Bernanke talks — but advisers way ahead of the yield curve

As the financial markets adjust to the latest hints on Fed policy — as gleaned from comments made today by Federal Reserve Chairman Ben Bernanke — many financial advisers are sitting tight with strategies based on the inevitable end of quantitative easing and eventual hike in interest rates. “It seems a little odd that people are now so focused on the Fed chairman’s comments as a turning point, when he has been signaling all along that it is his policy to taper back on quantitative easing as the economy improves,” said Mike PeQueen, managing director and partner at HighTower Advisors LLC. Like a lot of advisers, Mr. PeQueen has been adjusting client portfolios for more than a year to prepare for the impact of rising interest rates, which will push down the trading value of most bonds. “The concept of where interest rates are does occupy a lot of our thoughts, but that has been the case for a long time,” he said. “We’ve been adjusting duration exposure down in our bond portfolios, because investors have been anticipating higher rates and have been taking steps to prepare for that.” Mr. Bernanke, as part of scheduled announcement today, reassured the financial markets that the current strategy of purchasing $85 billion worth of Treasury bonds and mortgages will continue until further notice. The comments were more generic than a May 22 statement from Mr. Bernanke in which he mentioned that the five-year-old quantitative-easing policy could be “tapered” depending on the strength of the economy going forward. Even though the May statement was not out of line with the stated Fed policy, the bond market interpreted it as something akin to definitive, and abruptly sold off. The yield on the 10-year Treasury, currently above 2.2%, has gained 3.5% from a May 3 low of 1.63%, reflecting a drop in the price of the government paper. Mr. PeQueen described such reactions as uninformed at best and ignorant at worst. “If you’ve been positioning yourself, there’s no reason to panic when you think rates might start to rise,” he said. “If you have been buying long-duration bonds to pick up yield, you’ve been running in front of a steamroller to pick up pennies, and you’ve already been run over.” Granted, the central bank eventually will reduce its bond-buying strategy. But the pullback likely will happen over several months or possibly years. “Even if the Fed said they decide to cut their monthly bond purchases to $65 billion, from $85 billion, that’s still a lot of quantitative easing,” he said. “A kindergartner could have understood that as we get closer to 6.5% unemployment, it is inevitable that quantitative easing will be reduced.” In his comments today, Mr. Bernanke stressed that “our reduction policy is in no way predetermined,” reinforcing a commitment linking the policy to the strength of the economy. He also emphasized that there are no immediate plans to adjust the current Fed funds rates, now at near zero. This came as no surprise to most advisers. “This is nothing we need to be jumping up and down about,” said Clinton Struthers, owner of Struthers Financial Services. “We have taken a good look at our fixed-income positions to make sure we are really, really, really short-term,” he said. “In my opinion, rates should have risen a year ago, but I can’t control that; I can only take advantage of what’s there.” Theodore Feight, owner of Creative Financial Design, said his strategy has been to “play plenty of defense” with regard to bonds, especially since 85% of his clients are in retirement. “We are no longer adding any new money to bonds, because we think the bond market will be volatile for the next year to 18 months,” he said. “Anything in fixed income that we own that’s 10 years or longer in duration, we’ve set stops very, very tight.” Even though the Fed has not offered any new information on when quantitative-easing might be reduced, financial advisers are not interested in waiting to protect bond portfolios from the impact of rising rates. “The [Fed’s] May comments suddenly put into doubt how long the purchases would continue,” said Byron Green, president and lead portfolio manager at Green Investment Management Inc. “If Ben Bernanke is positive enough to start reducing the QE purchasing plan that should be considered positive for equities, and it might be negative for bonds,” he added. “We have increased our exposure to equities and reduced exposure to bonds in our balanced strategies, but if people get a little too overzealous, at some juncture, we might find it appealing to come in and increase our exposure to bonds.”