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Greek Default, Puerto Rico Debt Service Problems to Have Little Effect on US Rates

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Greece lies on the brink of collapse. Puerto Rico debt obligations are all going to be restructured. Even if the worst case were to materialize (both default), US interest rates are not headed for a dramatic decline or even a retest of recent lows. They are headed up.

The news is pretty bleak, but I still don’t believe that Greece will default.  I certainly do not believe that Puerto Rico will default.  In Greece, the institutions that hold these bonds (now German banks and US hedge funds) are too sophisticated to force a situation where they receive nothing, than to allow a situation where they recover a restructured bond.   The voting electorate is also too smart to vote for a continuation of the utter chaos they will see this week.  Same will be true in Puerto Rico.  Everybody will back away from the brink. These places are simply not analogous to Russia or Thailand in 1997, or Argentina more recently.

If we were to see a Greek default, there will be increased dislocation and volatility in the equity and debt markets.  The reality however remains that Greece is such a small part of the European economy, it will not have a major impact on anything.  Austerity in Europe will probably continue, but the US will continue its path towards pulling out of the low interest rate environment that we have been in.  In short, Greece is just to small and inconsequential and events there are not going to cause the rush to safety in the US that would drive long term bond yields back down.

I predict that interest rates will continue to rise towards a more normalized level with Janet Yellen and the Fed still on track to raise interest rates in September or October.   The 10 year Treasury will end the year closer to 3% than to 2% and savings rates will continue to move up gradually.  The bond bubble will begin to burst and this is a good time to favor cash over bonds.

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Time to Get Serious About The Bond Bubble Bursting

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As 10 year bond yields have gone from 1.80% to 2.15% over the last month, Janet Yellen, Bill Gross, Jeffrey Gundlach, Scott Mather and many others have made statements indicating that the bond bubble may finally be ready to burst. It is time to get serious about the potential consequences of the bond bubble bursting.

In 2013, the 10-year bond went to a 3.05% yield briefly.   Many traders who were heavily long fixed income got really hurt when this happened, but the general public was spared from the consequences of a end of cheap money as cash from global markets began pouring into the US to drive rates back down.

At this point, many experts are indicating that the current 10 year yields are well below where they should be at this point in the economic cycle and they should begin to move off of the unnatural post-recession lows that we have seen for the last 6 years in anticipation of a change in Fed policy.  Janet Yellen, herself, has indicated that the cycle of unnaturally low interest rates needs to come to an end and that when it does long term rates may spike higher.  High profile observers – including Bill Gross, Jeffrey Gundlach and Scott Mather - have all been quoted in mainstream financial media over the last several days as suggesting that as the Fed begins to raise rates, long bonds will go up more quickly.   Even if the rise in the Fed Funds rate is extremely slow and deliberate, 10 year rates will wind up back to 4% or 5% over the next year or two.

This is a good time to confront reality.  If 10 year rates were to go back to 4 or 5% (or 6 or 7%), the discounted present value of that cash produced by instruments that you may hold will become less valuable (i.e., will become discounted at a higher rate).   The value of long-term municipal bonds will fall.  Corporate bond spreads will widen, not narrow, and the value of corporate (high grade and high yield) bonds that you hold will fall sharply.  The value of your emerging market bond and EM bond funds will fall dramatically, as will the value of any preferred stock that you may hold (including Public Storage’s preferred stock that I have previously recommended). 

I do not pretend to be a real estate or a stock market expert, but it would seem that your real estate and equities will impacted as well.  Real estate values in frothy markets like New York, San Francisco and Miami may fall from their bubble levels as mortgage rates rise.  Stocks – including Blue Chip stocks such as Disney, Procter & Gamble, McDonalds and Coke – that trade at extremely high, above-market multiples of earnings against anemic growth will see a sharp correction.   (The broader market however may move higher and fast growing, dynamic growth stocks with large cash stockpiles, very low PE ratios, and PEG ratios below 1 such as Apple and Gilead should be virtually unaffected and continue to move dramatically higher).

This is probably not the time to sell your home or exit the stock market.  But, it is a good time to think about some key things you can do to protect yourself from a rise in interest rates.

1.  Think about raising cash, selling your bonds (except for those nearing maturity), bond funds, bond like instruments, and stocks with unsustainable valuations.  Earning 1% a year over the next two years is a better outcome than losing 20% or more of your principal over that period.    If you still aren’t earning 1% on savings, see this list of the highest yielding savings accounts.

2.  Put money in CDs.  You can earn 2.25% on a 5 year CD from Synchrony or Barclay’s Bank that allows only a six month interest penalty for early withdrawal.  As this article discusses, that is a pretty reasonable risk-reward scenario.  Alternatively, put your money in a CD that offers a better rate than cash and provides the opportunity to raise your rate should rates rise.  CIT Bank’s family of RampUp CDs are not only among the highest yielding CDs, but offer this flexibility.

3.   Invest in structured notes that are geared to pay out more money as interest rates rise.  I have written extensively about these notes on BestCashCow.  My favorite notes are those that pay a multiple of the spread between the 2 year and the 30 year Treasury (or Constant Maturity Swap) rates.  While this notes usually require assuming the credit of a bank, such as Chase or Morgan Stanley, they are currently paying around 6% and would move to paying their maximum distribution amounts of 9% to 10% should the interest rate spread widen.   These notes may not always be offered in primary markets and can be difficult to find in secondary markets.  Read my earlier articles on these notes here or here.

Happy investing.      


Acorns Investing App Makes It Easy to Put Money Into the Market

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I recently came across a new investment app that has become popular over the past year. The app, called Acorns provides a tool that rounds-up a user's debit or credit card purchases and then deposits that money into a portfolio comprised of ETF funds.

I recently came across a new investment app that has become popular over the past year. The app, called Acorns provides a tool that rounds-up a user's debit or credit card purchases and then deposits that money into a portfolio comprised of ETF funds. As an example, if you purchased a $2.67 cup of coffee, Acorns would take an additional $.33 cents out of your account to round the total purchase up to $3.00. The $.33 would then be put into an investment account.

The investment accounts that they provide are a basket of ETF funds that are selected by "a group of engineers mathematicians, and a Nobel-prize winning economist..." The entire investing process is automated, meaning the algorithms automatically choose a diversified basket of ETF funds and rebalance the portfolio when it is deemed necessary. Because it is all automated, the fees are relatively low. Fees are $1 per month for accounts with less than $5,000 or .25%/year for accounts with $5,000 or more in them. This is separate from any fees charged by the ETFs that Acorn chooses, but ETF fees are generally as low as you are going to get.

While the round-up funding method is the one that is most discussed, users can also choose to simply transfer a fixed amount of money into their investment account.

I was a bit skeptical at first but after I watched the video embedded below, I think that they are on to something. If a young person, or even an older person dips their toe into the water by investing round-ups, that removes many of the barriers to getting started as an investor. After all, what generally stops someone from investing is fear and a lack of what to do: how much should I invest, where should I invest, how much should I put in which funds, etc. But Acorns makes it easy for someone to start putting money to work and once this process starts it seems like an easy path to become a life-long saver and investor.

I also agree with one other point mentioned in the video. Financial educators can yell until they are blue in the face that people should start investing, but getting someone to take that first-step is the best way to get introduce them to the practice of savings and investing. Once someone has money in the market, they are much more likely to pay attention and be open to education.

My One Concern

The one concern I have, the reason I haven't signed up yet is security. Acorns is probably safe and I'm sure they have done everything in their power to secure it, but I've seen too many instances where "secure" systems were breached and social security numbers and other sensitive data was stolen. I'm sure Acorns is no less secure than any other major bank or brokerage but still, I feel nervous providing my information over a phone app.

Still, if I can get over this concern, Acorns is something I would be interested in checking out.