Permanent Value

Weekly Update: November 22-26, 2010

Bruce Doole
November 30th, 2010

The Markets

Interest rates are rising in the U.S. and that may actually portend good news for the economy.

Since a recent low of 2.38% on October 8, the yield on the 10-year Treasury note rose to a high of 2.91% last week, according to data from Yahoo! Finance. Similarly, yields on the 5-year Treasury rose from 1.04% on November 4 to a high of 1.56% last week.

Rising rates can be either good or bad — the key is the reason behind the rise. For example, if rates are rising because of a lack of confidence in a country’s ability to pay its debt obligations, such as is happening in Ireland and Portugal, then a rise in rates is a bad signal about the country’s future. On the other hand, if rates are rising due to strong economic growth, then that could suggest happy days are on the way.

Now, nobody would argue that the U.S. is experiencing strong economic growth; however, there are some positive signs that are being picked up by bond investors and that’s putting some upward pressure on bond yields, according to Bloomberg.

The recent good news includes weekly jobless claims, which fell last week to the lowest level since July 2008, according to MarketWatch; consumer spending, which rose for the fifth straight month in October, according to Bloomberg; and a better-than-forecast increase in consumer sentiment, which boosted the outlook for holiday-season spending at retailers, according to Bloomberg.

Rising rates also benefit savers because they receive a higher interest rate on their savings. But, just like eating too much pumpkin pie, a good thing can be taken to an extreme. If rates rise dramatically from here that would likely cause some economic indigestion. So far, we’re not in any danger of that scenario.

GOLD PRICES ROSE…

… 0.5% LAST WEEK AND ALSO ROSE 3.8% LAST WEEK, according to The Financial Times. Confused? Welcome to the world of currency translation.

When measured in terms of the dollar, gold prices rose 0.5% per ounce on the New York spot market last week (and rose 0.9% in dollar terms based on the afternoon fix from the London Bullion Market Association as shown in the chart above). However, when measured in terms of the euro, the New York spot price of the beautiful bullion rose 3.8% per ounce last week. The difference occurred because the value of the dollar rose about 3.0% last week relative to the euro, according to The Financial Times article. 

While this currency translation stuff might seem a bit esoteric and only of interest to financial wonks, it actually has a real-world implication for your investments. When you own investments that are denominated in other currencies — which can happen when you own multi-national companies or invest in funds that own foreign companies or foreign bonds — you have an added “currency risk.” And, as the world becomes more globally intertwined, the chance of a positive or negative currency translation effect may become larger.

From a practical standpoint, as the dollar gets stronger, it makes the return from overseas investments fall. Conversely, as the dollar gets weaker, it makes overseas investments rise as the overseas prices get translated into more dollars (because with a weaker dollar, it takes more dollars to “buy” the foreign currency). In recent years, the value of the dollar relative to a basket of six other currencies (the US Dollar Index) has bounced all over the place, but in the three years ending last week, the value of the dollar is up close to 6% against this basket, according to data from StockCharts.com.  Due to the currency risks, as well as other risks such as political instability, international investing may not be suitable for all investors.
 
As an advisor, trying to build a portfolio that goes up in value or provides steady income is only part of the equation. We also have to keep in mind how a stronger or weaker dollar affects you.

Market Returns

  This Week Year to Date Last 12 Months Last 5 Years
S&P 500 0.9% 6.7 % 9.0% -5.5%
Dow Jones Industrial Average .35% 6.37% 10.66% 1.47%