Weekly Economic Summary - August 27, 2010
OVERVIEW ~ August 16 through August 20 ~ The Dow Jones Industrial Average lost just 0.6% over the course of this week, ending at 10213.62, but perhaps more important than this seemingly slight loss was the fact that trading was very thin. About 3.2 billion shares of stock traded on Monday, for example, as against a usual average of 5.4 billion shares. Money has been moving out of the stock markets, according to a report by The Investment Company Institute with $232 billion in net outflows from equity funds from January 2008 through June 2010. Treasury securities and corporate bonds, meanwhile, have attracted massive amounts of money, taking interest rate yields lower, as reflected by the Freddie Mac average for its 30-year fixed-rate mortgage, which edged down yet another 2 basis points to 4.2% during the week.
FOCUS ~ Two observations arise from the movement of investor dollars out of stock and into bonds.
First, Treasury securities and other bonds offer something in a very uncertain economy that shares of stock cannot. You generally know that, unless a government or company defaults on its debt, you will at least get your principal back, along with a yield. Granted, that yield may not look very good if interest rates rise in the future, but it is far better than nothing, and vastly better than taking a loss.
Investors usually move to bonds and Treasury securities, therefore, when they want to protect themselves from possible losses. But the way, investors are favoring bonds is rarely this disproportionate.
Second, The Investment Company Institute, cited above, noted that while equity funds were losing capital for the past two and a half years, bond funds were taking in $559 billion. That suggests investors are treating bonds and Treasury securities as an aggressive play, not a defensive play. How aggressive? The yield on the 10-year Treasury Inflation-Protected Security (TIPS, protected by the U.S. Treasury against the potential yield-reducing effects of inflation) fell below 1% during the week, meaning it is currently selling at better than 100 times its projected eventual payout. That means investors are counting on still lower interest rates in the future to elevate the value of their investment, and they surely wouldn’t be buying just to hedge against falling stock market prices, as recent mild declines in the indices suggest.
Watch Treasury security and bond prices relative to their full-term yields as a potentially strong hint about where many investors may be expecting interest rates to go.