Interest Rates and Other Issues

Interest Rates and Other Issues

2nd Quarter 2013

The current investment environment is concerned with the political environment in Washington, the economy, inflation, the direction of interest rates, the future performance of the emerging markets, and the valuation of the U.S. stock market and earnings.

Political Environment

The political environment has not changed and probably won’t for the rest of President Obama’s term.  Gridlock is here to stay, which creates uncertainty for employers as it relates to hiring and capital expenditures.  We don’t foresee any change.


The high private and public debt to the Gross Domestic Product (GDP) continues to hang over the economy.  As long as the Total Debt to GDP ratio of 350% persists, the economy will not pick up but will remain in the slow growth situation that it is in.  Without excess free cash flow consumers that make up 67% of GDP do not have extra money to spend in the economy.  The increase in government debt is offsetting the gradual decrease in private debt.


Inflation is not a threat at this time even though we all know that food, energy and other essential items have gone up 10% in the last year ending June 30, 2013.  The government manipulates the Consumer Price Index (CPI) so that the cost-of-living increases for entitlement programs stay low.  This keeps the economy from growing as well.  We have no wage inflation, which is what caused the hyperinflation of the 1970s along with the large increase in the price of oil manipulated by the Saudis.

Interest Rates

The interest rate on the 10-year Treasury note jumped from 1.62% to 2.75% in May and June when Federal Reserve Chairman Ben Bernanke suggested that the Fed could start tapering its purchases of Treasury bonds and mortgage-backed securities from $85 billion per month in the Fall.  The market took this to mean that it would start tapering in September.  The sharp rise in interest rates caused disruption in markets not only in the U.S. but around the world.  Then at least four Fed presidents came on television and in newspapers to say that Bernanke really didn’t mean what he said, and that it depends on how the economy is performing.  Bernanke said later in July that the Fed could even buy more if the situation warranted.  We expect that the 10-year rate will rise slowly over the next two and a half years per a report issued by Goldman Sachs recently.  You will find a sensitivity analysis in this section that shows what effect this will have on fixed income returns.  You will also find a “Quarterly Review & Outlook” from Hoisington Investment Management Company that has a different and minority view of the direction of interest rates.  We added this report because of our high regard for Hoisington and because no one knows for sure in the short term where interest rates are going.  The 10-year Treasury has settled in at 2.60% recently.  Our first goal for our clients is to preserve assets and our second, but equally as important, is to grow your assets prudently.  This is why we are recommending that our clients replace their intermediate-term fixed income manager that has a duration in the portfolio of about five (5) years with a short term manager with a duration of about one (1) year.

Emerging Markets

Emerging markets – developing countries like China, India and Brazil – have performed very well since mid-2007 and performed well in 2012.  The momentum has shifted, however, away from the emerging economies to the developed world.  Japan, the U.S. and Europe are contributing more growth than the emerging nations.  Among forces driving the shift is a resurgent Japan.  Japan’s economy expanded 2.6% last quarter on an annualized basis.  The recovering U.S. economy has produced steady, albeit tepid, growth.  Europe still has serious problems but is showing signs of life.  At the same time Brazil, Russia, India and China are ailing or ratcheting back from their stellar performance of recent years.  There is no one reason emerging economies are suffering.  Rising U.S. interest rates have squeezed credit in parts of the emerging world.  Chinese economic indicators show a bottoming out of its slowdown.  But China’s dampened demand for commodities has affected Latin America and Southeast Asia.  Brazil, Latin America’s biggest economy, has stagnated partly due to China’s waning appetite for products like iron ore.  Indonesia, Southeast Asia’s largest economy, is taking a hit from China’s slowdown, with exports of coal and palm oil suffering.  In India, economic mismanagement has led to a plunging economy.  Bankers there are holding back credit, making it hard for businesses to invest and for consumers to spend.  At Monroe Vos we have rarely recommended an alternative allocation to emerging markets because we think that the core international manager is more qualified than we are to make the decision to invest in emerging markets.  Most managers can put up to 30% – 40% of their portfolio into emerging markets.

Stock Market

We continue to like the U.S. stock market over the rest of the world and that is why we have been recommending an overweight since the beginning of the year.  We continue to think that the U.S. is the “cleanest dirty shirt in the hamper”, and we do not think it is overvalued relative to other asset classes, including bonds.

Defined Contribution Trends

All of us – plan sponsors, recordkeepers and consultants – struggle with the issue of effectiveness of investment education for plan participants.  In the old days – 1980s-1990s – education meetings were the thing to do.  Either mandatory or voluntary meetings were held at various locations with presentations from recordkeeper representatives and consultants.  We did a lot of those during this period.  It became evident over time that plan participants were not getting the message.  Why should they?  Investing is hard enough for the pros.  Over time solutions to the problem were developed, like target date funds, recordkeeper programs that provide guidance/advice for a price, targeted education and outside firms that provide guidance/advice for a price.  All of these have shortcomings.

In the late 1990s, firms like ours created another solution called Asset Allocation Strategies using the core funds in our clients’ lineup to structure portfolios with different risk levels.  We developed Risk Tolerance Questionnaires to help the plan participant determine their individual risk tolerance.  We convinced recordkeepers to program their software to accommodate these Strategies.  These Strategies made it easier for the plan participant to choose a portfolio for them that is structured by professionals using tools common in the defined benefit pension area.  One of our largest clients has almost 70% of its assets in Asset Allocation Strategies, and its participants are very pleased with the results.

The Asset Allocation Strategies address only one of the two key factors, Risk Tolerance, that a plan participant needs to do to stay on track in building his/her 401(k)/403(b) retirement nest egg.  The other is Time Horizon.  In 2008 we recognized the need to provide a solution for plan participants that not only addressed their individual Risk Tolerance, but also their Time Horizon to retirement.  The solution is the Risk Based Retirement Date Strategies.  These are portfolios that use the core funds in our clients’ plan and that have three different Risk Tolerances: Aggressive, Moderate and Conservative.  The difference is that within ten (10) years of the individual plan participants’ retirement date, each portfolio will automatically become more conservative to end with 20%-30% in equities and the rest of the portfolio in fixed income and stable value.  This solution means that the plan participant has to make only two decisions: (a) what is my risk tolerance, and (b) when do I plan to retire?  Everything else is taken care of for the plan participant.  These Strategies protect a plan participant from a 2008 crash just before they are ready to retire.

We believe if presented correctly that this solution will be very attractive to plan participants by taking the confusion out of the investment choices that plan participants must make.  There are recordkeepers that will program this solution at no charge for our clients.


There is a very large furniture business in Houston called Gallery Furniture led by one of the greatest business leaders of our time named Jim McIngvale.  He is very, very successful but also one of the greatest inspirational business speakers I have ever heard.  He recently gave a speech to scholarship students about the ten principles of success in life.  One of these was, “Always tell your story.”  You will see a new first page of our quarterly performance reports that shows the Monroe Vos Mission Statement.  You will notice that it says nothing about Monroe Vos but only about you, our clients.  Our only goal is that you have a successful experience with our help.

Please take a look at our new website

Jamison Monroe
Chairman & CEO

Released: June 05th, 2013 01:00 PM

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