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The Tax Deal and Bond Yields

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12/08/2010

The big talk in Washington and on Wall Street is the proposed deal on an extension of the Bush tax cuts. Although the deal, worked out by President Obama and Republican leaders in Congress, hasn’t yet been made official, the details of the plan most likely will adhere to the key provisions that the president announced on Monday.

Here’s a quick rundown of the various terms of the tax deal:


Now, there’s been a lot of banter from the extreme wings of both parties, with liberal Democrats saying the president sold out on the issue of making the so-called rich pay more. Those on the right think that the temporary nature of the tax cuts, as well as the increase in unemployment benefits, will hamper future decision making and will cause even bigger deficits in the coming year (count me in with this group).

Certainly, the argument about a bigger deficit next year has been confirmed by the bond market. Long-term Treasury bond yields surged right after the agreement was announced. Why? Well, by some estimates, the deal is going to add north of $900 billion to the federal deficit. That increased deficit is bad for both Treasury bonds and municipal bonds and, hence, the spike in bond yields.

Just take a look here at the one-month chart of the 30-Year T-Bond Yield ($TYX). As you can see, yields spiked immediately following the president’s Dec. 6 announcement of the tax deal. The realization that this deal is very likely to be made official pushed yields even higher in today’s trading.

The prospect of bigger and bigger budget deficits going forward should be nothing new to Alert readers. For months now, we’ve been telling you about the tremendous amount of borrowing that’s going to be needed by sovereign governments around the world -- including the United States -- just to stay afloat in 2011. Some estimates peg that number at an incredible $10.2 trillion. Those are debt levels not seen since World War II.

This tax deal isn’t going to help that deficit at all, and bond traders know it. According to economists at JP Morgan, there likely will be a $1.5-trillion shortfall for the current fiscal year, up from their previous $1.2-trillion forecast. For fiscal 2012, their projection is up to $1.2 trillion, from $1.1 trillion, as the two-point cut in payroll taxes gets reversed.

What all this means is that the Treasury is going to have to sell more securities to fund those larger deficits, and that means bond yields (i.e., long-term interest rates) will continue to rise.

Fortunately, in my Successful Investing advisory service, we have exposure to an exchange-traded fund (ETF) designed to go higher along with bond yields. We currently have very solid unrealized gains in this position, as we have been way out in front of the rising-rates equation. If you’d like to know more about this service, just click here.

Is a Pullback in the Wind?

The equity markets continue moving back and forth on their volatile 2010 ride, and recent trading has been no exception. In fact, the market started out robustly higher in Tuesday’s trading, but by the closing bell, stocks actually had fallen into the red. Some technical analysts consider Tuesday a key reversal day for the Dow Industrials, and that reversal is considered a signal of a pending market decline.

Take a look at the chart here of the Dow Industrials. As you can see, the index has been very volatile all year long. The iconic measure of the market also remains trading well above both its short-term, 50-day, and long-term, 200-day moving averages. Yet, with the Dow near its year-to-date highs, there is plenty of worry that a correction of 4%-8% could be in the wind.

I think that if we do see this kind of pullback, it will be a healthy sign for stocks going forward, as they need to come back down to sustain the wider bullish uptrend. This pullback, if it does indeed take place, won’t impact intermediate- and long-term investors, but it won’t be too fun for short-term traders who are long this market.

If you have a lot of short-term money on the table, it might be time to start thinking about paring down your exposure. If you are a longer-term investor with a lot of cash on the sidelines, then I suggest waiting for the pullback to blow on to Wall Street. Then once the selling winds have passed, it will be time to get back into stocks.

ETF Talk: Retail Offers Investors a Holiday Gift

With Christmas approaching, the buying behavior of shoppers so far shows that they are hitting the stores and opening their wallets. With robust November retail sales, I am eyeing an exchange-traded fund (ETF) that lets you take advantage of the holiday shopping spree. The SPDR S&P Retail (XRT) seeks to replicate as closely as possible, before expenses, the total return performance of the S&P Retail Select Industry Index.

The fund’s top ten holdings, as of Sept. 30, were Best Buy, 1.68%; Walgreen, 1.61%; Amazon, 1.54%; TJX Cos., 1.52%; Kohls, 1.51%; Costco, 1.51%; CVS Caremark, 1.51%; Priceline.com, 1.50%; Wal Mart, 1.44%; and Target, 1.41%. As the chart below shows, XRT has been on the rise in recent weeks. In fact, from its opening price on Sept.1, XRT has risen 31.12% through yesterday’s close.

If you’ve made it to the mall this holiday season or checked out your favorite stores online, you’ll notice that good deals are everywhere. While there are signs that consumer sentiment is improving, shoppers in general appear frugal and are looking for serious bargains before they part with their hard-earned money.

According to The Wall Street Journal, “Consumer sentiment in November rose to the highest level since May. Factory output is expanding, and corporate profits are strong.” But consumers are concerned about significant setbacks to the economy that include “a sagging housing market, millions of workers who have been without jobs for more than six months and ripple effects from financial turmoil in Europe,” The Wall Street Journal reported. XRT is an ETF that holds bargain and value retailers that are most likely to be the big winners during this holiday season.

The enticing deals are paying off big time for retailers. This year’s “Black Friday” sales on the day after Thanksgiving jumped 12% from last year. Even more impressive were online sales, which topped $1 billion this year to mark the biggest online shopping day in history. In fact, “Cyber Monday,” the name given to the Monday after Thanksgiving, had a sales increase of 20% from the same day a year earlier.

Traditionally, the weeks after Thanksgiving are very slow for retailers, but this year may be an exception, as stores continue to slash prices to lure shoppers. If you think that sales will continue to climb and send retail stocks higher, then XRT may become my gift to you this holiday season.

For advice about which ETFs to buy and to sell, I urge you to sign up for my ETF Trader service by clicking here. As always, I am happy to answer any of your questions about ETFs, so do not hesitate to contact me if you have one. To send me a question, simply click here. You may just see your question answered in a future ETF Talk.

Get Your Precious Metals Watch List

The ETF universe now is teeming with more than 1,000 funds. Yet there is one asset class, particularly this year, that really has captured everyone’s attention -- and that’s precious metals.

Precious metals, like stocks and bonds, are an asset class which represents a great deal of risk along with the potential for big rewards. One of the biggest challenges confronting precious metals investors is dealing with the tremendous volatility in the sector.

We’ve seen this volatility in the premier precious metal, gold, since the value of the yellow metal has gyrated wildly over the past 12 months. Because gold and other precious metals generally are non-stock, non-bond correlated investments, they’ve become very attractive to individual investors, despite their propensity for volatility. This low market correlation is a crucial component for investors who seek diversification within their portfolios.

In our latest special report, “The Fabian Precious Metals Watch List,” we’ve identified 20 precious metals ETFs that give you access to both the bullion and mining segments of the best precious metals available to investors today. To get your free report, simply click here.

On Courage and Saddling Up

“Courage is being scared to death... and saddling up anyway.”

--John Wayne

The wisdom here in The Duke’s proclamation is hard to argue with, but what I want you to realize is that courage is necessary in just about every important decision in life -- and, particularly, in the key financial decisions that we all must make. Whether it’s starting a new business, making key investments, changing financial advisors or any one of a plethora of crucial choices that we all have to make, being able to act in the face of fear is going to give you the confidence necessary to choose with conviction.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars or anything else. Click here to ask Doug.

P.S. I encourage you to watch my recent webinar where I was a guest speaker with another publishing company, Profits Run, to discuss how to invest your money following the Nov. 2 midterm Congressional election. To listen, please click here.

P.P.S. Don’t miss out on The World MoneyShow Orlando, February 9-12, 2011, at The Gaylord Palms Resort. This event will be your one-stop resource for the education, research and advice that you need to make smart investment decisions in 2011 and beyond. Join me there and hear leading experts reveal where they see growth opportunities in stocks, bonds, ETFs, commodities and options. Click on this link to The World MoneyShow Orlando to register or call 800/970-4355. Be sure to provide priority code 020753.

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