Hidden Taxes Strangle Fixed Income Investors

The robust end of the year trend has poured over into the New Year as January finishes with a strong start to the year. Oil and energy related equities continue to advance with a resilient trend in place. Investors are optimistic, right now, as they have been since March 2009.

Starting with the US Dollar we see that it made lower lows, had lower highs, and closed lower for the week. But it did manage to close well off its intra-week lows. I continue to maintain a bearish dollar position in my clients’ accounts, which was opened on January 4th. The U.S. Dollar posted a late week gain (1/31 week), likely the result of turmoil in the mid-East. This news related buying might continue if the problem is not resolved. However, I think it is wise for us to stay in our profitable position, benefitting from a continuing drop in the US Dollar Index prices.

We entered back into US stocks on 11/5 and 12/17 and both of these have proven to be wise moves as we are riding a 7.54% and 6.27% gain. Often times, the US stock market will have a pullback in February and then really surge in the spring time. It will be interesting to see if there is still enough money to pour into stocks this spring, assuming the investing public continues their wave of optimism.

The most recent change (01/25/2011) I made to my clients’ portfolios was to go back into the US government long bond after closing a profitable short position against this bond. I still believe that interest rates will go lower from where they are now, which means the long bond will go up.

Interest Rates

These low interest rates do not benefit everyone, as we often times assume. How low are interest rates? Well, the average 12 month CD is paying just .9%. I remember back at the start of 2007 a $1 million investment in 10-year treasury bonds would provide annual income of $45,600 and a corporate bond (Baa-rated) would pay $62,200 annually. And, get this, 6 month CDs would pay out $53,100 each year.

As of February 1st, 2011 the same $1 million purchase of a 10 year Treasury bond would pay $36,870 yearly. And a corporate bond (A rated and 10 years) would pay $63,000 of interest annually. Meanwhile, a 6 month CD would pay about $2,500 each year. So what is significant about these facts?

Something has got to give, in my opinion. If prices start to rise on people and fixed income investors continue to get paid these very low interest rates then their purchasing power will diminish greatly. This kind of works like a tax on these people. I have already had some conservative clients, in their 60s; decide that they wanted to take more risk with some of their money. They were previously in all fixed income assets and made the decision for me to actively manage a portion of their money using other types of investments with more volatility. Of course, they still have a large position in fixed income where we are at least getting more than CDs.

Another big deflationary drop, like Bob Prechter and Gary Shilling expect, would make sense to me to match our current interest rate environment. I could also see runaway inflation (more popular to the masses right now) where interest rates take off like they did in the early 80s. I am prepared for either scenario with the way I actively manage your accounts. Unlike so many others out there, I am not 100% certain what is going to happen with our economy, so I am preparing for either inflation or deflation. “Divide your portion to seven, or even to eight, for you do not know what misfortune may occur on the earth.” – Ecclesiastes 11:2.

Eleven Two Fund Management is a Registered Investment Advisor (RIA) located in Marietta, GA. We are proud to be working with Christian Individuals, small business owners, and Families in over 16 states.

Eleven Two Fund Management
3162 Johnson Ferry Road #260-27
Marietta, GA 30062

Phone: 770.971.2888
Toll Free: 800.917.5016
Fax: 770.804.2076

Press Contact: Thomas Cloud, Jr CFP, CHFC

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