February 6, 2008
Last July I put together what I called the 7.5% Core Bond Portfolio. I selected a cross section of closed-end bond funds that would spread out our risk, domestic and foreign, floating and fixed rate. I don't know if any of you might have put some of your money in this portfolio.
My concern at this time is, that unlike last summer, we are now hearing more and more how the Fed will have to reduce interest rates further than they have done already. Last summer the fear was rising inflation meaning the Fed would have to tighten or raise interest rates. Well, we've already seen a 2% cut in rates which has caused our floating rate bond funds to come down in price. These include BGT, EFL, EFT, PHD and PPR. I can accept that share prices go up and down, but now in addition to them coming down, it is quite possible we'll see that they'll have to cut their dividends too. Since floating rate means exactly what it says, as rates come down, they will be making less money. That leads me to believe that their payouts will have to be reduced also.
If they do, then the share prices will come down further. So my thinking is (and I hate to do this) that you might want to sell your positions, park the cash you get and wait for the cut in interest rates (which should happen in the next couple of weeks). Then we can move that money back in there since I can't see the Fed going down to 1% again. But, who really knows just how bad the subprime mess will get? Japan went to 0%!!! The lower the rates, the more liquidity (which led to this mess in the first place) which will eventually lead to higher inflation, causing the Fed to raise rates again. It's a vicious cycle. Then the floating rate funds will go up again. Now, we're hearing that the European Union will have to cut rates in Europe too. So there's no escaping.
Now depending on whether you purchased any of these funds along the way, you can decide to hold on and just collect the dividends, buy more shares when the prices have come down more if the dividends are cut, or just sell your position and get back in later. In a non-retirement account you might be able to deduct any loss or as in my case, they are in my Roth so I'm out of luck. If you are comfortable holding these for the long term, then when this crisis is over (which might take 2-3 years), I'm sure rates will be up again. Prices of everyday living are doing nothing but going up. Wait till we are paying $8 for a gallon of gas like they're doing in Europe already! If you think we are heading into a recession now, wait till these prices really start soaring. That will be real pain.
So far this week has been another disaster in the markets. Tomorrow is headed for another bad day given that Cisco reported a not rosy forecast. Whatever good news is out there gets creamed by short sighted traders who fear their own shadows. Let's hope I'm wrong.
Pete Lipke
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