Month: May 2015

Bonds in a rising interest environment

The general rule of thumb with bonds is prices tend to go down as interest rates rise. Of course with any theory there are exceptions, however, the reasoning behind it is reasonably straight forward. It helps to understand some bond basics.

A bond is essentially a loan you make to an entity like a government or corporation in return for interest. You can sell a bond, like any other security. How much you can sell your bond for is determined by how desirable the interest rate of it is compared to others on the market.

For example:

If you own a bond that is paying 5% and new bonds being issued with the same term are paying 6%, then your old bond may be worth less to investors than the new ones and thus their price goes down.

Longer term bonds tend to feel the effects of interest rates before shorter term bonds. Bond investors often choose to buy shorter term bonds instead of longer term bonds as pressure from rising interest rates affects the bond market.

How are bonds doing now?

Over the past couple of weeks, long term bond prices have fallen a bit, likely due to rising interest rates. As a result, in a few of our models we have shifted to some shorter bond positions. So far theory and reality are relatively close on this one. But remember, the inverse relationship between bond prices and interest rates is a rule of thumb and not an absolute.

Read more on Investopedia about bonds and interest rates: Here

“Seasonality: Sell in May and go away?”

Last Friday was May 1st. For many, this date signifies the real beginning of spring, welcoming “May flowers” and the holiday May Day. In the investing world, it is the trigger point for some investors of an old stock market adage “Sell in May and go away.” This seasonality based risk management theory, is rooted in the idea that the market is softest from May to November for equity investors. Theoretically, you could sell your equities in May, buy in November and be better off than if you held them for the entire year.

Is seasonality real or just stock market lore?

According to the Stock Trader’s Almanac, since 1950, the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period.

So, is it real?

Well, our feeling is yes (and no). The problem with any hard-and-fast rule for investing is that it does not always work. In 2011, the seasonal theory might have had you looking brilliant, but in 2012, 2013 and 2014 – not so much.

Is just ignoring it the best policy?

Ignoring long term, statistical, unbiased data is rarely a good plan. We do utilize seasonality as a factor when we are making a change to our equity holdings in a portfolio. Is it the sole factor? No.

How about a simple sports analogy:

A football coach is calling a play that includes a pass. It is raining out and the ball is slippery. A good coach would most likely take these conditions into account when determining if a pass is worth the risk. The rain is a factor in the coach’s decision making process. Rain is not a deal-breaker every time for a pass – clearly, quarterbacks pass in the rain all the time. However, it is an additional risk that has to be considered and may change the call from the coach in some situations.

Would it be a great play to sell all your equities simply because it is May 1st? Maybe, but it would just be a guess. Seasonality data is real and it should be an added factor in upcoming portfolio decisions.

Read more on Investopedia about Sell in May: Here