Commentary on the Current Political Situation

The most discussed topic in financial markets currently is, as we all are aware, the government shutdown and the potential for a default on upcoming payments the government is obligated to make. The question has arisen from a few clients of what steps should be taken in light of these circumstances? Perhaps the most important response we can give you is that this is gut-check time for your asset allocation. Investors are in a situation of “unknowns.” (There are always “unknowns” in investing; they just seem more acute right now.) We happen to think, along with most strategists, investors, et al., that the actual probability of a default is pretty close to zero. It’s not zero, but it’s close. In the meantime, while Washington hopefully gets its act together, stocks have moved downward a bit. Recognize however, that the stock market is still up about 16% at this writing – well above an annual average.

For most clients, we currently have more cash, and hence are less invested, than we have been in a long time. This has been a conscious effort as lately we have found stocks to be expensive and interesting ideas few and far between. A stock market correction, usually defined as a 10% pullback, could conceivably change that dynamic and provide opportunities to put money to work. For those clients with government/agency bonds in their portfolios, we sleep pretty well – you’ll get your money back at maturity (or a bit later if a bond matured during a default).

If an investor’s anxiety is overwhelming given these events, it’s probably a sign that their risk tolerance is not as high as they think, and we should perhaps have a discussion about that. Dramatic tactical shifts are rarely the correct answer; long-term asset allocation and adhering to your financial plan is.

Nothing happened!

As you may be aware of by now, yesterday the Fed made news by doing nothing.  In fact, it did so little that stock markets around the world jumped dramatically as did gold, US bonds, and just about every currency other than ours.  So exactly what didn’t the Fed do yesterday?

In short, the Fed kept in place its programs of trying to stimulate US economic growth, despite widespread belief that it would start to reduce them (known as tapering).  For the past year, the Fed has been buying US treasury and mortgage securities to the tune of $85,000,000,000 each month in an attempt to keep interest rates low enough to encourage people to buy houses & companies to borrow.  In theory, this work should be reflected in things like stronger employment numbers and improving GDP. Yet, 5 years after the financial crisis, what we really heard from Mr. Bernanke is that the Fed sees an economy that still needs help. The latest GDP figures showed an economy growing at just 1.8% per year, well under the 2-2.5% many wish to see.  Unemployment is stuck at 7.3% with a labor force participation rate that is the lowest ever (which acts to make the unemployment rate artificially low). In short, as long as inflation is a meek 1.5% (the last official measurement), there is little to suggest that our economy is ready to be tapered off the Fed’s life support systems.

The markets had been expecting the Fed to do something like start to lower its purchases from $85,000,000,000 per month to something lower like $65,000,000,000, and perhaps remove that spending completely by the middle of 2014.  Instead, the Fed did nothing, which the stock & bond markets took as the Fed’s resolve to do whatever it takes to get our economy going.  The foot will have to come off the gas at some point, but the Fed told us yesterday that time is not anytime soon.


Wire Fraud & Your Advisor

As an investment advisor, we rely on the trust relationship developed with our clients for a range of activities.  The basic relationship is that of a fiduciary allowing us to buy & sell investments on your behalf, but our clients trust us with a host of other matters, as well: financial planning, phone calls for one-off advice on an opportunity, or help with the transfer of funds.  We enjoy the chance to serve you on all fronts.

For that reason, we are posting today to alert you to recent industry conversations surrounding wire fraud.  The challenge of fraud has been around as long as money has, but today the sophistication of would-be fraudsters is as great as ever.  And as your trusted partner we are taking steps to help you combat the hoards that would do you harm.

The financial industry has evolved its practices for the movement of money around the use of forms & documents to create a paper trail, and reliance upon original signatures was deemed the gold standard for hundreds of years.  Today, signed paperwork is still important, but in this digital age the creation of original-looking documents (called forgery) is an all-too-simple process.  And with the proliferation of email use, the ability to impersonate and/or dupe someone has never been easier.  At NWIC we work with our clients and their custodians to help combat fraud, and that has required the continual evolution of our processes.

When we are asked by clients to have their custodian move money to their own verified checking account, the chance for fraud is fairly low: after all, the owner of the accounts is the same person, and typically the process of establishing the true owner of the checking account is done at the time the account is set-up.  However, when a client requests that we have the custodian send their funds to a new, unknown party the burden to establish the authenticity of the request is considerably greater.

There is nothing particularly sinister about what’s called a third-party wire – we help clients wire their funds to third parties to buy houses, pay college tuition, or pay medical bills all the time.  Yet, knowing the request is genuine and that the recipient is an authorized one must be completed at each request, and that’s where you will start to notice some changes.  The new standard process in authentication is now to add voice to written request.  Thus, if you send us an email asking us to send funds to a third party (that is, anyone other than yourself), we will not only ask for you to complete and sign a wire authorization form, but we will also need to speak with you.

Typically, we will simply call you at home or on your cell phone to verify the details and ask you a few questions.  This is not only a chance to correct any typos we discover, but it’s also the best way to engage you in conversation and satisfy ourselves that your request is a valid one, and not that of an imposter.  And be aware: the typical fraud attempt relies on a sense of urgency and drama to cause people to act before thinking.  Thus, if you need funds sent from your account, try to provide us with as much advance warning as possible, and keep us updated on the best phone contact for you.  We look forward to speaking with you!

Fannie & Freddie – reports of their death are greatly exaggerated…

The news stories are again surfacing about Congress considering a new federal housing agency to replace the  troubled agencies now supporting the functioning of our mortgage market. As you may recall, the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) were placed under federal receivership during the 2008 crisis, and they have remained there to this day. 

Fannie & Freddie would be perfectly happy to go about their business of facilitating a functioning residential mortgage market under the protection of its federal receivership (think trustee) were it not for a particularly bothersome fact: they are making money again – and lots of it.  In fact, the two agencies just paid $15 billion back to the US Treasury in just the past 90 days as part of the terms of its 2008 rescue, and this has pushed the US Congress & President Obama to each raise the idea that it is time for Fannie & Freddie to draw to a close.

But, wait, you say: don’t we own a whole mess of  Fannie & Freddie bonds?  If these two agencies go away, what will become of those bonds?  The first answer is easy: yes, we own quite a fair amount of agency debt.  As two of the largest debt issuers in the world, just about any bond portfolio will have exposure to these entities, and NWIC is no different.  The second question is the one with which we are more concerned.

The simple truth is that there are roughly $3 trillion (yes, with a T) in direct obligations that need to find a home, and simply ignoring them is not an option (note, we are not talking about “mortgage bonds” that are backed by residential mortgages – these are indirect obligations of the agencies through their guarantees).  The default by a US government agency on this size obligation would make for a global financial catastrophe that would put 2008 to shame. There really is no choice but to repay these bonds as they come due, so that’s exactly what we expect to see happen.  Unfortunately, the news media and government talking heads gloss over this fact, leaving these details to the imagination.

Fortunately for our clients, these details are not something we like to leave to the imagination, so we have taken the time to see exactly what the latest proposal says about these existing bonds.  Sen. Corker from Tennessee has proposed legislation that you can see here, and it’s not until page 132 that we see any mention of the existing obligations of Fannie & Freddie.  Page 134 finally has the important information we’ve been looking for:


There’s not much to look at, but those are the magic words in the current proposal that should give you comfort.  In fact, we’d argue that the terms of support for Fannie & Freddie bonds are even stronger under this proposal.  Originally, the guaranty of these agencies’ debt was implicit – an assumption on the part of investors that is anything ever happened to the ability of the agencies to pay their obligations that the US Treasury would ride to the rescue.  Indeed, that’s exactly what happened in 2008, but the language above in Senator Corker’s bill would make that guaranty an explicit one and remove any further speculation as to the fate of Fannie & Freddie bonds.

To be sure, there is much work to be done before any new federal mortgage entity is created.  Some suggest that it could easily be another 3-4 years before the sausage making of Congress is compete on this, but in the meanwhile we think Fannie & Freddie bonds will (and will continue to) offer our clients a safe, liquid, and appropriate asset class to use in fixed income portfolio construction.

Economic Outlook–Conerly Charts

View the latest charts and comments on the U.S., Oregon, and Washington economies from Dr. Conerly of Conerly Consulting.

We are pleased to re-post Dr. Conerly’s August charts for our clients. Please see his site for more data and comments: Click the images below for larger versions.

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Ginnie Mae – why hast thou forsaken me?

For quite some time now, many of our clients have had questions about the notable lack of exposure to (either through bonds or ETFs) the mysterious entity known as the Government National Mortgage Association, or “Ginnie Mae.”  For that matter, we have avoided just about any mortgage bond exposure in our portfolios.  Why is that?

By way of background, GNMA does not issue, buy, or sell any mortgages.  Rather, GNMA is the name of the guarantor federal agency standing behind loans made and/or guaranteed by other federal agencies, such as the FHA (Federal Housing Administration) or the Veterans Administration.  Mortgages made by these agencies and guaranteed by GNMA are typically pooled together and sold to investors as GNMA mortgage bonds.  As such, they bear no credit risk and carry the same AAA as the US government (oops, AA+ if you listen to S&P).  And, yet, take a look at the price of a popular GNMA mutual fund, the Vanguard GNMA Fund (VFIIX) over the past 90 days:

This 4.5% drop over the quarter (truth: it dropped 5.6% in just 45 days!) could come as quite a shock to those of us accustomed to the usual strong income and price stability demonstrated in the years leading up to this.  The  reason lies in a unique characteristic of mortgage bonds that individual investors sometimes overlook.

When interest rates in the market go up, the conventional reasoning is that the new, higher rates available to investors put the old existing interest rates to shame, and the price of an old bond must go down to entice new buyers.  Conversely, if interest rates generally offered go down and you hold an older bond with a swell, higher rate, then folks will clamor for it and you should be able to sell your bond at a slightly higher price.  Mortgage bonds are no different, except for a wrinkle in when & how you get your money back.  A traditional bond has a set maturity date that can bail you out if you end up not liking its interest rate.  For example, if we own for you a 1% GE  bond that matures at the end of 2015 and rates go up in the market, we always have a couple choices: sell the bond (perhaps at a lower price) or be patient and wait for the bond to pay off in a couple years.  The longer we may have to wait for the bond to pay off the worse that option is, so you can start to see why longer maturity bonds drop more in price than short term bonds do when rates go up.

The specific challenge with mortgage bonds is that they have the unfortunate ability to effectively lengthen their maturity as rates go up: exactly the time when you want bonds with shorter maturity dates!  To see how that is, consider our GE bond maturing at the end of 2015.  It pays some modest amount of interest every six months and then the full face value of the bond on the maturity date.  And that’s it: nothing else, just a couple small payments during the year and a big fat check at the end.  Now think about your own mortgage and how that’s different. You most likely have a mortgage that has a set maturity date far off in the future, but the reality is very few of us actually take out 30 year mortgages and then dutifully make 360 payments in a row to our bank.  Have you ever moved? Then you paid off a mortgage early and replaced it with a new one.  Ever take advantage of lower rates to refi your mortgage? Then what you really did was pay off your mortgage early and got a new one with better terms.  Might you be one of those folks who adds some extra payment each month to pay off the mortgage more quickly and save interest along the way? In that case, your 30 year mortgage might really turn out to be a 20 year mortgage.  In fact, these kind of things happen so frequently that the average length of time Americans really keep their 30 year mortgages is just seven years! And so this is also the expectation of investors who buy mortgage bonds: they may have a stated maturity date of 30 years, but everyone fully expects them to pay off early. 

When interest rates go up and bond prices go down, though, things get a bit squirrelly with the assumption that the 30 year mortgages will really be seven years long.  In fact, what we see when rates go up is that people don’t look to refinance their existing mortgages: they keep them as they are.  And when the economy is still struggling and people are a bit unsure of their finances, jumping jobs to relocate and making extra payments on your mortgage goes out the window pretty quickly, too.  All of these factors act to make our assumed seven year mortgage bond start to look a lot like a 10-15 year average.  When interest rates are going up and bond prices are coming down, would you rather have to wait  7 years to get your money back or 15 years? 

We manage bond portfolios here at NWIC with a strong preference for certainty. We like to be fairly certain we will be paid back, so we only buy investment grade bonds.  We like to be fairly certain clients won’t be rocked by changes in interest rates, so we like to buy bonds that generally mature within 10 years (and much less than that today).  So when we consider mortgage bonds, be they GNMA bonds or funds/ETFs that buy GNMA bonds, we get a bit uncomfortable when a reasonable seven year wait for our money can become a 10-15 year wait at exactly the wrong time.  To be sure, GNMA bonds/funds/ETFs are legitimate and well-established investment vehicles that offer safety of principal and reasonable income, but the last 90 days have shown us that these characteristics don’t always mean price stability, too.

Behavioral Finance highlights

Miss our recent open house presentation? Here are a few highlights from our Behavioral Finance discussion.


To keep up to date, follow Northwest on Twitter.


Economic Outlook–Conerly Charts

View the latest charts and comments on the U.S., Oregon, and Washington economies from Dr. Conerly of Conerly Consulting.

We are pleased to re-post Dr. Conerly’s July charts for our clients. Please see his site for more data and comments: Click the images below for larger versions.

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To keep up to date, follow Northwest on Twitter.


Northwest Q2 Letter

Dear Clients:

Before we discuss investments, we have a few other topics to cover.  A transition in life is typically accompanied by a long “to-do” list. Occasionally some of the details don’t make your list and thus are never addressed.  Don’t let changing your beneficiaries be one of the tasks that gets overlooked!  At the time of death the current beneficiary on your account will be the one to receive the proceeds of your IRA or Trust even if it’s no longer your intent to have that person as the beneficiary.  For your IRA accounts, you can either contact your custodian to get a Change of Beneficiary form, or contact us and we will send you the form.

We want to connect with you.  Many of you know we have a blog linked to our web site ( ) where we discuss topics of interest in the capital markets and other areas of client interest.  We are also on Twitter, where we tweet links to our blog comments in addition to other information you will find valuable.  If you are on Twitter, please search for @NWInvestment and follow us so you can stay up to date.  Finally, if you are a LinkedIn user, you can connect with our company page.


Stocks continue to have an exemplary year, as the S&P 500 was up 13.8% through June 30th.  The long run annual average for stocks hovers around 10% (depending on exactly what you look at), so this is shaping up to be a rewarding year.  There are concerns on the horizon, however, and that has led us to allow a bit more cash to build up in client accounts than normally would be there.  Perhaps the most significant factor is the interest rate environment – please read the “Fixed Income” section of this letter below for more details.  In addition, most foreign economies are growing very slowly, if at all, and earnings gains for businesses here at home look to be somewhat muted in the second half of the year.

All in all, we are somewhat cautious right now.  We spend our days sifting through a variety of informational sources looking for good investments.  Those good investments are elusive currently.  There are certainly a lot of well-run, growing, healthy businesses listed on the stock exchange – the problem is valuation.  We are looking for a margin of safety, and the pickings are slim in that regard.

Most of you will be aware that we sold the majority of our REIT position in the second quarter in our Model portfolios.  We have felt for a while that valuations in this space were stretched.  Where once yields well above 6% were commonplace in this asset class, the yield on the REIT ETF fell below 3% earlier this year.  That was not an attractive risk-return tradeoff in our view.  Proceeds have gone to small cap stocks and preferred stocks.  If you have a custom allocation (i.e., not one of our Models), we will need a signed change of allocation form if you want to follow our recommendation.

NW Equity Income

The current yield on the Equity Income Portfolio stands at about 2.9% weighted by position size, which is just about the lowest it’s been in the history of this portfolio.  Primarily, this is a function of a run-up in stock prices.  With income in short supply for investors, many who would ordinarily purchase bonds for income have instead purchased dividend-paying stocks.  The cautionary note here is that the risk of stocks compared to bonds is apples to oranges.  A given stock may have an attractive yield of, say, 4%, but if that stock falls in price by 20%, that is real pain to the investor.  A bond may only yield 1% (or whatever) in this environment, but the kinds of bonds we purchase are very unlikely to have a significant price decline like a stock.

Note that many clients have holdings that were purchased over the last several years and their yield based on their cost could well be between 4%-5%.

NW Blue Chip Growth

While our buy/sell activity was fairly muted in Q2 in Blue Chip Portfolios, there were a fair number of holdings who announced dividend increases.  Examples include Oracle, which doubled its dividend to $0.12/share, PepsiCo which increased its dividend 6% as it continued with a long string of increases, and Johnson & Johnson, which pushed its dividend up another 8.2%.

Many companies also continued to repurchase their shares.  Both of these actions serve to return excess funds, which are not needed to reinvest back into the business, to investors.

NW Smaller Companies

We added one new holding to the Smaller Companies portfolio during the quarter:  Navigant Consulting (NCI).  NCI, a specialty consulting firm, provides dispute, investigative, economic, operational, risk management, and financial and regulatory advisory solutions to companies, legal counsel, and governmental agencies facing the challenges of uncertainty, risk, distress, and significant change in the United States, the United Kingdom, and internationally.  NCI has shown increasing profitability over the last few years, has a good balance sheet, and offers good potential returns to shareholders.

In other news, Advent Software, a current portfolio holding, announced it would pay a special $9 per share dividend out of cash on hand as well as utilizing its debt facilities.  This move to reward shareholders was announced in Q2 and should be received into client accounts on July 9.


The second quarter of 2013 started innocently enough with the interest rate on the 10 year US Treasury note at 1.87%.  In fact, yields actually continued to move lower through April, reaching a low of 1.66% by May 1.  However, some pieces of good economic news with respect to personal spending, consumer confidence, jobless claims, and inflation started a push on interest rates gradually upward through mid June to 2.2% as the markets saw an improving economy that might someday be able to stand on its own two feet.

However attractive the concept of a healthy economy that is self-sustaining might be, the fixed income markets weren’t quite ready for the same assessment from the head of the Fed, Dr. Ben Bernanke.  On June 19 he had the audacity to suggest that at some day in the future the Fed would not need to feed the US economy $85 billion each month.  Mind you, he said that day was not now, and he added that rather than taking away $85 billion/month he might just reduce it somewhat. Nonetheless, within 5 days interest rates on the 10 year jumped to 2.6% and pundits predicted higher & higher rates and an imminent bond market meltdown. Thankfully, we are not in the business of entertainment – we manage your money as your fiduciary – so some perspective is in order.

In the business entertainment world (you know that Cramer and CNBC are in the entertainment business, right?), the 10 year US treasury bond is an important rate for a range of things and is closely followed.  Many residential mortgage rates are set based upon the 10 year, and general corporate borrowing can be affected by its level, too.  So, as a barometer of the cost of money, the 10 year has its place.  And, if you owned the 10 year treasury as rates have increased the price of that bond has gone down.  The 10 year treasury on May 1 had the market price of $103.33 (and a yield of 1.63%), and by the end of June its value had dropped to $96.17 for a 6.9% drop in the span of just 60 days!

Contrast that with changes on the price of the 3 year US treasury.  Today we manage our Intermediate Fixed Income bond portfolios to have short maturities (on average) that are much closer to 3 years. The graph below shows how these two different bonds behaved during the May and June periods of this year.

bondsThe white line is the price of the 10 year treasury (what Jim Cramer & Rick Santelli scream about), while the orange line (3 year treasury) is much closer to what Northwest bond portfolios are designed to do.  Both bonds were lower in price during the time period; only one of them makes for good entertainment.  Rest assured, we seek to invest our clients’ bond portfolios for low volatility and safety – not entertainment value.

We thank you for the trust you have placed in Northwest.  Alleviating the financial burden that comes with managing wealth is what we do. Numerous studies show that the individual investor’s emotions take over when it comes to managing their own money and thus they underperform the markets.*  We would be more than happy to have an initial meeting with anyone you know that is feeling burdened by the sudden responsibility of managing their wealth.

Should you have any questions or would like to set up a quarterly portfolio review meeting, please do not hesitate to contact us at 800.685.7884.