2002 (forgive the error in date in the chart) the market fell a little over 50% from its high before beginning its recovery.  Ironically, the market hit a new peak almost exactly five years later and then fell over a 15 month period a total of 56%.

Even a conservative investor lost up to 17% during these two drawdowns.

I used the Vanguard Total Stock Market Index as my proxy and assumed it was paired with a stable value type fund that earned 0%.  Neither assumption is perfect as some held fixed income that went up during these stretches which would offset some off the loss and some held other assets that might have gone up, offsetting some of the loss.  However, fixed income today is in a different place and may NOT add much value during a sustained market drop.

From current levels it’s highly unlikely that some investing today will earn the famous 10% return from stocks that has always been promised for long term investors, not that some still aren’t forecasting that.

There are some valuation hawks that are forecasting stock returns under 5% for the next decade.

Let’s compromise and say that returns will be 7.5% on stocks over the coming ten years (this is not my opinion or advice, just an assumption), choose an equity allocation above and ask yourself whether or not you could handle such a drawdown and whether it would be worth it for the extra return.

Scott Dauenhauer CFP, MSFP, AIF

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I listened to the audio book version of Walter Isaacson’s biography titled simply, Steve Jobs.

I found myself listening every chance I could find – while doing dishes (which I actually volunteered to do just so I could slip on the headphones), running, driving (I always listen to podcasts or audio books while running or driving anyway), working outside, anytime I had an extra few minutes – it was that good.

In addition to being a highly inspirational book, it was also an honest look at who Steve Jobs was, flaws and all.  Isaacson found that Jobs’ flaws were almost as destructive as his genius was successful.

The journey of Steve Jobs is filled with irony, but at the forefront of everything he did was a desire to change the world.  He had a belief system that drove him, a need to control everything and a disdain for anyone who wanted to put profits above perfection. “It’s not about the money” was a common refrain.

You always know where you stand with Steve Jobs, Isaacson says “Steve Jobs had a tendency to see things in a binary way: A person was either a hero or a bozo, a product was either amazing or shit.” As Isaacson would point out on more than one occasion, a person could be a hero or bozo even on the same day.  But as a rule, Jobs didn’t suffer fools.

Interestingly enough I’m not sure I would put Steve Jobs up as a role model.  Don’t get me wrong, I love what he did at Apple and think that businesses would do better to attempt to emulate his outcomes, but he was not easy to get along with.  He loved his family, but was not exactly there for them – even would he could be.  His strange diets and ability to distort reality came with some side affects that hurt those closes to him.

But what a visionary he was.  His ability to see what the customer needed, even before they did was unmatched.  Few CEO’s embodied their companies like Jobs and his premature death is not just a loss to his family (who loved him dearly, despite his quirks), but to the world.  We can only hope his spirit lives on in those he left behind at Apple.

I could write for hours about Jobs, but that would be giving away to much and taking the pleasure of reading this biography away from you.  Rarely do I read biographies, but Isaacson’s Steve Jobs has changed my mind, I’m now reading his book on Einstein and plan to read at least four biographies a year.

It’s so cliche to say “pick this book up, you won’t be able to put it down,” but if it was ever true about anything, it’s true about Steve Jobs.

Scott Dauenhauer CFP, MSFP, AIF

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What if I told you I had a no-risk, common sense method that would earn you an average of 12% annually, would you be interested?

Of course you would, heck, now I’m interested.

Doubling your money every six years can be in your future, if….you just buy an Equity Indexed Annuity from a certain insurance agent.

The insurance agent website ProducersWeb (PW) allows insurance agents to create a public blog within the PW site, giving agents more exposure.  PW evidently could care less about the content.  Somehow I ended up on the site and came across an article with the following tag line:

Through focusing on indexed products during the fall and winter months, the client’s money doubles every six years. Be a master of your client’s destiny by following this age-old market-timing strategy that does work.

Essentially the strategy is to use “seasonality” to be in the markets during the best periods, in this case, being out during the summer months (the old, Sell in May adage).

The blogger explains why the “seasonality” approach works:

Selling in May and going away has been described by some pundits as a market-timing strategy but can really be explained by the simple law of supply and demand. Savers, investors and institutions typically put more money into the winter months and take it out during the summer months due to the IRA, 401(k) matchs, tax season, pension contributions and portfolio window dressing.

So there you have it, a simple explanation for why the markets always go down during the summer months and why you can take advantage of it, it’s common sense!  Using the above strategy one need only to follow this sage advice:

“…after choosing the hot months to contract on a FIUL or FIA product, the client can always rebalance and allocate money to a fixed account during the cold, dark days of winter and spring swoon.”

Evidently the key to huge, risk free returns has been found, one only needs a greater fool to be a counterparty – the insurance company offering the Equity Indexed Annuity.

This is all just foolishness, in my opinion.

Whether or not “sell in May” actually works is highly debated and is by no means a common sense, sure bet.  Michael at the Market Science blog recently posted a debunking of the Sell in May concept.

But debunking seasonality is less the issue, the real issue is that if the data really showed such an affect was possible, the insurance companies would adjust their models to ensure that it couldn’t be taken advantage of.  Insurance company actuaries as a whole are not idiots, they have a lot of data at their fingertips and price their products accordingly.  They don’t always get it right, but I can assure you, if they were paying 12% annually on their equity indexed annuity products, the actuaries would be fired.

With no evidence an agent can make a claim on a well followed website of no-risk 12% annual returns and no one says anything.  The following claim was made:

Through focusing on indexed products during the fall and winter months, the client’s money doubles every six years.

Had I made the same claim I would be subject to all sorts of investigations.

Here’s the bottom line folks – if it sounds to good to be true, it is.

You are not going to double your money (earn 12% annually) by buying Equity Indexed Annuities and if you do, you should take some of that gain and quickly short the insurer (this is not investment advice) as they are not going to be around long.

ProducersWeb should do a better job policing their blogs.  At a minimum, someone posting such outrageous claims should be required to show evidence that an actual product has earned such returns and has the possibility to do so in the future.

At the end of the day, this sell in May annuity strategy is just an April fools joke.

Scott Dauenhauer, CFP, MSFP, AIF

P.S. I’m not going to put the link to the blog here, it’s just not worth giving credit – but if you want the link you can e-mail me…or just troll the ProducersWeb blog site.

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I take great pride in providing financial planning and investment advice on a fiduciary basis, so it pains me when I see the ‘fiduciary’ term abused.

Reuters uncovered an arrangement last week between a few large custodians and several Registered Investment Advisory firms that doesn’t appear to be in the best interest of clients.  The article starts off:

At least three wealth management firms that market themselves as objective financial advisers are getting payments for investing their clients’ money in certain mutual funds, a practice that even some of these firms say could create conflicts of interest.

On the surface this might not sound like a big deal, but it underlies a big secret in the industry, one that is even bigger than this abuse – the use of no-transaction-fee (NTF) mutual fund supermarkets.  An RIA who manages money for clients must “custody” those assets with a company, usually a broker-dealer.  The biggest custodians that RIA’s use are Charles Schwab, TD Ameritrade and Fidelity.

Custodians offer two sets of mutual funds that advisors may utilize, one set has no-transaction fee charged to the end client, the other does have a transaction fee.  In many cases the same mutual fund can be offered with or without a transaction fee.  Since mutual fund fees never show up on a client statement, but custodian transaction fees do, there is an appearance that no-transaction fee (NTF) mutual funds are cheaper – in fact, they almost never are.

I rarely use no-transaction fee funds because it usually costs my clients more money, way more money than a transaction fee fund.  The reason they cost more is because the custodians have negotiated for themselves a fee from the mutual fund companies ranging from .25 – .40% annually, a fee not collected from transaction fee funds.  There is a built in conflict of interest for the custodian to get the RIA to use their NTF network of funds.

I’ll provide a quick example.  If you have $100,000 to invest and an advisor recommends a set of NTF funds, the custodian will receive anywhere from $250 – $400 annually from the mutual funds you were recommended.  Had you purchased the same fund, but a different share class you might have instead paid a transaction fee of $25 per purchase.

Before I make my point, I do want to point out that I’ve never been pushed by any custodian (and I’ve used all three of the majors) to use the NTF funds over the transaction fee funds.  In addition, the custodians provide valuable services to both me and my clients and deserve to be paid for providing those services.  Lastly, NTF funds may in fact make much more sense than transaction-fee funds depending on the client’s portfolio needs.

Back to the example.  If you were buying four mutual funds and chose to buy the transaction fee version you end up paying $100 in fees (4 buys times $25).  The difference is those fees are only paid if you buy or sell, there is no ongoing annual fee (from the custodian, the advisor will charge a separate fee).  If there were no rebalances over a five year period, the person buying the NTF funds might pay anywhere from $1,250 – $2,000 in fees to the custodian while the transaction fee client only paid $100.  A huge difference.

In reality, most clients have numerous accounts and will rebalance at least once a year, which makes the fees for trading seem onerous.  This is where a true fiduciary shines.  A true fiduciary makes the determination up front which method of payment would work better for each client type.  A client that has a single account and a need for a single, balanced mutual fund would likely be recommended a transaction-fee fund (say from Vanguard).  If they buy and hold that fund for five years, a total of $25 is paid to the custodian, quite a deal.  But if the client has multiple accounts and will need to be rebalanced often, perhaps the NTF network of funds is best.

Of course the story I’m referring takes the NTF funds network to another level.  A few big firms have negotiated with a few of the big custodians to receive a portion of the .25 – .40% annual fees generated by their clients placed into the NTF network.  This practice is bothersome to me as I can think of no reason for the arrangement to be in place that would benefit the end client.  Disclosing this as a conflict is NOT enough, this is an easy conflict to avoid and thus should be avoided.  If there is a cost to the RIA firm for taking on of services that would otherwise be provided by the custodian, this cost should be charged directly to the end client via the advisor’s fee schedule, not buried in a mutual fund.

The firms mentioned in the above article have an extra incentive to recommend one set of mutual funds over another, I have a problem with this.  I think this practice puts the fiduciary industry in a bad light and hurts the message.

The difference in the fiduciary industry is that when true fiduciaries see these practices, they are called out.  I can’t say the same for majority of the non-fiduciary financial services industry.  None of us are perfect, even the best make mistakes, but the practice of negotiating a piece of the action on client assets from custodians should be stopped.

I do have one caveat. If the custodians offered to rebate back the fees they receive from the mutual funds to the actual client that generated those fees and then charged a transaction fee to cover their costs, I would be fine with such a practice.

Scott Dauenhauer, CFP, MSFP, AIF