Is it time to switch from Bonds to dividend paying stocks?

What are the risks facing us in the next year or two? The inversion of the yield curve which has happen on three separate occasions has me worried. It signals more stock market volatility, it is a sign that the bond market fears subpar economic growth and that a trade war could cause a global recession.

Historically an inverted yield curve has been a reliable, though not perfect, predictor of a recession. Each of the last five recessions was preceded by the two and 10 year Treasury yields inverting. (the two year yield is higher than the 10 year yield)

So, is the Bond Market Insane?

We now have $17 trillion worth of negative interest rate bonds, mostly in the sovereign bond space. That is about 25% of the entire bond market and 43% of bonds outside the US. In simple terms, you buy a $100 bond but pay $105 for it and you are guarantee to get $100 back when the bond matures. Who in their right mind would buy an investment that if held to maturity would lose money?

There has never been such an animal in the classification of bonds. Until a few years ago, traders and investors around the world would have considered negative rate bonds as imaginary as a children’s fairytale.

Mark Grant wrote this about negative interest rates in Europe:

While the European Union is not creating “Pixie Dust Money,” at the ECB, and then buying their own nations’ sovereign, and corporate debt, to purposefully hurt the financial markets, or the United States, that is exactly the “collateral damage,” that they are causing. The nations of the EU cannot afford to pay for their budgets, or their social programs, so the ECB has moved down their borrowing costs to less than zero, in most cases.

Check out their 5-year sovereign debt yields:

Why I am reducing my bond holdings and switching to dividend paying stocks.

  1. Since I am retired, the recommended withdraw rate from my retirement account is 4%.  Interest from bonds are not meeting my needs.
  2. Dividend paying stocks will lose some value during the next recession but less than the overall stock market. Plus, I will get paid to wait for the stock market to recover.
  3. In Canada, the dividend tax credit increases my after tax return by 25% over bonds.
  4. The next recession could be extra long because Central banks have already lowered interest rates. They will have less tools to stimulate the economy when a recession hits.
  5. The yield of both Canadian & U.S. 10 year bonds are below inflation which reduces the value of money over time.

 

Telecommunication companies like AT&T (Ticker: T) and Bell Canada (Ticker: BCE) have dividend yields of 5.7% and 5.08% which are much higher than bond yields. Some Canadian banks also have dividend yields in the 5% area and they continue to raise them. (ticker symbols:  BNS & CM).

These are not recommendations but examples to illustrate that they are a wide variety of dividend paying stocks with higher yields than bonds. They are not recession proof but do provide a steady income stream. Keep in mind that even cash isn’t safe because inflation will over time reduce its purchasing power.

 

 

 

 

 

 

 

 

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Opinion: The Fed cutting interest rates could be a big mistake

Stock market watchers are expecting a rate cut this week because they believe that the U.S. economy is experiencing a slowdown. Second quarter GDP growth was 2.1% which is lower than the 3.1% growth rate during the first quarter. However, consumer spending rose 4.3% despite the fact that tax refunds were smaller than previous years. The GOP tax cuts did increase the weekly take home pay for consumers which accounts for some of the strong spending.

Growth deceleration in the second quarter was due mostly to tariffs and a fear of a global slowdown.  China’s economic growth has slumped to its lowest level in nearly three decades due to the prolonged trade war with the United States. However, the biggest drag on the U.S. economy has been a slump in business investment which was down 5.5 percent.

It is hard for corporations to spend money with Trump’s tariff threats on most of its trading partners. The new NAFTA or USMCA hasn’t even been approved by Congress; then add the uncertainty of a smooth Brexit (Britain leaving the European Union) and you a recipe for a slowdown in business spending.  In reality the Trump administration is partly to blame for the slump in world economic growth.

In order for the Trump administration to win the trade war they need interest rate cuts in order to lower the value of the U.S. dollar so that their tariffs are more effective. China can easily lower the value of their currency compared to the U.S. because the Federal Reserve is an independent agency.

Why I believe that lowering U.S. interest rates is a bad idea!

  1. Trump has relentlessly used social media to criticize the Fed. To remain independent, the Fed has to resist political pressure.
  2. Unemployment is at the lowest level in decades; the economy doesn’t need more stimulus.
  3. Lowering interest rates will enable Trump to pursue a more aggressive use of tariffs which in turn will further slow world economic growth.
  4. Cheap money will allow corporations to buy back more of their shares adding debt to their balance sheet.
  5. Low interest rates will encourage more wasteful government spending, adding to the already large national debt.
  6. Pension plans will get less interest on fixed income investments making it more difficult to meet their monthly commitments.
  7. Consumers will get less interest on their savings accounts.

Conclusion: Cutting interest rates could make matters worse. It could prolong the trade war with China and enable the Trump administration to actually follow through with threats of imposing more tariffs on their other trading partners.

 

 

 

 

 

 

 

Reality Check on Trump’s tax cuts and trade deals

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Let me start with Larry Kudlow, the Director of the National Economic Council, who said back in April of 2018 that he believes the U.S. tax cuts could generate GDP growth of 5 percent annually for a short time. The U.S. economy did manage a 4.2% GDP growth in the second quarter of 2018 but the annual rate was only 3.1 percent. Sorry, forever Trumpers but Obama had 2.9% GDP growth in 2015 without the tax cuts.

GDP growth projections even fooled the Federal Reserve which signaled three rate hikes for 2019 but the slow down in world economic growth has forced the Fed to put any more rate hikes on hold. Market watchers believe there is a strong possibility that the Fed may have to cut rates if U.S. growth continues to slow down.

April fools : Tax cuts will for pay themselves

  • The budget deficit grew 77 percent in the first four months of fiscal 2019 compared with the same period in 2018, the U.S. Treasury reported earlier this month. The total deficit was $310 billion up from $176 billion over the same four-month period a year earlier. The cause of the massive increase, according to Treasury officials: tax revenues fell dramatically and government spending increased significantly. Even worse news is that the budget deficit is projected to exceed $1 trillion in 2020.
  • The national debt, which has exceeded $21 trillion, will soar to more than $33 trillion in 2028, according to the non-partisan Congressional Budget Office (CBO). By then, debt held by the public will almost match the size of the nation’s economy, reaching 96 percent of gross domestic product, a higher level than any point since just after World War II and well past the level that economists say could court a crisis.

Trump campaigned on a promise to shrink the country’s trade deficit, arguing loudly during campaign stops before and after taking office that bad trade deals have allowed other countries to take advantage of the United States. Trump imposed tariffs as a way to reduce the trade deficit with America’s trading partners.

April Fools: Imposing tariffs will reduce the U.S. trade deficit

The U.S. trade deficit hit a 10-year high in 2018, growing by $69 billion, according to figures released March 6 by the Census Bureau. Trump’s constant verbal blasts and a number of arm-twisting PR stunts focused on efforts to revive American manufacturing and reduce dependence on imported goods such as steel and other materials failed to produce any meaningful results.

Trump promised to scuttle all those bad trade deals and replace them with pacts that would re-energize our country’s manufacturing sector. Very little has happened on any of those items during the past two years.

Yes, Trump pulled the United States out of the Trans-Pacific Partnership and renegotiated the North American Free Trade Agreement, both of which he called some of the “worst” deals”, and he’s currently pursuing separate deals with China and the European Union.

It’s important to note, however, that Trump has signed just one new trade deal, with South Korea. The NAFTA replacement, known as the US-Mexico-Canada Agreement, still needs to be approved by Congress and lawmakers on both sides of the aisle have raised concerns. Canada and Mexico will not ratify the new agreement unless the U.S. remove the tariffs on steel and aluminium

So far, engaging in trade wars with just about any country America does business with has not delivered promised results of more jobs for U.S. workers. Companies are not relocating manufacturing plants back to America.

 

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Santa Claus rally, No, No, No?

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Is there any hope for a Santa Claus rally this year? What are the chances the markets could reverse the worst December since 1931?

A Santa Claus rally, which would begin on Monday, is a very specific event. It is the tendency for the market to rise in the last five trading days of the year and the first two of the New Year. According to the Stock Trader’s Almanac, it is good for an average gain of 1.3% in the S&P since 1950.

What caused the Dow Jones Industrial Average to have its worst week since the financial crisis in 2008, down nearly 7 percent and cause the Nasdaq to close down into bear market territory?

  1. The Federal Reserve’s rate hike on Wednesday drove the losses this week and investors were hoping for a more dovish tone regarding future rate hikes. Despite the fact that Chairman Powell reduced the projected number rate hikes from three to two and reduced the neutral rate to 2.8% from 3%.
  2. In my humble opinion, President Trump is partly to blame for the severity of the losses this week due to his criticism of the Fed.  He backed Powell into a corner and forced him to show that the Fed is an independent institution. (the Fed could have put more emphasis on being data dependent) According to some reports, Trump has also discussed firing Powell privately because of his frustration with stock market losses in recent months.
  3. In an extensive interview at the White House on Thursday, Trump’s trade adviser, Peter Navarro said that it would be “difficult” for the U.S. and China to arrive at an agreement after the 90-day period of talks unless Beijing was prepared for a full overhaul of its trade and industrial practices.
  4. Political chaos in Washington with partial government shutdown, sudden withdrawal of troops out of Syria and the resignation of Defensive Secretary Mattis.

Investors are still worried about:

  • A slowdown in economic growth as more companies scale back their sales growth and profit outlook for 2019
  • Fear that a flat yield curve will invert if the Fed continues to hike short-term interest rates
  • The unwinding of the Fed’s balance sheet will reduce the availability of credit for corporations
  • The trade war with China will escalate causing more inflation
  • More economists are jumping on the recession bandwagon for 2020
  • Political chaos in Washington will get even worse when the Democrats take power in January

A dead cat bounce is a possibility in January

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dead cat bounce is a small short-lived recovery from a prolonged decline or a bear market that is followed by the continuation of the down turn. You need nerves of steel to trade a dead cat bounce but for long-term investors it could be a good time to reduce market risk and re-balance your portfolio.

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Blame Yellen and Trump for rapid raising U.S. interest rates

  

I believe that the former head of the Federal Reserve, Janet Yellen, is partly responsible for rapid raising U.S. interest rates. Although, GDP growth wasn’t overheating during her term, she could have started to unwind the Fed’s balance sheet which had 4 trillion dollars’ worth of treasuries. Instead she bought more treasuries after they matured and expanded the balance sheet by buying more treasuries with the interest earned.

This kept long term interest rate extremely low and allowed corporations to borrow money at low rates to buy back their shares. The Fed’s lack of action has help fuel the longest bull market in history.

Sorry Trump supporters but your man is also to blame. His policies are inflationary!

  1. The trump’s administration decision to pull out of the Iran deal has cause oil prices to rise. One million barrels of oil a day is being taken off the market.
  2. Trump’s tariff war with China and other trading partners will force corporations to increase prices because their costs are going up. Costs could go up even higher if Trump increases tariffs on imports from China from 10% to 25% in January 2019
  3. The corporate tax cuts and government spending has juiced the economy causing unemployment to fall to the lowest level in nearly fifty years sparking fears of raising wage growth.

The Trump’s administration spin that the tax cuts will pay for themselves is simply not true. Both the Reagan and Bush tax cuts added to the fiscal deficit.

The new Fed chairman, Jerome Powell has a difficult job of unwinding the Fed’s balance sheet by buying less treasuries just as the federal government is issuing more debt to cover the Trump’s tax cuts. Trump will add another trillion dollars to the deficit. More supply of treasuries plus less buyers equals raising interest rates.

Trump blaming Powell for the massive drop in the stock market last week is ridiculous. No one knows for sure what caused investors to hit the sell button. Was it fear of raising interest rates, a forecast of slower global growth by the IMF, fear of an escalating trade war with China or fear of runaway inflation.

My guess is all or none of the above. Maybe the stock market was just due for a correction.

 

 

 

 

Trump criticized the Federal Reserve’s interest-rate increases, it’s the economy, stupid

President Trump blasts the Federal Reserve’s interest-rate increases last week, breaking with more than two decades of White House tradition of avoiding comments on monetary policy out of respect for the independence of the U.S. central bank.

The Fed has raised interest rates five times since Trump took office in January 2017, with two of those coming this year under Chairman Jerome Powell, the president’s pick to replace Janet Yellen.

“I am not happy about it. But at the same time I’m letting them do what they feel is best,” Trump said. In the interview, Trump called Powell a “very good man.”

Since 1977, the Federal Reserve has operated under a mandate from Congress to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates”, what is now commonly referred to as the Fed’s “dual mandate.”

The GOP’s tax cuts put the petal to the metal in an already accelerating U.S. economy. The unemployment rate which was heading lower got some extra juice. A 4 percent unemployment rate is very close to the Fed’s goal of maximum employment. However, wage inflation hasn’t show up yet as corporations are increasing dividends and buying back shares instead of increasing employee wages. (So much for trickle-down economics)

The real threat to the U.S. economy is inflation which has started to rear its ugly head due to a rebound in oil prices. The Fed is concern that the Trump administration’s use of tariffs to get better trading deals from all its trading partners will eventually lead to higher inflation. The Federal Reserve can let inflation run a little hotter temporally but it may be forced to accelerate interest rate increases.

Powell addressed Congress last week and told lawmakers that “for now — the best way forward is to keep gradually raising the federal funds rate.” Fed officials have penciled in two more hikes this year. That is one more rate hike then when Yellen was heading the Fed.

The probability that investors assigned to a Fed rate hike in September was little changed near 90 percent after the president’s remarks, while the probability of a December hike was also holding near 65 percent, according to trading in federal funds futures.

Will tariffs clause more inflation and or job loses?

The impact of tariffs takes time to make its way through the economy. Corporations will try to pass on higher input costs to their customers. Higher prices could lead to a decease in sales, causing corporations to cut costs by reducing their work force.

In my humble opinion, it all depends on the amount of the tariff. A 10 percent tariff will add to inflation but a 25 percent tariff will clause job loses.

Case in point, American farmers are feeling the pain of increase tariffs levied by U.S.  trading partners.

Trade conflicts “are having a real and costly impact on the rural economy and the ability of rural businesses to keep their doors open,” said Wisconsin Senator Tammy Baldwin, a Democrat, asking Trump to develop a farm plan. “Without prompt action, we could lose farmers and the rural businesses they support and depend on at an even more rapid rate.”

The Trump administration announced that it will deliver US$12 billion in aid to farmers who’ve been hit by dropping prices for crops and livestock amid a burgeoning trade war in which agriculture is a main target for retaliation against U.S. tariffs.

I am confused, Trump wants U.S. trading partners to eliminate all tariffs and subsidies. Yet, he is threatening more tariffs and providing more subsidies.