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June 2012 Investment Journal 


Markets in June bided their time early on, waiting for three pivotal news events late in the month: the FOMC meeting, the US Supreme Court decision on Obamacare, and the Eurozone bailout of Spain. Collectively, markets decided the outcome of these decisions were friendly, sending risk assets like stocks to their biggest one month gain in years:
Indices June 2012
Indices Chart June 2012
On June 6, the Chinese central bank (Peoples's Bank of China) cut their short term interest rates for the first time since 2008, thus joining latecomers including India in the global race to see who can have the lowest rates. The Chinese economy, like much of the world, has been slowing, and this move is intended to stimulate more borrowing and lending. As in the US, this change in the direction of official interest rates will take time to play out, and it will happen incrementally, with a succession of lower rate levels to be announced. This move is significant as it is the last major central bank to start a rate cutting cycle, and China's potential "hard landing" scenario will only accelerate the race to zero.
On June 20th the Fed announced the extension of "Operation Twist". This means they will sell shorter maturity bonds and re-invest in longer maturities, hopefully causing long term rates to decline ("flattening the yield curve") and providing a "stimulative" effect on the economy. The U.S. Dollar strengthened in the days following the announcement, then fell off. 
As the month came to a close, Europe announced measures to fix its banking system, which brought the euro higher and contributed to a drop in the dollar. On June 28th, reports began to circulate that Spanish Banks could receive direct injections of aid and a new Eurozone Banking Supervisor will be created, giving more "unity" to the area. This bailout also has in store some concessions that will be made for Italy and Ireland. The Netherlands and Finland are not yet on board with the decision to provide the funds to Spain, and, as usual, lots of details are hanging.
As this Journal is written, Europe also cut its' official lending rates by .25% to .75%, and its deposit rates to 0%. China cut its rates again the same day, and the Bank of England started another Quantitative Easing policy. 
These are not unrelated events. Time has not healed the sick condition of bank balance sheets, and now central bankers face the additional challenge of rapidly cooling global economies. Economic releases globally were almost universally weak in June, especially the US Purchasing Managers Index, which contracted below the "50" level, putting it back in recessionary territory for the first time since July 2009. New Orders and Prices Paid components of the PMI Index "crashed" from the prior month, dropping the most in over three DECADES, and getting a lot of attention in the financial press. 
 As we have long pointed out, there is nothing left in the gas tank of traditional monetary tools to stimulate growth, so it's time to try the unconventional methods. Courtesy of the Danish Central Bank, we now have a taste of the future: On July 5, they announced an official deposit rate of NEGATIVE .20%; i.e. if you'd like the comfort of leaving your cash with the Danish Fed, your 100 Krone will be returned at a rate of 99.80. 
As we noted last month, new Swiss Franc bond issues are being sold and trade in the aftermarket with negative nominal rates. France and Germany this week sold short dated government debt with negative yields for the first time ever. What is going on here? From our vantage point, it is indicative of how desperate large investors are to "buy protection". i.e. there is a shrinking amount of "high quality" government bonds, and far too many buyers with no other alternatives (Eurozone investors have had their fill of PIIGS bonds). In the event of another Lehman type event in Europe, the flight to quality will likely push yields broadly into negative territory.
This bizarre "negative yield" situation is thus spreading. How long before it comes to the USA? What alternatives do investors have? The US Dollar and USD bonds have been a beneficiary so far, and there is still room for gains as yields in the USA march lower. There is also renewed interest in high quality dividend paying equities.
Here in the USA, the Supreme Court's June 26 decision on health care took most by surprise. The early read is that market observers consider it negative for health insurers, and neutral to positive for everyone else. About the only solid conclusion to be drawn at this point is that small businesses will not hire new workers if it puts them at or near the 50 employee population that makes them subject to penalties under PPACA. 
Lastly, the drought in the Midwest is really causing problems for the regions crops. As a result, prices in the agricultural futures market have surged 25 percent over a few short weeks. This is an excessively sharp move in a short period, which ought to be alleviated with some rain in the forecast. Meanwhile, weather forecasters have been busy and are in demand for CNBC appearances. 
Thank you for reading our Journal; we'll be back to you early in August for the July wrap-up.

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