The recent calamity in the banking sector is complicated, but one issue stands out. Even the safest of investments have risk.

 

Understanding the relationship between bond prices and interest rates is extremely important. Bonds, overall, are considered safer investments than stocks and history indicates that bonds have been less volatile than stocks most of the time. However, when interest rates rise, bonds can get hurt for a variety of reasons, and credit risk is at the top of the list.

 

Credit risk refers to the possibility that a corporation (or a government entity) could default on a bond they have issued. That happens when the issuer fails to pay back the principal or cannot make interest payments. Normally, U.S. government bonds, called Treasuries, have lower credit risk. Presently, however, even Treasuries have some credit risk. If Congress refuses to increase the debt limit by this summer and allows the country to default, the consequences for our government debt could be grave.

 

However, all bonds have interest rate and duration risk. Bond prices and interest rates move in opposite directions. As interest rates fall (as they have for much of the past decade), the value of fixed-income investments rise. Since last year, interest rates have risen substantially due to the Federal Reserve Bank's efforts to combat inflation.

 

This is where duration risk comes in. Let's say you have long-dated U.S. Treasury bonds that do not come to maturity for 10, 20 or even 30 years from now. If you hold them to maturity, you will receive your principal investment back plus whatever interest rate coupon was promised. However, if rates rise (as they are doing now), and for whatever reason, you sell your bonds before their maturity date, you could end up receiving less than what you paid for your bond.

 

In general, duration is expressed in terms of years and generally bonds with long maturities and low coupons have the longest duration. These bonds are more sensitive to a change in market interest rates and thus are more volatile in a changing interest rate environment. Over the last year, the Fed has increased interest rates at its fastest pace in recent history, which has caused the price of bond holdings to decline substantially.

 

Enter the Silicon Valley Bank (SVB) stage left. SVB, like most banks, relies on a mixture of short-term and long-term financing. The short-term side largely consists of customer deposits. A bank's assets typically consist of long-term loans that get paid back with interest over time as well as bonds the bank purchases that pay out over the term of the bond.

 

More than half of SVB's assets at the end of last year were "safe" bonds issued by the U.S. government or federal mortgage institutions, which they had purchased before the Fed's tightening policies began. Safe from default risk, maybe, but not from the climbing interest rates. And most, if not all, of those bonds, were low coupon, and long-term in nature — a classic case of duration risk.

 

The nightmare that all banks fear is a bank run. Think of "It's a Wonderful Life" and George Bailey's Building and Loan, a small community bank in Bedford Falls. Depression-era depositors, fearing for their financial lives, rushed to take their money out of Bailey's bank. Few depositors understood how credit and loans work. They thought their money was simply sitting in the safe. George tried to explain the concept but ended up making good for his customers by giving them his honeymoon money.

 

In the case of SVB, the same thing occurred, although, unlike George Bailey, the management of the bank could not make their depositors whole. For most depositors, there was no need to stand in line. A simple electronic transfer via computer transferred millions out of the bank in seconds. As a result, SVB was forced to sell bonds at a loss to satisfy depositor demands until it couldn't. The rest is history.

 

What may some readers have in common with SVB? In today's market, there has been a mad rush to capture higher interest returns after years of an interest rate famine. The U.S. Treasury markets, especially on the short end, have seen yields of 5 percent or above for six-month, one-year, and two-year notes and bills.

 

Putting excess cash into these high-yielding instruments and intending to hold them to maturity is a reasonable financial strategy. However, if you need to sell them to raise cash for an emergency may leave you open to losses. Remember that a bond's yield is not the same as the interest rate coupon promised at maturity on that instrument.

 

A six-month note may have been issued with a fixed 1.75 percent coupon, however, because of the Fed's recent interest rate hikes, the price of the note has declined. As it does the yield has climbed. 

 

You are in effect, buying that note at a discount to the original purchase price. If you hold the instrument to maturity, you will receive the full-face value of the note when it was issued, plus the coupon. That is ideal. But remember, yields will go up and down over time in an inverse relationship with the instrument's price depending on market conditions. If things change and you need to sell early, you may face the same issues as SVB. That is the risk you are taking when you buy Treasuries.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Stocks fell this week as investors turned more bearish. You can blame Fed Chairman Jerome Powell for that as well as troubles in the banking sector.

 

"Higher for Longer" may be finally sinking in. Powell's two-day testimony in front of the House and the Senate this week was decidedly hawkish. In retrospect, there was nothing new in his statements, but for some reason the financial markets were willing to listen. Congress heard his message as well: inflation is still a problem, the jobs market needs to weaken, and if higher interest rates mean a recession, then so be it.

 

Those who had been confident that the Fed would raise the Fed funds rate by only 25 basis points at the March FOMC meeting are having to rethink that stance. Chairman Powell would not commit to a specific increase. He insisted the Fed would remain data dependent in determining the next rate move. Over in the bond market, indications are that a 50-basis point hike is just as likely now as a 25-basis point hike.

 

However, the Fed is not the only concern of the markets. Two regional banks, one a noted small crypto bank, Silvergate Capital Corp., announced that they would be "winding down" operations. On Thursday, a second bank, SVB Financial Group, which owns Silicon Valley Bank and focuses on lending money to start-up companies, announced they are being forced to sell assets and raise $1.75 billion in a stock offering. This is the 16th largest U.S. bank. Management admitted that higher interest rates are hurting their bond holdings, which is weighing on the company's flow of cash. On Friday, banking regulators closed the bank and the FDIC has taken over.

 

These announcements triggered a wholesale round of selling in the banking sector. Silvergate's stock price was down almost 42 percent, while Silicon Valley Bank's shares lost more than 60 percent of their value and another 40 percent in after-hours trading. The global mega-banks fell along with the rest of the sector. Those big banks suffered 5 percent-plus losses, while the regional bank's exchange-traded fund also fell by over 8 percent.

 

On Friday, the much-awaited U.S. jobs report for February came in stronger than expected with the nation gaining 311,000 new jobs, versus an expected gain of 225,000. However, the unemployment rate ticked higher to 3.6 percent on a rise in labor force participation. Average hourly earnings ticked down to plus-0.2 percent from plus-0.3 percent, which was a small positive on the disinflation front. 

 

As you might expect, the troubles in the banking sector spilled over into the overall markets. The three main averages — the S&P 500, the Dow, and NASDAQ — lost 1.5 percent-2 percent on Thursday and continued down on Friday. It seems to me that the market's direction is going to be dependent on what happens on Tuesday. That is when we will receive the next all-important Consumer Price Index release for February. Investors, like the Fed, remain data dependent.

 

A cooler CPI number would be an excuse for markets to rally and climb out of this hole we have dug for ourselves. A hotter number would mean the rate of inflation remains stubbornly higher than the Fed would like. That would almost certainly mean we decline with the S&P 500 Index testing 3,800 or lower as a result. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Coats to protect your pets from severe weather, or orange safety vests during hunting season are fairly common but today, the fashion industry has embraced the concept and taken pet clothing to new heights.

 

Canine couture is a big business. The pet clothing business market is growing by 4.5-5 percent per year, and by 2030 should exceed $9.15 billion annually, according to Brainy Insights, a research firm that tracks sales in the pet industry. The U.S. accounts for 30 percent of global sales and hit almost $2 billion in 2022.

 

I divide the pet clothing market into two segments: clothes that are practical, and clothes that are indulgent. Practical items have a surprisingly long history. Ancient Greek armies, for example, would fasten leather boots on their horses to protect them from the snow. Greyhound and whippet owners have long-used coats to keep their pets warm in cold weather. Police horses and dogs are often dressed in fluorescent coverings.

 

Certain kinds of animals benefit from wearing coats, boots, and rain gear. Dogs that are old, thin, tiny, elderly, have thin coats, or are ill often need protection from severe temperatures, rain, and snow. Therapy jackets and those that are used for medical conditions such as hip dysplasia, and canine arthritis or to protect an incision from the aftermath of surgery are useful protective clothing. 

 

Our dog, Atreyu (a poodle), has an insulated coat, which came in handy this winter in sub-zero temperatures. He also wears an orange vest during hunting seasons. Boots, on the other hand, while useful, (due to the heavy use of salt in our area during snow season), are a no-go. As it is, this dog is such a drama queen that he balks and runs when he sees his coat come out of the closet.

 

Canine couture, however, is an entirely different world. It is here that I believe that our tendency to anthropomorphize our pets has run rampant. Anthropomorphism is the tendency to map human traits and emotions onto animals. For many, assigning human characteristics to our pets helps them to make sense of the world around them.

 

For others seeing our pets as human-like fulfills a social need. They believe that dressing dogs, cats, and other animals in trendy, high-fashion clothing allows the pet and the owner to stand out and gain social status among certain groups. In short, you are dressing your pet for success. Doing so today, however, may cost you more than dressing yourself.

 

A deluge of high-end fashion houses has jumped into the pet clothing business with specially designed pet collections. Dior, Prada, Versace, and Fendi, among many others, offer everything from designer purses to matching people/pet outfits for all occasions.

 

Their success has spawned all sorts of marketing efforts. Tika, an Italian greyhound model, has over a million Instagram followers and has been a big celebrity at New York City's Fashion Week. Boobie Billie, an Italian sighthound/Chihuahua, another Instagram favorite, has launched a luxury clothing line. Dozens of lesser-known pet celebrities are modeling for various brands and establishing followings on social media. Dog agencies are springing up and signing these four-legged stars to contracts. The rates vary per dog, but these new influencers have millions of followers.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

There is a discrepancy growing between bond and stock markets. The bond vigilantes are betting the Fed is nowhere near done hiking rates. Stock jockeys disagree. Which camp will prove correct?

 

A look at the government's U.S. Treasury bond auctions this week resulted in most yields going higher. Buyers insisted on higher returns to purchase the billions of dollars in U.S. Treasury notes, bills, and bonds that are a weekly occurrence in the financial markets.

 

Overall sentiment in the markets has turned cautious and, for some, downright bearish once again after the January rally in stocks. Recession fears are once again taking center stage for many although there is still not enough evidence to prove it definitively.

 

Fourth-quarter Gross Domestic Product (GDP), for example, increased by a downwardly revised 2.7 percent annualized rate from the 2.9 percent pace reported last month. Slightly lower, yes, but the point is that GDP was still growing. And once again, the number of Americans filing new claims for unemployment benefits fell last week. The week-after-week decline continues to point to a persistently tight labor market in a growing economy.

 

The Personal Consumption Expenditures Price Index (PCE) for last month came in hotter than expected. PCE rose 0.6 percent and 5.4 percent year-over-year. Even after you strip out food and energy, core PCE rose 0.6 percent from 4.7 percent last year. The Commerce Department also showed that consumer spending rose 1.8 percent last month after falling the previous month and personal income rose by almost 1 percent.

 

Given the most recent macroeconomic data, it is hard to dispute that the economy is still growing, the decline in inflation is at least pausing, and that leads to the fear that the Fed may be at least thinking about increasing the amount of their next rate hike. 

 

This data is telling the bond market that the Fed may still have a long row to hoe before inflation gets back to the 2 percent target. They are certain that the central bank's tough interest rate regime will continue for much longer than the equity markets believe. Many analysts are beginning to think that the Fed funds terminal rate of interest could rise from its present range of 5.00 percent -- 5.25 percent to as high as 6 percent. It is the main reason that yields are rising, and bond auctions are suddenly problematic.

 

Over in the equity markets, these data points have taken some of the wind out of the sails of the bulls. The S&P 500 Index had a bad week, as did the Dow, NASDAQ, and the small-cap Russell Indexes. If the S&P 500 drops below the 3,950 level then we may see a decline into the mid-3,850 area.

 

As I wrote in my column this week, short-term, U.S. Treasuries are looking interesting for those who are sitting on a large amount of cash. In a down equity market, a 5.09 percent yield on a six-month Treasury note, or a 5.13 percent yield on a one-year Treasury bill is nothing to sneeze at. Investors are now receiving a yield equivalent to what equity investors can receive from the S&P 500 Index.  Granted, there is some interest rate risk if the terminal rate on Fed funds does rise to 6 percent. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

It may not be the 1970s when interest rates offered investors double-digit returns, but 5 percent on a six-month U.S. Treasury bill isn't bad.

 

We last saw that kind of return in 2007. To be sure, the rate still comes up short when compared to the 6.4 percent annual rate of inflation right now. Yet inflation is declining and has fallen for seven months in a row.

 

The dilemma investors faced last year was that there simply was no haven to park their cash. The stock market was treacherous and falling. The Federal Reserve Bank was hiking interest rates on an almost monthly basis to combat inflation, and most bond prices were falling almost as much as equities.

 

This year the stock market rallied for the first month and a half, but many investors have now turned less bullish. Over the last week or so, the bond market has begun to price in at least three more interest rate hikes in the first half of the year. The strength of the economy and a slight uptick in some of the most recent inflation readings has been behind the increase in bond yields across the spectrum. The rush for cash and cash alternatives has suddenly taken a front seat in preferred investments.  

 

At this point, investors can earn 5 percent or more on the six-month Treasury Bill, which is one of the safest debt securities in the world. Certificates of Deposits (CDs) are yielding 4.8 percent for the same three-month maturity. Buyers need to go out to one-year CDs and beyond to capture an equivalent 5 percent yield or above.

 

At this point, the three-month Treasury bill at 5.07 percent has a yield that is now competitive with far riskier assets like stocks as measured by the S&P 500 Index. Readers need to be aware that these "riskless" securities are not quite what they seem. Treasuries, while backed by the full faith and credit of the U.S. government, do have interest rate risk. If interest rates climb higher, the price of all notes, bills, and bonds declines. The longer dated the bonds are, the deeper the decline when rates rise.

 

However, there may be another, upcoming glitch in the risk profile of the six-month bill's perceived safety. Last week I wrote a column on the present political debate on raising the debt ceiling. The Congressional Budget Office is now projecting that the U.S. government will run out of cash to pay its bills sometime between July and September. The six-month U.S. note will mature sometime in that time, which puts it squarely in the crosshairs of this partisan battle. It is conceivable that some investors, wary that there may be a government default, are steering clear of the note, while others are willing to take the risk.

 

However, I noticed that both the one-year (5.08 percent) and 18-month (5.01) U.S. Treasury notes are now trading above 5 percent. That indicates to me that the present rise in yields is more about higher interest rates tethered to the Fed's intent to keep interest rates higher for longer than it is about fears of a debt crisis.

 

The question is whether yields on other government debt will follow suit.  Recently, weekly bill auctions have drawn strong demand. However, auctions this week indicated that bond investors, fearing future rate increases, were demanding higher yields. The U.S. Treasury sold $60 billion of three-month bills, $48 billion of six-month bills, and $34 billion of one-year paper as well as auctions of two-, five-, and seven-year notes.

 

For those who are waiting out the volatility in the stock market in cash, short-term U.S. Treasuries could be an interesting purchase right now.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.