What Inflation?

For some time now we’ve been hearing worries about the inability of most bonds to keep pace with inflation. Because bonds are “fixed” income investments, the ability to exceed inflation is a major concern, especially in a low interest rate environment. The truth is, despite what your grocery bill may look like, inflation is actually quite weak right now. The core consumer price index (CPI) which excludes food and energy, is currently running at 1.8% year-over-year as of October, less than the Fed’s 2% inflation target.

Well what about inflation expectations, or future inflation, you ask?

The 5-year break-even inflation rate, calculated by subtracting the yield on a Treasury Inflation-Protected Security from that of a nominal US Treasury note is currently 1.48%, the lowest it’s been since October 2011. This implies investors expect inflation to average 1.48% annually over the next five years, in-spite of years of a near-zero Fed Funds rate and massive quantitative easing by the Federal Reserve.

Recent inflation readings, despite an uptick in US GDP (normally inflationary) since the starkly negative growth from Q1, have quieted both inflation hawks on the Federal Open Market Committee and economic pundits alike. Data from the Chicago Mercantile Exchange’s FedWatch indicates the market expects the Fed, whose dual mandate is full employment and stability of prices, to raise rates towards the end of 2015, as opposed to the first or second quarter as previously believed.

What factors are contributing to low inflation and potential continuation of accommodative monetary policy?

Among others, weakening worldwide economic growth is likely the largest factor. Weak growth and the expectation of greater quantitative easing by the European Central Bank (ECB), has pushed Eurozone sovereign debt to record lows (the German 10-yr yields 0.74%!). Improving US economic conditions and a global search for yield has made the US an attractive place for foreign investors, whether in Treasuries or riskier domestic investments. The stronger dollar also makes foreign goods, and as a result domestic goods, cheaper for American consumers. Although energy is not included in core inflation, oil, and as a result gasoline, is also cheaper. Another factor is tepid wage growth, even in the face of solid employment gains in the US, which is seen as both a consequence and cause of weakening inflation.

What does this all mean for bonds?

As yields around the world stand at or near record lows, with the potential to go lower if the ECB begins buying sovereign debt, it’s hard to expect domestic interest will rise the way most investors and economists expected heading into 2014. This sounds like more frustrating news for bond investors, but there is a silver lining! The purchasing power of a bond’s coupon is enhanced as inflation falls, which is definitely something to feel good about. We continue to seek bonds with justifiably higher yields than peer bonds of similar rating and maturity using a fundamental approach.

November Conerly Charts: Economic Growth and Positive Oregon Employment Trends

View the latest charts and comments on the U.S., Oregon, and Washington economies from Dr. Conerly of Conerly Consulting. Plus, read about “The Economics of 3-D Printing” as explained by Dr. Conerly on Forbes.com.

We are pleased to re-post Dr. Conerly’s charts for our clients. Please see his site for more data and the articles on 3-D Printing: www.conerlyconsulting.com. Conerly ChartsConerly Charts2 Conerly Charts3

Recent Market Volatility

With the 24-hour news cycle, all of you probably are aware of some increased volatility in stocks after a quiet summer.  It seems that October always brings such events and mostly on the downside.  The chart attached shows how subdued volatility has been over the last couple of years.  It also shows that it has been a few years without a meaningful correction in stocks.  We are due for a correction in stocks which is typically defined as down over ten percent.

Is this it?  We really don’t know and no one else does either.  So far, the Dow Jones Industrials are down a little over 5.5% from their recent highs so if it does become a correction, we have some more days like this to go.  While 200 and 300 points on the Dow seems like a big number and would have been a market crash in 1987, today it is less than two percent.

This pullback also has made some companies we have on our target list attractive buys in our opinion.  So, we plan to stay focused on buying high quality companies at a discount to their intrinsic value rather than trying to time the market.

Please do not hesitate to contact us if you have any questions.

dow jones


Congratulations to our Associate Portfolio Manager Cheyne Sorensen for passing the June 2014 CFA Level II exam! Only 46% of candidates taking Level II passed the exam. Now for Level III!


A few words about the CFA Program from the CFA Institute Website:

The Chartered Financial Analyst® (CFA) credential has become the most respected and recognized investment designation in the world; enrolling in the CFA Program is your first step toward earning this qualification.

The CFA Program curriculum covers concepts and skills you will use at all stages of your career, bridging academic theory, current industry practice, and ethical and professional standards to provide a strong foundation of advanced investment analysis and real-world portfolio management skills.




Go Big or Go Home? Not So Fast!

NWIC_logo 4Value comes in all shapes and sizes in the world of fixed income. Unlike the stock market, availability of the bonds you like can be limited and offerings might even disappear from the secondary market during the time it takes to conduct proper research. The scarcity of coveted bonds can have several varying effects on the price of a bond. A small bond issuance of a desirable company may be in short supply, and consequently, have higher prices for those investors wishing to own the bonds. Another scenario is that the bond is in such short supply, and trades so infrequently, that when bonds do become available, they trade at wider spreads (lower prices) than their credit rating and appeal suggests. We often target bonds of this nature because we can add yield safely by essentially providing liquidity to the market. Investors who become crunched for cash for one reason or another may find themselves needing to sell one of these small, infrequently traded bond positions. When this happens, small listings (10-25 bonds) will show up on one of the several bond platforms and inventory lists we view daily. In order to move this bond inventory, which is too small to raise the interest of mutual funds, dealers must “mark down” the price to entice those buyers willing to do the research and purchase a small position. These small bond lots, which we call “odd-lot” or “spinach” pieces, offer the buyer anywhere from a few basis points (a basis point is 1/100th of 1%) more than a comparable bond to spreads in the 20+ basis point range.

At NWIC, we view the ability and know-how to buy odd-lots as a huge advantage for our clients. Investment firms smaller than ours rarely have a devoted bond manager with the time to sort through many small issues and either buy bond funds or more expensive new issues. Investment firms that are much larger operate more like mutual funds themselves and often miss the bargain odd-lot pieces. Most dealers will even say first hand that for bond pieces smaller than $100K, there is significantly less fund demand, making those bonds cheaper and preserving their availability to a degree.

As always, there are several caveats. For the same reason we are able to buy these marked down odd-lots at cheaper than normal prices, we strongly reinforce the buy-and-hold principle. Trying to sell one of these pieces prior to maturity can lead to a mark down on the sell-side. Not to fret! Our portfolios contain a diverse array bonds across the corporate, municipal, and government sectors to ensure that we are adding yield over and above going market interest rates while also preserving the bedrock characteristics of a safe and liquid bond portfolio.

It is also important to point out while there is value buying small lots, we also attain institutional pricing for individual clients by leveraging our ability to buy much larger quantities of bonds than is typical for single accounts. If this sounds contradictory to our appreciation above for small quantities, remember that the bond market is a much more fragmented market than the stock market, and that what may be available or cheap now, may change in only a matter of minutes. Finding good deals may take on the form of providing liquidity to other investors who need to sell a rarely traded bond, or doing the homework to find out why a larger issue appears cheap relative to comparable investments.

Below are two examples of odd-lot bonds. One demonstrates the benefit of odd-lots while one presents an area of caution. (Bear in mind that due to the nature of odd-lot bonds, the bonds described herein may not have been purchased directly for your portfolio. If your account was not a recipient in one round of odd-lot purchases, it will likely be a recipient in the next round, should your allocation levels warrant a bond purchase):

1) Juniper Networks 3.1% 3/15/2016 (Baa2/BBB): The most active corporate bonds will have trade amounts in the millions of dollars per day. As we mentioned above, sometimes a good name, such as Juniper Networks will show up as an odd-lot. We recently found a 35 bond lot ($35,000 par value) available and purchased it at an attractive price and yield. This trade was on July 18th and was the only trade that day, a thinly traded bond for sure. The bond was purchased at a yield to maturity of 1.03%, a spread of 55 basis points to a two-year Treasury (despite being just a 20 month bond). We view this as a strong credit that owing to infrequent trading was purchased more cheaply than a comparable bond, or even the same bond had there been more trades on that day.

2) Metropolitan Transit Authority 5.5% 7/1/2017 (Aa2/AA+): As we discussed in an earlier post “What are These Bonds in my Portfolio?” we buy odd-lot municipals that are pre-refunded and backed by US Treasuries. This bond happens to be escrowed to maturity, which is like pre-refunding, but takes place upon maturity as opposed to an earlier call date. At first glance, this bond is a very safe municipal bond, backed 100% by Treasuries and offering a 2.11% yield to maturity on a tax equivalent basis for investors in the highest income bracket. This represents a spread of 116 basis points to a comparable Treasury, despite the fact that the credit is identical (the credit is identical to a Treasury but this bond would be less liquid). The Schwab listing for this bond only shows a yield-to-maturity, which normally implies that what you see is what you get, in this case an annualized return of 2.11%. Further digging into the SEC filings for this bond reveals a more concerning reality. This bond is subject to a sinking fund call (I won’t go into that definition right now but it is another way for an issuer to take back a bond from its holder prior to maturity). The research for this bond involves reading the footnote of an SEC filing from 2002 which states:

2002 Footnote

Footnote two is the relevant one here and indicates that we can lose the bond prior to maturity. After plugging the offering price into the sinking fund analysis page of our Bloomberg software, we get a yield to the sinking fund call date of -0.73%. It’s hard to say for sure whether this bond will be subject in the end to the sinking fund call, but it would be ill-advised to buy a bond that has even a small likelihood of a negative return.

These examples highlight two of the many ways we seek to create and add value for our fixed income clients and also how our research and relevant knowledge shapes our conservative investment decisions.

The fixed income securities referenced above are not the only fixed income securities we have purchased in the last year for our clients.  If you would like a list of all fixed income securities purchased in the last year, please contact us.  Additionally, it should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.