Weekly Access

Big Bad Bond Market


The biggest post-election news is the bond market.  Yields are up over one half of a percent to 2.25% on the 10-Year Treasury, which means bond prices fell.

The main reason behind the move in prices was higher inflation expectations. One of the main risks bond investors take into account is future inflation.  With President-Elect Trump’s big plans for infrastructure spending and tax cuts, it could mean greater money flowing in the system.  In addition, protectionist trade policy, if implemented, would also be inflationary for goods and services due to less competitiveness among companies.  In turn, this would lead to a larger federal budget deficit.  Traders and investors are pricing in the likelihood of these policies being passed by the Republican led Senate and House.  These policies go against many Congressional Republicans who spent the last several years threatening to shut down the government due to high budget deficits.

Post-Election Outlook


Political values are important to individuals, but mixing politics with portfolio decisions is not profitable on a consistent and repeatable basis.

Analysis based on fundamentals and the valuation of asset classes is what matters for investments. We plan to stay in our lane and take a non-partisan view to what this election means for the economy and investments.

Do You Know What’s In Your Index?


Passive investing is all the rage these days.  Low fees, tax efficiency – who wouldn’t want to be in on this party?  We sure are.  In our view, it makes sense for certain parts of our portfolios.  Per Morgan Stanley, since 2007, US passive strategies have seen $914 billion in inflows while active funds had $857 billion in outflows.

In certain asset classes, there are nuances with indices that may not be what the end user intends.  But because indexing is automatically considered great these days, few are going beyond the surface to dig deeper.

IRA + HSA - The Alphabet Soup of Retirement Savings


Health Savings Accounts (HSAs) have been around since 2003 as a tax-preferred savings vehicle for participants in high-deductible health insurance plans. Despite their name, HSAs can serve as an excellent tool for retirement savings as well.

Real Estate is the New Kid on the Block


For the first time since adding technology in 1999, Standard & Poor’s is adding a new sector to the S&P 500 Index.  Real estate, previously falling under the classification ‘financials,’ just became an independent sector.

Show Me the Money Markets Reform


In July 2014, the SEC passed new rules and regulations around money markets that were to be phased in by October 2016.  The main objective of the reforms was to create greater stability within money market funds.

The Emerging Gap


Despite the high stock prices and a great run in bond prices, investors can hardly be described as exuberant.  Perhaps it is because they look at the investment landscape and do not see much that they like. 

Politicians Changing Attitude toward Debt


By Michael McKeown, CFA, CPA - Chief Investment Officer

It was only a few years ago that people from both sides of the aisle in Congress were calling for austerity.  The same went for members of the ECB and politicians in Germany and the UK.  All across the globe cutting debt was the way to prosperity.

It turns out those policies were wrong.

Perhaps ‘wrong’ is too harsh a term.  'Poorly timed' given the economic situation, may be more descriptive.

Countries are changing their approach when it comes to debt.  This may be due to the rise of populist political movements or growth that is not what it used to be.  In July, several countries announced plans to expand spending.

  • A 60 billion Canadian dollar fiscal stimulus plan was unveiled by Justin Trudeau, including infrastructure spending.  This equates to 3% of GDP.
  • 20 trillion yen stimulus package including projects for high speed rail and infrastructure (including loan and guarantees) was introduced.  This equates to 4% of GDP.
  • UK’s Philip Hammond, Chancellor of the Exchequer, indicated a possible stimulus package this autumn to counter the negative effects of the vote to leave the European Union.

"The US is doing better than the rest not because its quantitative easing worked better, but because it is the only country with a central bank that openly argued against fiscal austerity."  This quote is from Richard Koo, Chief Economist from the Nomura Research Institute. He is one of the few economists to witness and live through Japan’s 20 years of quantitative easing.  In addition, he correctly diagnosed the balance sheet problems for the nation.

The U.S. indeed turned out to be the least austere, despite some people actively campaigning for it.  This turned out to be the correct policy.  Why? Households were deleveraging and corporations not investing.  A government deficit was necessary to fill the gap left by households and corporations.  It is a big reason why the U.S. is the only country out of the 4 major economic blocs to not battle deflation over the last year.

The chart above shows the inflation rates across the developed world.  The U.S. topped Europe, Japan, and the UK at 1% over the last year.

Both of the major parties' Presidential candidates this fall both support greater spending.  The fiscal spending impulse could result in higher inflation.  In turn, this could cause bond investors to want more compensation for inflation risks.  This would cause yields to rise and bond prices to fall.

Just like greater fiscal spending, rising bond yields go against the trend of the last several years.  A rise in U.S. bond yields over the next year or two, does not mean a secular change is ahead.  Other factors, such as the yields offered by global bond markets and growth trends, will determine the path of interest rates.

Adding to the short-term risk of a rising bond yields is the positioning of real money traders.  Commercial traders have the largest bet against bonds since early 2013 (just before the Taper Tantrum when yields spiked).  In contrast, small traders have the largest bet on bonds in four years, which is usually a contrarian indicator.

The chart above shows that the U.S. 2-year Treasury note yields far above Japan and Europe.  Thankfully, it is in positive territory.

Based on the data presented, and compared to the rest of the world, America is not doing that bad.


This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

Brexit Breakdown


By Michael McKeown, CFA, CPA - Chief Investment Officer

After four decades as a member, on Thursday, voters in the U.K. voted to leave the European Union.  It was a close vote, 52% for “Leave” to 48% for "Stay."  This means that the long-standing trade and immigration agreements that covers 28 countries will no longer apply to Great Britain after its official exit.  The majority of citizens clearly felt that EU membership was inhibiting growth and prosperity.

Currencies and stock markets fell around the globe on Friday as votes were tallied the previous night.  Europe was obviously hit the hardest by sellers as the uncertainty about other countries potentially leaving the bloc and the economic outlook gets murkier.

The demographic split among the vote is getting attention as the ‘older’ generation voted to leave and ‘younger’ voted to stay in the EU. But the London-based Financial Times went further and explained:

“As the votes were counted on Thursday night and Friday morning, the piles of ballot papers told their own story about those parts of Britain that felt comfortable in a modern, connected world, and those which felt cut off from the fruits of globalisation.

Voters in London and Scotland, the two most prosperous parts of the UK, turned out in large numbers to deliver a clear message that they wanted to remain in the EU and its huge single market.

But elsewhere — in the old industrial centres of the north, the small towns of the Midlands and the faded seaside resorts — the ballot papers were stacked high in favour of Leave, rejection of an establishment that had let them down.”

Politics… well, we won’t touch that here, but suffice it to say the environment could be better and it is a sign that populists' leanings across other countries have momentum.  This is a headline risk to the economy and markets, but it does not always mean there will be fundamental changes to either.


“This will end badly.”

This is pretty much the phrase at least one person says concerning any headline risk in the financial world right now… low interest rates, the U.S. dollar, China, the Middle East, venture-backed technology companies being overvalued, oil prices… Brexit.

But what if it doesn’t?

Exhibit A – Japan.

Yes, the country has negative interest rates, its society is very old with poor demographic trends, and its stock market has shown signs of life but is no higher than where it was in 1989.  But by and large – the standard of living improved incredibly over the last couple of decades and its nominal growth was positive on average.

In the U.S., the unemployment rate is low.  Inflation is also low.  Growth is lower than in the past, but it is still positive and at the same trend of the last few years. Still, the stock market is near all-time highs and bond investors enjoyed great returns the last couple of years. 

Everyone in Cleveland is seeing things a little rosier today thanks to the Cavaliers winning an NBA championship (though in my defense, I began drafting this note two weeks ago).

There is always an event in the financial news merry-go-round to bring out the pessimists.  Nonetheless, the term “Secular Stagnation” is being thrown around by ‘top’ economists to describe the disappointing output level, implying it is simply fate that we are at a permanently lower plateau.  Perhaps it is an inopportune time to have a pro-cyclical view but being an optimist paid off over the very long term – for the lowly economists and investors alike.

In terms of portfolios, we came into the Brexit vote tactically underweight international equities, meaning the allocation was below the long-term strategic target.  Morgan Stanley Research believes there is approximately 15-20% downside risk to European equities, which we would view as an opportunity to buy international stocks and rebalance to equalweight or back to the strategic targets.


This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

The Mortgage Rate Vortex


By Michael McKeown, CFA, CPA - Chief Investment Officer

Interest rates are nearing the lowest level in three years.  While we discussed what this means for future returns on the asset side of the balance sheet, it is an advantage on the debt side.

In many ways, mortgages are the tail that wags the interest rate dog.  If interest rates rise too fast, it can hurt the housing market, which the Fed certainly does not want to see.  When interest rates fall though, it allows homeowners to refinance mortgages to lower interest rates, assuming enough home equity is there.  It also creates a hedging vortex for real-money mortgaged-backed security investors, which can plunge rates even lower. 

The trend in mortgage rates over the last 15 years was down, though not without many zigs and zags.  Today, rates are at the lowest point since early 2013.

15-year term mortgages always offer lower interest rates than a longer 30-year mortgage.  15 years ago, this difference was relatively small; only about 0.4%.  For the debtor, this was a fairly nominal difference.  Today, the difference is approximately 0.75%, which is also a low spread.  But when rates go from 3% to 4%, instead of from 7% to 7.5%, it is important to not only look at not the raw numbers, but also the ratio between 15 and 30-year mortgage rates.  Doing so, one can see a high percentage increase in interest expense.  In addition, we can look at that previous ratio with respect to the 10-year treasury.  As seen below, today’s 30-year mortgage rate is about 23% higher than the 15-year.

Refinancing after interest rates fall gives homeowners the chance to pay down mortgages faster, lower interest rates, and lock in a great return on investment (when considering the extra payment as the ‘investment’ and the reduction of interest the ‘return’). 

Let’s look at an example of a $250,000 mortgage in year one of the term.  Comparing mortgage rates in 2001 to 2016 lets us see how much more valuable a refinancing can be when interest rates are low.  

The annual payments increases by $6,153 but the interest paid drops by $1,233, which goes towards principal.  This results in a 20% return on investment (ROI), which was four times the risk-free rate of return for the 10-year Treasury.

Let’s look at an example using the average conventional mortgage rates today.

With the 30-year at 3.93%, it makes sense to move to a 15-year at 3.20%, though the tradeoff being that the payment goes up nearly 50%.  Still, the interest saved of $1,937 results in a 28% ROI.  Since the 10-year Treasury risk free rate is so low today compared to that ROI, it is that much more valuable to refinance.  One can make 17 times the risk free rate in the above scenario in the first year.  This only increases in subsequent years as the mortgage principal declines at a quicker pace.

The average rate for all outstanding mortgages today in the United States is 4%.  In a hypothetical scenario where 15-year mortgage rates fall to 2.5%, the mortgagee could refinance from the original 30-year term to 15-years.  That is, if the mortgagee is willing to pay a 34% higher mortgage payment per month.  This may sound like a lot, but it is almost matched dollar for dollar by greater principal pay down.  The return on this investment is a whopping 80% per year over the first five years!  Moreover, assuming the payments are always made, it is a guaranteed return – well worth it in any interest rate environment.

In light of the negative interest rates from Japan to Europe hitting record lows, we will be watching in the months ahead to see if the downtrend in U.S. interest rates continues to create another wave of refinancing activity.  Mortgagees should be ready to pounce (and go through the painful refinancing process of pulling documents), but just think about that return on investment and it is well worth it.


This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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