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“When the facts change, I change my mind. What do you do?”
The quote is attributed to economist John Maynard Keynes, even though it’s likely Keynes never uttered it. Still, I like the sentiment, because I see facts changing, which could lead to me changing my mind.
For the past two years, I’ve been bearish on fixed-income investments for two important reasons: (1) Investments of any quality don’t provide enough yield to compensate for inflation and time value. (2) Prices have been artificially elevated (if not manipulated) by the Federal Reserve.
By continually buying billions of dollars of Treasury notes and bonds and mortgage-backed securities each month (known as quantitative easing), the Fed has artificially kept yields low and fixed-income prices high. The risk is that should the Fed taper quantitative easing, yields would rise and prices would fall, leading to capital losses.
For the past six months, the vast majority of market watchers expected the Fed to taper this past September. This didn’t occur and now expectations have been pushed back to the first quarter of 2014.
I’m less convinced tapering will occur that soon. Gross Domestic Product (GDP) growth remains weak. Third-quarter GDP growth will be reported on Thursday, and an annualized growth rate above 2% would be a godsend.
Job growth is equally anemic, and I see no improvement. Uncertainty over employee costs related to the Obamacare debacle could easily retard job growth for the next 12 months, if not beyond.
In other words, I expect quantitative easing to persist into the relevant future. This means the risk of buying fixed-income investments has been reduced.
But it doesn’t mean all risk has been removed. Many of these investments still provide ridiculously low yields, so the risk of losing purchasing power over time remains.