Treasury yields were higher again this week as better than expected economic data early in the week and increasing concerns that the Fed may curtail bond purchases earlier than anticipated trumped soft economic releases Wednesday and Thursday. Yields were higher Monday as retail sales in April increased 0.1% vs. estimates of a decline of 0.3%. Yields were higher again Tuesday on concerns that the Fed may slow bond purchases. Treasury prices went higher Wednesday as industrial production in April declined 0.5%, which was worse than the estimated decline of 0.2% and manufacturing activity in the New York region declined more than expected. Also Wednesday, the Producer Price Index declined 0.7% vs. expectations of a decline of 0.6%. Prices continued higher Thursday as housing starts in April declined 16.5%, significantly more than the estimated decline of 6.4% and the Philadelphia Fed index was lower than expected. U of M Consumer Confidence index increased to 83.7 vs. expectations of 77.9 helping send yields higher Friday. The market will be listening closely to Fed Chairman Ben Bernanke’s testimony next week for any clues about the future of ongoing bond purchases. Major economic reports (and related consensus forecasts) for next week include: Wednesday: April Existing Home Sales (4.98M, 1.20% MoM), Fed Minutes from April 30th -May 1st FOMC Meeting; Thursday: April New Home Sales (425,000, 1.90% MoM), Kansas City Fed Manufacturing Activity (-4); Friday: April Durable Goods Orders (1.50%).

View from the Observation Deck

1. The time period depicted in the chart (379 months) captures the peak in interest rates on 9/30/81 (10-Year T-Note closed at 15.84%) through 4/30/13 (10-Year T-Note closed at 1.67%).
2. In short, it represents the 31-plus year rally in the bond market. While interest rates declined more than 14 percentage points over that span, they did not fall each and every calendar year.
3. Using the average yield on the 10-Year T-Note for every calendar year since 1981, interest rates actually rose in 9 of the 31 years, or 29% of the time, according to data from the Federal Reserve.
4. Interest rate levels help determine the cost of capital for corporations, which can influence earnings. Interest rates on debt instruments, if high enough, can also compete with equities for investor capital.
5. The price-to-earnings ratio (P/E) on the S&P 500 has fluctuated significantly over the past 31-plus years. Based on monthly data points, it peaked at 30.20 on 6/30/99, while its low was 7.31 on 5/31/82.
6. Perhaps more importantly, its average over that span was 17.92, which is higher than today’s (5/15/13) trailing 12-month P/E of 16.23 and much higher than its forward-looking P/E of 15.04. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The S&P 500 is a capitalization-weighted index comprised of 500 stocks used to measure large-cap U.S. stock market performance.

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View from the Observation Deck

1. The yield on the benchmark 10-Year T-Note is closing in on the 2.00% mark in today’s trading session. That is approximately half its 4.02% average yield from 2000 through 2012, according to Bloomberg.  
2. For the first time since it began its quantitative easing initiatives, the Federal Reserve appears to be openly contemplating an exit strategy from its current $85 billion per month bond-buying program. 
3. The last time the yield on the 10-Year T-Note closed above the 4.00% level was on 10/14/08. If you look at the chart, total U.S. Treasury issuance surged in 2009, 2010, 2011 and 2012.
4. Normally, when the supply of bonds increases substantially one would expect yields to move higher as well. That did not happen this go around due global growth fears and a sustained intervention by the Fed, in our opinion.
5. A bond’s price typically declines as interest rates rise.
6. Using the 10-Year T-Note as a barometer of what could happen if yields were to rise, a 100 basis point increase in its yield (1.95% to 2.95%) would result in a price decline of 8.67%, according to Bloomberg.
7. A 205 basis point increase (1.95% to 4.00%) would result in a price decline of 16.89%, according to Bloomberg.
8. We believe that any investor who purchased Treasuries because of the Fed’s bond-buying support should monitor the direction of interest rates and any directives from the Fed in the coming months. 

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing.

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View from the Observation Deck

1. Commodity prices, on the aggregate, have declined by 13.8% over the past two years (thru 5/8), as measured by the Reuters/Jefferies CRB Index. The index is down 1.4% so far in 2013.
2. While we only displayed photos (see chart) of four of the commodity components (crude oil, corn, coffee and gold) tracked by the index, there are in fact a total of 19 that capture a broad universe of activity.
3. On a year-to-date basis, very few components are up. The following five are higher: Natural Gas (+18.6%); Cotton (+17.0%); Crude Oil (+4.5%); Coffee (+2.9%); and Gasoline (+2.3%), according to Bloomberg.
4. Many things can impact the direction of commodity prices. Some of them include supply/demand, infrastructure spending initiatives, inflationary pressures and currencies, particularly the U.S. dollar.
5. The U.S. dollar remains the world’s reserve currency. Commodities are still priced in U.S. dollars. Commodity prices tend to share an inverse relationship with the dollar (see chart).
6. When the value of the U.S. dollar falls, foreign buyers gain more buying power when purchasing commodities and vice versa. More dollars pursuing commodities tends to drive commodity prices higher and vice versa.
7. The combination of a stronger U.S. dollar, relatively low inflationary pressures, the ongoing European debt crisis and tempered economic growth in China has dampened demand for commodities, in our opinion. 
8. We believe that while most mining companies’ equity valuations look more compelling today than in 2008, investors might be best served by monitoring the influences we have noted and wait for them to turn for the better.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The Thomson/Reuters CRB Commodity Index is an average of commodity futures prices with monthly rebalancing, while the U.S. Dollar Index (DXY) indicates the general international value of the U.S. dollar relative to a basket of major world currencies.

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View from the Observation Deck

1. The Obama Administration pushed hard for Congress to raise taxes on the wealthiest Americans following last year’s presidential election. Congress did.
2. The discussion, however, did not end with the passage of the American Taxpayer Relief Act. The Obama Administration continues to push for addition sources of revenue.
3. While the new tax law raises the top federal marginal rate from 35% to 39.6% starting in 2013, income levels below the top rate were permanently extended, including the 15% maximum tax rate on qualified stock dividends.
4. One of the ways that investors can position some of their capital to potentially generate a more tax-efficient total return is to combine dividend-paying stocks with municipal bonds (see chart).
5. The two indices referenced in the chart were chosen simply for illustrative purposes. The Dow Jones U.S. Select Dividend Index is one of the original dividend-paying stock indices.
6. Looking ahead, we believe the demand for municipal bonds will remain strong as more and more Americans are forced to seek out ways to offset any future tax burdens.
7. We see the demand for dividend-paying stocks actually rising in the years ahead as approximately 10,000 baby boomers, on average, turn 65 years old every day for the next 20 years, according to the Federal Reserve.
8. With Americans living longer, we believe retirees will need greater exposure to growth and income-oriented securities, such as dividend-paying stocks, to cover living expenses.
9. Combining dividend-paying stocks with municipal bonds in a buy and hold strategy is one way of navigating through a challenging tax climate, in our opinion.

This chart is for illustrative purposes only and not indicative of any actual investment. The illustration excludes the effects of taxes and brokerage commissions or other expenses incurred when investing. Investors cannot invest directly in an index. The Dow Jones U.S. Select Dividend Index represents the most widely traded of the market’s highest-yielding stocks, while the Barclays Capital Municipal Bond: Long Bond (22+) Subindex tracks the four main sectors (state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds) of the USD-denominated long-term tax exempt bond market.

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