1/14/2015

CumberlandAdvisorsPrint

OneSarasotaTower,2N.TamiamiTrail
Suite303,Sarasota,FL34236
614E.LandisAve,Vineland,NJ08360
(800)2577013
www.cumber.com

1%on10yearNote?
J anuary1 3 ,2 0 1 5 DavidR .Kotok ,C hairm anandC hie fInve stm e ntO ffice r

WhatiftheFeddoesntraiseratesatallthisyear?Therescertainlyagoodamountofvolatility
possiblewiththeECBmeetingJan22,theGreekelectionJan25,andtheFOMCannouncementJan
28.DonRissmiller,Strategas,Jan.11.
Donsquestionisavalidone,notwithstandingtherecentheadlinenumbersfromtheemployment
report.MycolleagueBobEisenbeishasexaminedthecompositionoftheFedspolicymakingbody,the
FederalOpenMarketCommittee(FOMC).Hethinksaslightmoveupinrateswillcomebefore
yearend.Thereisnoneedformetorepeatanyofthathere.ForBobsdiscussionseehisrecent
commentaryatwww.cumber.com.
MyviewissimilartoBobsanditistheconsensuswithinourfirm.IwouldaddthatIbelievethe
marketssufferfromdysfunctionwhentheinterestrateiszeroorveryclosetozero.Asweseeit,
gettingthepolicyrateupto0.50%isawayfortheFedtorestoremarketfunction.Atonehalfofone
percent,cashearnssomethinginsteadofnothing.Abovezero,choicesmaybemadeintheveryfront
endofthemoneymarketcurve.Zerodoesthefinancialmarketsandtheeconomyadisservice.Our
friendsinotherjurisdictionssuchastheEurozonearelearningthatthehardway.
ButwhathappenstothelongerratesoncetheFedmovesfromzerotosomethingelse?Will
benchmarklongtermratesriseorfall?Someargueforhigherrates.Theyhavebeendoingsofor
years,andtheyhavebeenconsistentlywrong.Maybethemovetolowerlongerratesisalready
anticipatingtheFedwillmoveawayfromzero?
FriendandfishingbuddyGaryShillinghasbeenonthecorrectsideofthebondyieldoutlookfor
years.Hesaysthebondrallythatstartedon1981isnotover.InhisJanuaryInsightGaryreaffirmed
hisposition:
WeexpectafurtherrallyinTreasurypriceswiththe30yearyielddroppingto2%,perhapsbytheendof
2015.Ifthe10yearnotedropsto1%,asweforecast,thetotalreturnwouldbe12.4%.Thesemayseem
likebiggains.Butthatswhathappenswhenyieldsarelow.Webelievethatthebondrallyofalifetime
marcheson.
Couldweseea1%10yearTreasurynoteyield?Maybe.AndthesoonertheFedmovesawayfrom
zero,thesoonerwewillknowwherethemarketclearsandatwhatyield.Itisquitepossiblethat
wellseeashorttermrateof0.50%,anintermediatetermratebetween1%and2%(itisalready
there),andalongtermTreasuryratecloseto2.0%andbetween2%and3%(it,too,isalready
there).
Lookaroundtheworldat10yearyieldsinvariouscountriesonDecember31.IntheEurozone,
benchmarkGermanywasat0.54%.Netherlandswas0.68%,Austriawas0.71%,Francewas0.84%,
Italywas1.88%,andSpainwas1.61%.InSwitzerland(whichpegsitscurrencytotheeuro)theyield
was0.37%.
ElsewhereinEuropebutnotintheEurozone,Swedenwasat0.94%,Norwaywas1.55%,andthe
UnitedKingdomwas1.76%.AndinthecountrywiththehighestamountofQEandthelargestdebt
toGDPratio,Japan,the10yearyieldwas0.33%.
Comparetheseyieldswiththeyieldofthe10yearUSTreasurybenchmarknoteonDecember31.It
was2.17%.Thatsright,theworldsreservecurrency,denominatedinthestrengtheningUSdollar,in
acountrythathasceasedQEandisshrinkingitsfederaldeficit,wasyieldingmorethantheothers.If
youweresittingabroadandallocatingbondmoniesglobally,whichbondwouldyouselectforyour
sovereigndebtglobalfund?Notethatnearlyallhighestcreditqualityyieldsarelowertodaythan
theywereatyearend.
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1/14/2015

CumberlandAdvisorsPrint

ItseemstousthattheUSTreasurynoteistheworldsbestgovernmentbondidea.Isitanywonder
thatthebondmarketrallyinTreasurysecuritiescontinues?Andisthereanyneartermactionthat
willchangethis?Itseemstheanswerisno.GaryShillingscourageousandconsistentforecastmay
beright.
Sowhatisabondinvestortodo?
AtCumberland,weelecttousespreadproductandnotTreasuries.Wedoourowncreditresearch
andmakeourownindividualbondselections.WeincludeMunis(taxableandtaxfree)asanoption.
After40plusyears,wethinkweknowalittlebitabouthowtoexaminecreditandhowtoreadbond
indenturesandinterpretcovenants.Andwedosometacticalhedgingbecausewedonotknowwhen
thismarketforecastwillchange.Wearegladthatwedidnotabandonthebondmarket.
TranslatethisoutlooktothestockmarketintheUnitedStates.Suddenlythestockmarketdoesnt
lookasexpensiveasmanythink.Surethemedianp/eforanNYSEstockisthehighesteverinthe
postwarperiodandhasexceeded1962,1998&2005.(HattiptoJohnMelloy@CNBCwho
forwardedJimPaulsenschart.)Thatreferenceisworrisome.Andsuretheratiooftotalstockmarket
valueintheUScomparedtoUSGDPishigherthananyothertimeexceptforthetechstockbubble
peak15yearsago.That,too,isworrisome.Butthosereferenceswereintimeswhentheyieldson
risklessdebtweremuchhigher.Whataboutnow?
Letsusealowearningsestimateofabout$125for2015.AtanS&P500priceof2250,theearnings
yieldwouldbecloseto6%,thep/ewouldbe18.Usinga2%yieldfortheriskless10yearTreasury
note,theequityriskpremiumwouldbe4percentagepoints@1%theequityriskpremiumwouldbe
5.Botharewayabovethehistoricequilibriumofabout3%.AndS&Pdividendyieldswould
approximatetheyieldontheriskless10yearnoteandexceedtheyieldoncash,eveniftheFed
raisedratesbeforetheendofthisyear.
WithintheUSstockmarketthenumbersabovereflectthemarkdownoftheenergysectorandits
earnings.Andtheysupportthenotionthatthemostcompellingsectortoownistheutilitysector,
whichhappenstobeCumberlandslargestoverweightinitsdomesticUSETFportfolios.
Insum,weexpecthighervolatilityin2015.Ithastobesowheninterestratesarethislowandwhen
thereisavastgapamongvariouscountries,theircurrenciesandtheircentralbankpolicies.
Buthighervolatilityisbidirectional.Itwillterrifyinvestorsonthedownsideandexhilaratethemon
theupside.2015islikelytoofferboth.
Itisgoingtobeaninterestingyear.

DavidR.Kotok,ChairmanandChiefInvestmentOfficer

C um be rlandAdvisorsisre giste re dwiththe SEC unde rthe Inve stm e ntAdvisorsActof1940.Allinform ation
containe dhe re inisforinform ationalpurpose sonlyanddoe snotconstitute asolicitationoroffe rtose llse curitie s
orinve stm e ntadvisoryse rvice s.Suchanoffe rcanonlybe m ade instate sand/orinte rnationaljurisdictionswhe re
C um be rlandAdvisorsise ithe rre giste re dorisaNotice File rorwhe re ane x e m ptionfrom suchre gistrationorfiling
isavailable .Ne waccountswillnotbe acce pte dunle ssanduntilalllocalre gulationshave be e nsatisfie d.This
pre se ntationdoe snotpurporttobe acom ple te de scriptionofourpe rform ance orinve stm e ntse rvice s.
Ple ase fe e lfre e toforwardourcom m e ntarie s(withprope rattribution)toothe rswhom aybe inte re ste d.
Foralistofallequityrecommendationsforthepastyear,pleasecontactThrseM.Pantalioneat856692
6690,ext.315.Itisnotourinte ntiontostate orim plyinanym anne rthatpastre sultsandprofitabilityisan
indicationoffuture pe rform ance .Allm ate rialpre se nte discom pile dfrom source sbe lie ve dtobe re liable .Howe ve r,
accuracycannotbe guarante e d.
C opyright2015C um be rlandAdvisors.

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