Sunday, December 5, 2010

Black Friday Buys and Bond Fund Sells

A number of members of this blog community were disappointed that I did not comment on this year’s “Black Friday” shopping. Worse, they felt that this absence was an economic indicator of a decline in my family’s gift trove. I plead guilty to disappointing some of our blog community. Perhaps more importantly, I plead guilty of observing without analyzing. What I saw on Black Friday and reinforced again on visits later that weekend, were unimpressive crowds carrying fairly few shopping bags, mostly from a promotionally-oriented department store. The only two stores that had crowd control lines were Apple, which was jammed and GameStop, an electronic game shop. I found these observations unremarkable and so, dear reader, I did not comment on them. Your concern forced me to dig deeper for my observations and to come up with useful analytical comments.


What I should have focused on was the large number of people who were clearly looking, but not buying. But they did buy on Monday over the Internet, as online shopping on “Cyber Monday” was a record. Evidently some of the lookers returned this weekend, as there were lines at various cash registers. As shopping has become a varsity sport, I should have focused on how the playing strategies of the buyers and the stores would engage. The shoppers were determining the beginning price levels and the availability of merchandise. The merchants were timing their price discount moves. Evidently on the second major shopping weekend, to use a securities market term, clearing prices were reached before last minute frenzy price activity, which comes later. (We know a number of executives that run into their friends on December 24th each year when they are attempting to fill the fondest merchandise desires of their spouses or significant others.) Some of the stores were up to their game mode, but others discouragingly were not. At a visit to a downscale mall’s old chain store in search of a particular home tool, one had to search for a sales person (who turned out to be an order clerk rather than a sales communicator) and the experience proved to be disappointing. Later, the particular item was found in stock in a more exurban location.

The Analytical Summary

Under current tense economic conditions the terms of trade-price, availability and service are critically important to making a sale. In their own way buyers are every bit as knowledgeable as the sellers. True merchants are in shorter supply than in the past as many family-owned stores have disappeared. These are the lessons to be learned from looking deeper as to actions and more importantly, the lack of actions.

Carrying Over the Lessons to the Investment World:
Bond Fund Buyers are A.W.O.L

AWOL is a military term meaning absent without leave, which covers the situation when a serviceman or woman is absent without permission or explanation. Over the last several weeks the prodigious flow of money into bond mutual funds has slowed materially and perhaps in some cases reversed. This phenomenon extends beyond the tax exempt funds which could be attributed to the finally recognized deterioration of the status of some government bodies’ ability to meet future payments. The slowdown is occurring in the larger taxable side even though its small yields are still higher than yields on cash instruments, which suggests a structural change is likely occurring. What is happening, I believe, is the recognition that inflation is being built into the after-tax spendable returns.

The Clue

As essentially an equity-oriented asset manager, I have learned to have great respect for the bond market. Often it is more sensitive to underlying economic changes. For a number of our accounts we have used Treasury Inflation Protected Securities (TIPS) to identify an inflation risk. One of the factors that I use to reach these conclusions is the spread between the yields on the ten year US Treasury and the ten year TIPS issues. For some time this spread has been below 2.2%. This week the spread widened to 2.24%, the highest it has been in awhile.(Historically the spread has been above 3%.) The spread widened, not primarily because the Treasury yield went up, but because the yield on the TIPS issue declined to 0.77%. While this has been good for my accounts because a decline in bond yields means that bond prices rose, this increasing recognition of rising inflation is troubling. The rise in inflationary expectations is being manipulated by the Federal Reserve and confirmed by many commodity prices, e.g. oil at $89.

Portfolio Implications

Buyers will buy at attractive prices and are focused on their after tax spending power. Thus, get out of all of your “high quality” long term bonds and bond funds. One may choose equities and equity funds focused on natural resources and unit growth with favorable pricing capabilities. However, harking back to last week’s blog, be aware we are at risk to unhedged problems from China.

One should always observe what is going on, but should also analyze the implications and quickly recognize and accept occasional wrong guesses.

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