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Going From a Building Economy to a Neural Economy

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Neural EconomyTrends and correlations, just don’t happen. They happen for reasons. The economy is transforming to a “neural” economy from a “building” economy. Technology, businesses and job conditions (types of jobs, wages and competition) are different today versus any time in the past. Would you apply models developed in the 1800s (when the U.S. economy was largely agrarian) to the industrial economy of the 20th century? Of course not. Then why apply model theory created in the 20th century to the new neural economy? The answer is you shouldn’t.

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Using models might be “good enough” and keep accounts within suitability parameters. For us, “good enough” is not good enough. We would like to address the volatility which pervaded the capital markets last Friday. Equities, corporate bonds and U.S. Treasury prices all trended lower as a result of strongerthan expected jobs data. So much for inverse correlations, right? We believe that this was the result of irrational thinking, possibly by market participants adhering to models. Bond Squad would like to advise everyone to step back and take a look around.

We had a very good print of 295,000 new jobs. Yes, wage growth printed at just 2.0%, but that was still 35% above core PCE (1.3%), similar to the historical “norm” of 33% seen during economic expansions. There are many anti-inflationary forces present in the economy. A Fed tightening would also be antiinflationary. It is for this reason that we do not believe the Fed will be especially aggressive when tightening. Bond Squad believes that a September liftoff to tightening is most likely, but a June lift-off is possible. The word “patience” could disappear from the next FOMC meeting statement. Anti-inflationary Fed policy, manageable wage growth and lower structural inflation should augur for low long-term rates. That long-term rates leaped higher in the data might indicate that market participants and investors don’t “get it.”

Another drag on long-term U.S. rates are low long-term foreign sovereign rates. The ECB will begin buying bonds on Monday, 3/9/15. Some investors might be encouraged to sell EMU sovereign debt to the ECB (at, near or below 0.00% yields) and purchase U.S. Treasuries to enjoy both higher yields and a strengthening currency. Money could also move from Europe into U.S. equities to take advantage of the stronger U.S. economy and a stronger dollar. Investors who panicked and sold assets into last Friday’s weakness are at risk of being “whip-sawed.” We would not be surprised to see prices of long-dated UST, investment grade corporate bonds and bondlike equities recover in the coming days or weeks as reality sets in. The selloff seen last Friday is an example of the knee-jerk response by investors we have warned about, previously. It is important to develop an overall long-term strategy and stick with it. However, it is equally important to be able to adjust tactics to achieve an overall strategic victory. Just as the most reliable reconnaissance remains a soldier (or Marine) on the ground, the best investors, advisor or portfolio manager is a knowledgeable person “in the trenches.”

By Thomas Byrne Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
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Thomas Byrne

Thomas Byrne serves ad the Director of Fixed Income for Wealth Strategies Management LLC. Thomas brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets. High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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