This is a publication by Scott Anderson Financial. Scott K. Anderson, CPA, CFP®, EA is a Registered Investment Advisor in Newport Beach, California.
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In This Issue

Monthly Quote

“Every individual matters. Every individual has a role to play. Every individual makes a difference.”
– Jane Goodall

Monthly Riddle

Its teeth are sharp and its spine is straight. It is not innately vicious, it does not hunt, but to cut things up is definitely its fate. What is it?
Last month’s riddle: You use it between your head and your toes, the more it works the thinner it grows. What is it? Last month’s answer: Soap.

It's Your Money Workshop

Hear Scott & Julie talk about Fixed Income Investing:
Tuesday, May 12
9:30am - 11:00am
Orange Public Library
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The Downside of Up:

Bonds, Bond Funds and Ignoring the Torment of the Interest Rate Spirits

Scott K Anderson Jr., CPA, CFP®, EA
In case you missed it: Christmas is coming, there is a presidential election in 2016, and interest rates are going up.

That Christmas is coming each December has been foretold for over 2,000 years.  That there will be a presidential election in 2016 has been foretold since 1788 when the first presidential election for a four-year term was held. That interest rates were going up has been discussed and predicted for the last 6½ years as the Federal Reserve System has pursued various strategies to keep interest rates from going up in order to foster the economic recovery. The Fed’s brilliant strategy (?) worked so well that when the Fed ended the program in 2014, interest rates went… down further.

The point is that the possibility of interest rates going up has been discussed for a long time.  As a result, under the Efficient Market Theory of security pricing, that eventuality has been fully priced into the market prices of all securities.  In other words, the possibility that the Fed will raise interest rates is no new news to the market.

The downside of owning bonds and bond funds (which is a mutual fund made up of bonds instead of stocks) is that the price of the bonds will fall when interest rates go up. The frequently hysterical media will interview the financially illiterate Chicken Little who will somberly report that the sky is falling with the passing of the low-interest rate environment. While Chicken Little is scratching the bump on its head, the more perceptive money managers will have already taken action to do at least two things: a) gradually lower the duration of the bond fund to make it less sensitive to the interest rate change; and, b) raise cash to both be able to purchase higher yielding securities when they become available and to defend against redemption as Chicken Little and friends flee from bond funds.   

Duration is a metric professional bond traders and bond fund managers use to gauge the sensitivity of bond prices to changing interest rates.  Duration is expressed in years.  It is very important to remember that bonds mature and the bondholder will get their principle back.  The nearness of the maturity strongly influences just how much the price of the bond will change as interest rates change.  For a bond maturing next week or in six months, there will be virtually no change in price as interest rates change (a.k.a. low or short duration).  For a bond maturing in thirty years, there will be a substantial change in price as interest rates change (a.k.a. long duration but not “high” duration). 

Low duration bond funds are usually funds with a calculated duration of three years or less. Long duration bond funds are usually funds with a calculated duration of seven to ten years or more. The difference between duration and effective or average maturity is that duration takes into account the time value of the cash flow from the coupon rate of interest and the principle received back at maturity, whereas effective or average maturity takes into account only the length of time to maturity.

In picking bond funds for our client accounts, (We don’t buy individual bonds), we stick to the Goldilocks duration of around five years or less.  The duration of bond funds in our portfolios are longer than low duration funds which means they are earning interest rates beyond the pittance of the low duration funds but would not change in price too much as interest rates change. In the end, if the bonds in the bond fund are held to maturity, the price of the bonds in the bond fund will inexorably rise back to the face value of the bond which is paid at maturity. In the meantime, in a bond fund, bonds are maturing and the cash proceeds are being reinvested at the current (presumably higher) rate of interest.

Bond funds should not be bought for trading.  Leave the trading to the manager of the bond fund – that is his/her job and they are on it 24/7. Bond funds are in client portfolios because they generate interest income for the client - regardless of their price or change in price.

Riley is my golden retriever.  She gives me all kinds of benefits including the benefit of long walks that get me out of the house and away from my desk. These walks are fundamentally healthy, and a great way to meet people and stay connected.  Riley is pretty obedient but when a squirrel shows up, Riley loses all control.  Eventually, Riley will tire of sitting under the tree in which the squirrel took refuge and will come back to me bringing all those wonderful things that a dog brings (if you are a dog lover). I can’t stop Riley from suddenly and uncontrollably chasing squirrels, but I can tend to stay away from areas where there are lots of squirrels.

Owning bonds and bond funds are a lot like Riley and her squirrels.  Bonds and bond funds provide a steady cash return and money back at maturity, but their price can bounce around as interest rates change in the meantime. Riley is a wonderful dog almost all the time but given to sudden and uncontrollable fits of squirrel chasing. If I wanted a pet that did not chase squirrels, I would get a cat, but cats do not do long walks. In the end, Riley will come back to me, and we will continue our walk just like bonds and bond funds that pay interest period after period until they mature. Then I can reinvest the cash into a newer bond with a presumably higher (but in recent years sometimes) lower interest rate.

So, kind reader, the reason bonds and bond funds are part of any investment portfolio is the periodic receipt of cash interest. When the bonds mature, the cash will be reinvested into new bonds that pay the then market rate of interest whatever that may be at the time.  What happens to the bond price between purchase and redemption is largely irrelevant.

To make this article fair and balanced, I note that I have had cats as pets for almost as long as I have had dogs.  Our last cat, an orange tabby cat named “Doozie”, would actually follow Kelly (Riley’s golden retriever predecessor) and I on our evening walk but Doozie was equally distracted by every bird, lizard, and other dog along the way.  So nothing in bonds or pets is perfect but that is not the reason to not to have them in your world.  
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Monthly Economic Update: May 2015

Brought to you by GW Financial, Inc.

Stocks wavered in April, with the S&P 500 ultimately rising a decent 0.85%. Investors were cautious, readjusting their assumptions about the strength of the economy and the Federal Reserve’s timing for raising interest rates. Oil prices soared. While Q1 GDP and the latest hiring figures were unimpressive, there were nice gains for consumer spending and retail purchases. The pace of existing home sales picked up while new home sales slipped. Headlines about Greece and China weighed on U.S. equities at mid-month. The market was still choppy, but less so than it had been in March.1
Was the economy doing well? Or not as well as commonly believed? Last month, two headlines emerged that affected investor perceptions.
For the first time in a year, the economy added less than 200,000 jobs in a month: payrolls grew by 126,000 in March according to the Labor Department. In addition, 69,000 hires were retrospectively subtracted from January and February hiring totals. The headline unemployment rate stayed at 5.5% in March, with “total” unemployment (the U-6 rate including the underemployed) at 10.9%.2
The federal government’s first estimate of Q1 GDP was just 0.1%. Analysts polled by MarketWatch had forecast 1.1% expansion. In Q4 2014, the economy grew 2.2%.3
Countering these news items, personal spending improved 0.4% in March while retail sales rose 0.9%. Although the Commerce Department reported no personal wage growth in March, word came that the federal government’s employer cost index rose 0.7% in Q1 (those costs include wages). Both the headline and core Consumer Price Index were up 0.2% for March.3,4
News of rising oil prices and reduced hiring may have impacted consumer outlooks. While the University of Michigan’s consumer sentiment index rose 2.9 points in April to a mark of 95.9, the Conference Board’s consumer confidence index fell 6.2 points to 95.2.3
The manufacturing sector looked a bit tepid: U.S. industrial production had fallen 0.6% in March, and the Institute for Supply Management’s manufacturing PMI stayed at 51.5 in April. ISM’s service sector PMI came in at 56.5 for March, 0.4 points below its February mark.3,5
With energy costs rising, producer prices increased 0.2% for March, as opposed to the 0.5% retreat seen in February. After going negative for four straight months, headline durable goods orders increased by 4.0% in March.4,6
The latest Federal Reserve policy statement acknowledged paltry Q1 growth and the disappointing March jobs report, yet Fed officials maintained their view that “economic activity will expand at a moderate pace” in the near term. In other words, an interest rate hike in mid-2015 was improbable but not impossible.7
The odds of Greece making its upcoming €200 million payment to the International Monetary Fund seemed to lengthen, even with the IMF extending the deadline to May 6. The Syriza party announced it would stick to its commitment to fully fund Greek social welfare programs and termed the austerity measures implemented as part of the IMF bailout “crimes”. A Grexit could happen in May and the Greek economy – which has already endured the worst recession recorded in any country since the Great Depression – could sink further. As for the broad euro area, its jobless rate remained at 11.3% with consumer prices expected to be unchanged for April after a 0.1% dip for March.8,9
In China, securities regulators discouraged margin lending in mid-April as small investors were borrowing dangerous amounts of money to buy stocks in a runaway bull market. New rules permitted fund managers to lend shares for short-selling, and investors were allowed to short a greater number of stocks. These developments prompted a brief global selloff on April 17.10
HSBC’s final April factory PMI for China showed contraction at 48.9, pointing to a distinct slowdown and perhaps a need for added stimulus. Markit’s April factory PMI for the euro area declined 0.2 points from its March level to 52.0.11
The multi-country Dow Jones and MSCI indices all posted April gains. Leading the way, the MSCI Emerging Markets Index rose 7.51%. The Asia Dow improved 4.99% last month, the Europe Dow 3.82%, the Global Dow 3.23%, the MSCI World Index 2.16% and the Dow Jones Americas 1.17%.1,12
In Europe, Russia’s ever-volatile RTS index soared 16.91%. Smaller monthly gains came for the U.K.’s FTSE 100 (2.77%) and France’s CAC 40 (0.26%); monthly losses came for Spain’s IBEX 35 (1.18%), Italy’s FTSE MIB (0.48%) and Germany’s DAX (4.26%).1
Turning to the Americas, Argentina’s Merval gained 11.19%, Brazil’s Bovespa 9.93%, Mexico’s IPC All-Share 1.96% and Canada’s TSX Composite 2.16%. In the Asia Pacific region, April brought losses of 1.72% for Australia’s S&P/ASX 200 and 3.38% for India’s Sensex, but also gains of 4.22% for South Korea’s Kospi, 1.63% for Japan’s Nikkei 225, 18.51% for China’s Shanghai Composite and 12.98% for Hong Kong’s Hang Seng.1
Oil was the big story here. WTI crude ascended 25.86% during April, finishing the month at $59.63 on the NYMEX. Heating oil and unleaded gasoline saw respective gains of 15.62% and 15.60%. Additionally, April saw a 3.25% improvement in natural gas futures.13
Away from the energy sector, there were big gains for some crops and a loss for the U.S. Dollar Index. Cocoa prices were up 9.10% for the month; sugar prices rose 7.72%, cotton prices 7.58%. Coffee went +3.43%, soybeans +0.59%, corn -3.46% and wheat -8.46%. The USDX retreated 3.97% to a close of 94.60 on April 30. Copper logged a 5.04% gain for the month, and platinum rose 0.90%; gold lost 0.02% and silver 3.04%. Gold ended April at $1,182.40 on the COMEX, silver at $16.15.13,14
The housing market approached its busiest season with momentum. Existing home sales rose 6.1% for March with the annualized pace hitting an 18-month peak, the National Association of Realtors reported. Existing home prices were up 5.1% year-over-year according to NAR; the 20-city S&P/Case-Shiller home price index measured their annualized improvement at 4.2%. NAR’s pending home sales index followed its 3.6% February advance with a 1.1% gain for March.3,15
Three other housing indicators went negative in March, however. New home sales fell 11.4%, but they were still up 19.4% compared to a year ago. The Census Bureau also found housing starts down 2.0% in March, and building permits down 5.7%; in annualized terms, starts were down 2.5% but permits up 2.9%.16,17
Freddie Mac’s April 30 Primary Mortgage Market Survey found the average interest rate on a conventional home loan down just 0.01% from March 26 at 3.68%. Rates on 15-year FRMs declined 0.03% to 2.94% and rates on 5/1-year ARMs dipped 0.07% to 2.85%; rates on 1-year ARMs rose 0.03% to 2.49%.18
April saw a notable contrast between the big three and the Russell 2000. The Dow, Nasdaq and S&P posted respective monthly gains of 0.36%, 0.83% and 0.85%, yet the Russell fell 2.61%. The CBOE VIX also had a down month, losing 4.84%. At the close on April 30, here was where all five indices stood: DJIA, 17,840.52; COMP, 4,941.42; SPX, 2,085.51; RUT, 1,220.13; VIX, 14.55. Paralleling the climb in energy futures, the PHLX Oil Service Index gained 17.07% for April.1
DJIA +0.10 +7.60 +12.41 +7.50
NASDAQ +4.34 +20.09 +20.15 +15.71
S&P 500 +1.29 +10.70 +15.15 +8.03
10 YR TIPS 0.11% 0.49% 1.29% 1.61%
Sources:,, – 4/30/151,19,20
Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly.
These returns do not include dividends. 10-year TIPS real yield = projected return at maturity given expected inflation.
As May unfolds, perceptions of the economy (and what the Fed will do to manage it) have subtly changed. Analysts at Citigroup and Bank of America Merrill Lynch now believe the Fed will probably wait until December to adjust interest rates, and questions are emerging about how robust the economy really is. When the Fed was aggressively buying bonds, Wall Street could accept subpar economic growth – but after the March hiring dip and the disappointing initial Q1 GDP estimate, bulls are less enthusiastic about how 2015 may play out. Still, this year may mirror 2014 – a bad first quarter, better subsequent quarters, and ultimately solid yearly returns for stocks. If hiring, consumer spending and other fundamental indicators are decent or better and corporate profits beat (reduced) expectations, a bit of a tailwind may help the aging bull market.21
UPCOMING ECONOMIC RELEASES: Among the notable news items for the rest of May, we find ISM’s April service sector PMI (5/5), the April ADP employment change report (5/6), the April Challenger job-cut report (5/7), the Labor Department’s April employment report and March wholesale inventories (5/8), April retail sales and March business inventories (5/13), April’s PPI (5/14), April industrial output and the preliminary May consumer sentiment index from the University of Michigan (5/15), April housing starts and building permits (5/19), the minutes from the April 29 Fed policy meeting (5/20), April existing home sales and leading economic indicators from the Conference Board (5/21), the April CPI (5/22), May’s Conference Board consumer confidence index, April new home sales and hard goods orders and March’s Case-Shiller home price index (5/26), April pending home sales (5/28), and then the final May University of Michigan consumer sentiment index and the second estimate of Q1 GDP from the Bureau of Economic Analysis (5/29). April consumer spending figures arrive on June 1.
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This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. MarketingPro, Inc. is not affiliated with any broker or brokerage firm that may be providing this information to you. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is not a solicitation or recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx®, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world's largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. The MSCI Emerging Markets Index is a float-adjusted market capitalization index consisting of indices in more than 25 emerging economies. The Asia Dow measures the Asia equity markets by tracking 30 leading blue-chip companies in the region. The Europe Dow measures the European equity markets by tracking 30 leading blue-chip companies in the region. The Global Dow is a 150-stock index of corporations from around the world created by Dow Jones & Company. The MSCI World Index is a free-float weighted equity index that includes developed world markets, and does not include emerging markets. The Dow Jones Americas Index measures the Latin American equity markets by tracking 30 leading blue-chip companies in the region. The RTS Index (abbreviated: RTSI, Russian: Индекс РТС) is a free-float capitalization-weighted index of 50 Russian stocks traded on the Moscow Exchange. The FTSE 100 Index is a share index of the 100 companies listed on the London Stock Exchange with the highest market capitalization. The CAC-40 Index is a narrow-based, modified capitalization-weighted index of 40 companies listed on the Paris Bourse. The IBEX 35 is the benchmark stock market index of the Bolsa de Madrid, Spain's principal stock exchange. The FTSE MIB (Milano Italia Borsa) is the benchmark stock market index for the Borsa Italiana, the Italian national stock exchange. The DAX 30 is a Blue Chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange. The MERVAL Index (MERcado de VALores, literally Stock Exchange) is the most important index of the Buenos Aires Stock Exchange. The Bovespa Index is a gross total return index weighted by traded volume & is comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange. The Mexican IPC index (Indice de Precios y Cotizaciones) is a major stock market index which tracks the performance of leading companies listed on the Mexican Stock Exchange. The S&P/TSX Composite Index is an index of the stock (equity) prices of the largest companies on the Toronto Stock Exchange (TSX) as measured by market capitalization. The S&P/ASX 200 index is a market-capitalization weighted and float-adjusted stock market index of Australian stocks listed on the Australian Securities Exchange from Standard & Poor’s. The BSE SENSEX (Bombay Stock Exchange Sensitive Index), also-called the BSE 30 (BOMBAY STOCK EXCHANGE) or simply the SENSEX, is a free-float market capitalization-weighted stock market index of 30 well-established and financially sound companies listed on the Bombay Stock Exchange (BSE). The Korea Composite Stock Price Index or KOSPI is the major stock market index of South Korea, representing all common stocks traded on the Korea Exchange. Nikkei 225 (Ticker: ^N225) is a stock market index for the Tokyo Stock Exchange (TSE). The Nikkei average is the most watched index of Asian stocks. The SSE Composite Index is an index of all stocks (A shares and B shares) that are traded at the Shanghai Stock Exchange. The Hang Seng Index is a freefloat-adjusted market capitalization-weighted stock market index that is the main indicator of the overall market performance in Hong Kong. The US Dollar Index measures the performance of the U.S. dollar against a basket of six currencies. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional.
IRS Circular 230 Disclosure: if this newsletter contains any type of tax advice, please be advised that, based on current IRS rules and standards, the advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to the matter.
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