Dorato News, October 2017

A Quarterly Newsletter for the Clients of Dorato Capital Management, LLC.

Portfolio Issues

Another Hack

Another day, another data breach. Though this time the company that was breached was Equifax, which has credit information on most of us. For a while now, I've just assumed that the bad guys have any information they need to open an account in my name. My advice, and what I've done for myself, is to place a credit freeze on my accounts with each of the three credit agencies -- Equifax, TransUnion, and Experian. In Colorado, there's no cost to institute a credit freeze. But even if you live in a state where the credit agencies are allowed to charge a one-time fee, it's probably worth it. There's a slight hassle, and a small charge if you need to lift the freeze in order to get a loan or a credit card or some such thing. But again, the fee is probably worth it.

October 2017 Cartoon
"Truth be told, your company is kind of a loser if it hasn't been hacked."

Market View

THE BIG PICTURE

Risk and Return

The Federal Reserve has decided to start reducing its fixed income holdings. Prior to 2008, the Federal Reserve owned about $900 Billion in total assets. It currently holds about $1.7 Trillion worth of mortgage-backed securities and about $2.6 Trillion of US Treasury securities, most of which it purchased over the last ten years. Nobody is really sure how much lower interest rates are as a result of the Federal Reserve's purchases. I've seen estimates from as little as .15% to as high as 1%. If you're a borrower, this means you've been paying lower interest rates on your debt. If you're a saver, and you own interest-paying securities, you've been getting lower interest payments on those products.

The Federal Reserve will move very slowly. As its holdings come due, the Federal Reserve reinvests those amounts in new securities. The plan is to not reinvest the entire amount that comes due each month. So they will still buy, but will slowly ratchet down that reinvestment amount. The cut in reinvestment is small relative to the size of their total holdings, only $10 billion each month. Assuming nothing dramatic happens, they will slowly ratchet down the amount they will reinvest. Slowly, slowly, so as not to upset anyone.

It was an experiment for the Federal Reserve to purchase these securities, and it will be an experiment as it tries to reduce its holdings. For the cautious optimists in the crowd, the hope is that interest rates move up slowly, so the economy can adjust to higher rates in a controlled fashion. But since this is an experiment, no one knows quite how the future will unfold. Keep your fingers crossed.

Most of us think the actions of the Federal Reserve over the last ten years have generally been helpful for the economic recovery, and for the continued strong performance of US stocks. As the Federal Reserve removes some of the unusual support for the economy, we should probably expect to see some wobbles as everyone readjusts. In particular, whoever has taken on big chunks of debt, with the thought that low interest rates will last indefinitely, might have to think again. Debt, like a hammer, is a wonderful tool, as long as you don't bash yourself with it.

US stocks continue to hover at all-time highs, though there's been little gain in the last several months. With the Federal Reserve's new plans likely to lead to an uptick in interest rates, which would be a kind of brake on the economy, something needs to come out of Washington -- lower taxes, infrastructure spending -- to provide a little oomph to keep the economy going. In the end, its businesses and consumers that keep the economy going, not Washington. But Washington certainly plays a supporting role in that drama.

The fact that stocks are near all-time highs does not necessarily concern me. What concerns me is the price of stocks relative to their earnings, and that number is high - in the 19 to 20 range. You will hear arguments that this time is different, due to low interest rates, or some other plausible-sounding reason. But I doubt this time is any different. A high price to earnings ratio for the overall market is always a cautionary sign.

This does not mean you sell everything you own and stuff your cash under the mattress. Just be cautious. Don't take on more risk than you can handle. Accept the probability of lower than average returns for the next five to ten years. Return and risk are two words that go together, like peanut butter and jelly. Keep them together in your decision-making, and you'll be fine.

Sources: Economist, Financial Times, Wall Street Journal, Value Line, Vanguard