As we approach the end of the second quarter, a familiar pattern has emerged. For the last three years we have seen yields rise in the fourth quarter, peak in the first quarter of the new year, and subsequently decline into the summer months. 2012 is progressing in a similar fashion. We saw yields peak in March, as an exceptionally mild winter distorted seasonal adjustments. Since that time yields have moved substantially lower for a number of reasons.The never-ending drama in Europe was the primary driver of yields moving lower on treasuries. The flow of money from Europe seeking a safe haven intensified as tensions rose in Greece, Italy, and Spain. 10-year treasuries declined almost 100 basis points in a span of two and a half months. The same movement in yields was seen on the benchmark 30-year treasury. On top of the flight to quality bid from Europe, China’s economy also appears to have slowed. China’s central bank cut rates in order to stimulate their economy. It remains to be seen if they will be successful, since China’s largest export market is Europe and Europe is, for all intents and purposes, in recession.
Investors are also concerned about fiscal policy, or the lack thereof. At the end of this year, tax rates on income and capital gains are scheduled to rise substantially. This potential increase in rates has hindered job creation and expansion. Business owners are reluctant to hire, given the uncertain tax and regulatory environment. We have seen this reflected in labour-market data as well as retail sales over the last few months. The budget debate at the federal level is also creating uncertainty and economic weakness. There may be a significant decline in government spending and transfers in 2013. This would only exacerbate a deteriorating economic environment. Deleveraging by households and state and local governments should keep economic activity from accelerating appreciably.
Cumberland Advisors’ taxable bond portfolios continue to capitalise on the weakness in the US and global economies. We have remained longer than benchmark with respect to duration and continue to overweight taxable municipal bonds in client portfolios. The higher-yielding benefit of taxable munis has helped provide returns in excess of our benchmark in our composite portfolios.