Category Archives: Public Markets

Q3 2017 Letter

October 2017

It continues to be a good year for equity investors across the board. The S&P 500 Index finished the quarter up 14.2% year to date, including reinvested dividends. The Russell 2000 Index of small and mid-cap stocks was up 10.9%, developed international stocks were up 20%, and emerging market stocks were up 27.8% over the same period.

Many of the themes we have written about recently remain in effect including slow but positive economic growth, low interest rates, subdued inflation, and low market volatility. In addition, the stock market continues to move higher, building on the second longest bull market advance in history. Central bank policy is garnering more attention now that the Federal Reserve has announced its intention to gradually reduce the size of its balance sheet, shifting from a policy of quantitative easing to a policy some have called quantitative tightening.

Prior to 2008, the Federal Reserve’s balance sheet had been modest and stable for many years. In response to the Great Financial Crisis, the Federal Reserve and other central banks embarked on a series of unconventional policies which included large scale asset purchases known as quantitative easing. In simple terms, quantitative easing works like this: a central bank creates money and uses it to purchase securities in the open market. Central bank purchases inject cash into the system and take tradeable securities out of the system. The supply of cash goes up and the supply of securities goes down. This is intended to provide liquidity, lower interest rates, and increase the price of financial assets creating a wealth effect that will in turn spur growth.

It took 100 years for the Fed’s balance sheet to reach $800 billion. From 2008 to 2014 it grew to $4.5 trillion. In other words, the Fed more than quintupled the size of its balance sheet in order to stimulate borrowing and spending. Similar actions have been taken by the European Central Bank (ECB) and the Bank of Japan. As a result, global central bank balance sheets have grown to a whopping $14 trillion. To put this in context, in order to blow through a trillion dollars in a single year you would have to find a way spend $1.9 million every minute (with no sleeping allowed).

In the era of quantitative easing, global central banks have been price insensitive buyers of mortgage and other asset-backed securities, government bonds, corporate debt, and even equity securities. The Fed now owns approximately 30% of all outstanding mortgage-backed securities as compared with none before the financial crisis. The ECB has purchased the bonds of Nestle, Unilever, Shell and other publicly traded companies due to a scarcity of government bonds. The Bank of Japan owns 40% of all Japanese government bonds and a remarkable 71% of all shares in Japan-listed ETFs.

Many believe these massive and unprecedented purchases have distorted financial markets. Interest rates are lower than in prior bull markets, credit spreads are tighter than usual, and equity prices are higher than they ever have been, except for a brief period leading up to the peak of the technology bubble in 2000. A recent cover story in The Economist describes it as “the bull market in everything” and asks “is it time to worry?” While investors can always find sources of worry, long stretches of high returns and low volatility can lull investors into forgetting that risk exists.

All investors should take note that the heady days of quantitative easing are coming to an end. The Federal Reserve is beginning to reduce its balance sheet by $10 billion a month, gradually increasing the pace to $50 billion a month next year. The ECB is expected to gradually reduce purchases from $90 billion a month to around $50 billion a month and then completely end purchases by the end of next year. The good news is that these moves have been well telegraphed in advance and markets have reacted favorably thus far. The pace is slow and gradual but it remains a fundamental shift in the environment that has been so supportive of risk assets globally. We will continue to monitor these developments closely.

q3 2017

Source: DoubleLine Funds

We are pleased to announce that Lloyd Flood has joined our firm. Lloyd brings three decades of experience working as a portfolio manager, trader, and financial analyst. He is a CFA charterholder and holds an undergraduate degree in Business Administration from Auburn University and an MBA from Mercer. We are delighted to welcome Lloyd to the team.

As always, we welcome your thoughts and appreciate the confidence you have placed in our firm. We are grateful for the opportunity to work with you and your family.

Nicholas Hoffman & Co.

Investing in 100 Year Bonds? It Might Hurt


May 16, 2016

Let’s talk interest rates this week. With global growth slowing in so much of the world, low interest rates are becoming the norm more and more. A global search for yield on sovereign debt estimates that over 80 percent of the world’s government bond debt is yielding less than 3 percent. In fact, in certain parts of the world interest rates have gone negative. Let’s look at various countries and what their average government debt is yielding:

Country           Effective Yield

US                           1.29%

UK                          1.41%

France                    0.21%

Germany              -0.10%

Italy                       0.99%

Switzerland          -0.38%

Australia               1.98%

Not much yield on the sovereign side but what about the debt of companies, is there any yield there?

US Corporate Bonds                                       3.03%

US High Yield Bonds                                        7.75%

Emerging Market Corporate Bonds              5.56%

European Corporate Bonds                           0.81%

The demand and need for income is usually high in an investor’s portfolio. It is a fact that today’s buyers of bonds are enthusiastic about investing in bonds at virtually any price for any period of time. The WSJ this week noted that the demand for debt (income) in Europe is so great that companies and nations are issuing very long term debt that doesn’t mature for 50 and 100 years! The Spanish government issued a 50-year bond that rewards the investors a yield of only 3.45%. Last month the French government sold a 50-year at a return of only 1.75%. Six years ago the same 50-year debt carried a rate of 4%. Have investors lost their minds locking in a 1.75% for 50 years?

It’s not just bond investors that are impacted in this new low interest rate environment. We had a discussion this week with a long time real estate professional on the state of his market. He pointed out how the demand for yield and the acceptance of low rates has spread to real estate investors. Report after report shows that the metric used in calculating the value of income-producing real estate called the capitalization rate (cap rates) continues to drop for all property types. Long-term players in the real estate market are beginning to question some of the valuations due to these historically low cap rates. The problem is buyers continue to look for yield.

If you are the manager of a pension fund, you must invest your capital to produce income in order to pay your pensioners. You must find investments that generate the yield you need. In the past you might get that yield from government bonds, but not today. That might cause you as the portfolio manager to turn to riskier options in corporate or high yield bonds. But what if that rate is too low? The next option is to invest in longer and longer term bonds. Both of these options are very risky to the bond investor, but the reality is they are doing it and there is no end in sight to their demand and to their problems. If you need to borrow money globally there has never been a better time – the buyers for your debt await with open arms and low rates.

Carl Gambrell