The values of U.S. Treasuries have continued to decline and will keep deteriorating as long as the Federal Reserve raises rates and government data shows economic strength. Further downward pressure has come from foreign central banks that have been net sellers of Treasury notes for several reasons:
- Central banks are diversifying away from the dollar into gold and other currencies
- As Europe and Japan raise their rates relative to the US, the favorable interest rate gap will diminish further
- Foreign confidence in Bernanke is not as strong as American confidence
While US securities may diminish in attractiveness, a weak dollar should make US companies and hard assets increasingly attractive to foreign buyouts. Either way, a growing number of sages believe that the economy is slowing, credit is weakening, interest rate hikes are over, and Treasuries will strengthen by year’s end.
June saw a slight bounce back in equity mutual funds which took a beating in May, the worst month for equity funds since July 2004. None-the-less, most equity market indices remain significantly below their 2006 peaks. Categories that had recently been the strongest fared the worst, including small-cap, natural resources, commodities and emerging-market international funds. Consequently, many institutional investors have reduced their exposure to risky assets. With such a precipitous decline in equity levels, stock market volatility, which was dormant for months, picked up markedly in May and June. Volatility nearly doubled to its highest level in two years as global equity markets and sectors lost value and concern about the market’s future increased.
Closed-end funds (CEFs), along with much of the bond market, are wading through areas of concern regarding valuation, yield, and credit. As such, several cautionary indicators are causing hesitancy amongst investors:
- Rising leverage costs as short-term borrowing rates increase
- Falling dividends because of rising interest expenses
- Low relative fund yields as market interest rates have risen (e.g., 2-year Treasuries now yield 5.15%)
- Corporate credit concerns are high as the current economic boom matures
These factors led to lackluster CEF performance in March and April and hampered general CEF returns in May and June. Over the past year and a half, dividend cuts have been a recurring theme for most CEFs (floating rate CEFs being the notable exception) and dividend cuts will remain a fact of life, at least through year-end.
Michael Ashley Schulman, CFA
Hollencrest Capital Management