The Two-Percent Warning

In professional football, the two-minute warning flashes when two minutes of game time remain on the game clock, approaching the end of the second and fourth quarters. If the ball is in play when the clock reaches 2 minutes, the two-minute warning is called immediately after the play concludes and the ball is declared dead.

 For the trading week ending February 8, 2013, the U.S. Treasury Yield Curve flashed a two-percent warning. Unlike in athletics, the bond market football was not declared dead and minutes later the game did not stop.

 The legendary football coach, Vince Lombardi, was a stickler for fundamentals. When the Green Bay Packers lost to a team judged inferior, the next morning the dejected players had no idea of what to expect from their respected but feared coach. Announcing to the team that “we go back to basics this morning,” holding a football high in the air, strategist Lombardi yelled, “Gentleman, this is a football!”

While the now famous statement may have seemed sophomoric, it was brilliantly effective. So, without insulting your intelligence, kindly allow a review of fundamentals. Since U. S. Treasury, securities theoretically are immune from default or credit risk, the U.S. Treasury Yield Curve is a widely-followed benchmark for debt markets. Uncle Sam borrows money for periods ranging from one month to 30 years, issuing an I.O.U. backed by taxpayers. Treasury bills cover terms of less than a year. Treasury notes are issued in terms of 2, 3, 5 and 10 years; Treasury bonds, 20 and 30 years. The yield curve is a graph reflecting interest rates paid on paper covering one month to 30 years. It appears in major financial and business mediums and on numerous financial web sites. The yield on the 10-year note is a key benchmark, widely followed as a harbinger of things to come. Are yields rising or falling, and what does that mean?

 At the end of the 1970s inflationary bout, in 1981 the 10-year Treasury note hit a historical high of 15.84%. In a crisis-driven rush to safety, on August 8, 2012, the rate hit an all time low of 1.394%. When interest rates decline, the value of a bond rises. Think about that. Over more than thirty years interest rates trended down and bonds as an asset class benefited. Many financial advisors and investors have experienced only a bull market in bonds, never a prolonged bear market! Since bond values drop as interest rates rise, complacency and recent experience can be dangerous.

On Friday, February 8, 2013, the 10-year Treasury closed at 1.953%. But for 3 trading days, 2/4-6/2013, the yield on the10-year note topped 2.00%, a Two-Percent Warning. The trend is to the upside. Losses are reflected in bond mutual funds, Exchange Traded Funds (ETFs), and other fixed income holdings. The bond game has not halted. But the 30-year bull market in bonds is dead, and the game is changing.

With any fixed income holding, given falling interest rates in recent periods, eschew past performance as a guide in fund selection, especially in 401(k) and other retirement accounts. In a rising interest rate environment, aggravated by inflation, fixed income investing is not likely to grow future purchasing power on a net basis after taxes and inflation. Meet with your financial advisor. Rethink your Investment Policy. Bonds as a defensive mechanism may require a change in strategy. What performed well over the last several years may not do so going forward.

As Coach Lombardi would encourage, a review of fundamentals is wise. How exposed are you to losses given potentially rising interest rates? What is your money for? How long will it last given forecasted expenses, tax rates, inflation, and longevity? What is your tolerance for risk (volatility)? Are you saving money or spending down your stash? Should alternative asset classes or defensive strategies be included in your asset allocation, as many large pension funds are doing?

Heed the Two-Percent Warning. It’s a game changer!

 Required Disclosure:  Lewis Walker is President of Walker Capital Management LLC. and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA).  Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with the Walker Capital Companies. ▪  3930 East Jones Bridge Road ▪ Suite 150 ▪ Peachtree Corners, GA 30092 ▪ 770-441-2603 ▪ lewisw@theinvestmentcoach.com

Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results.