Issue 29 - December 1, 2005


Determined Not to Yield

The word “stubborn” comes to mind as we review the recent trading range of the
U.S. Treasury yield curve.

In general, we find the characteristics of stubbornness to be beneficial to long-term investing. By constructing resilient portfolios that can defend through short-term volatility, strategic stubbornness is often rewarded during opportunistic market moves. Staying in the game and withstanding a miserable October in the U.S. equity market to enjoy a very positive November is a perfect example of such stubbornness.

On the other hand, U.S. bond market participants have continued to demonstrate behavior that has taken stubbornness to an extreme. The U.S. Treasury curve is now almost perfectly flat, with essentially no premium for buyers of long-dated bonds versus short-term bonds. Put another way, despite an increase in short-term rates of 300% in the last 18 months, the benchmark U.S. Treasury ten-year note remains essentially unchanged.

Bond Market History Lessons

We witnessed flat and even inverted Treasury yield curves in the not too distant
past (in 1981 and 1989). Why would a buyer buy long bonds at the same or lower
rate than short-term bonds? The rationale lies in the belief that long rates are going
to be much lower in the future and that the attractive rates should be locked-in. In general, long-term rates would be headed lower in response to a significantly weakening U.S. economy. This was the case in both 1981 and 1989 when the flat curve was an accurate barometer of coming activity. Current economic factors are substantially different however.

• The current absolute level of rates is substantially lower. One might be tempted to lock in ten year rates of 7.50% to 12% (as was the case in the 1980’s). Locking in at the current market rate of 4.5% assumes that rates will be even lower (and that the economy would be significantly deteriorated).

• The U.S. economy is also coming off of an extraordinary set of circumstances: the bursting of the U.S. equity market bubble, the subsequent 9/11 attacks, and fears of a Japan-like deflation. These events took short-term rates down to an unprecedented level of 1%. Today’s rising rates represent more of an unwinding of situational accommodation than a tightening intended to slow down an overheated economy.

The Federal Reserve will have two more meetings under the stewardship of Alan Greenspan. We expect the committee to raise the benchmark by an additional 25
basis points on each occasion which would leave us with a neutral Federal Funds rate of 4.50%.

It is entirely possible that this level of short-term rates could persist for some time. This will create a very challenging scenario for long-duration bond bulls. Bonds yielding no more than a money market fund with four times the price volatility are not particularly attractive. In addition, there would be no more positive “carry” meaning that there would be no way to profitably finance these longer bond purchases. Historically, a flat curve has been unsustainable and we would expect investors to once again require some modest premium for owning longer-term bonds.

2005 Home Stretch

As we enter the final month of this year, long-term investors continue to be encouraged. The Federal Reserve is certainly within sight of finishing up the rate increases and the equity market is priced to what can be described as reasonable valuations. While we have lost the tailwind of ultra low interest rates, the absolute level of current rates is still well below historical norms and credit is widely available. Rising energy prices are certainly a drag on the economy, but as we commented in our last newsletter, the growth in wage gains is also a very powerful positive force.

One trend which we see continuing to distinguish itself is the rise in fiscal
importance of the global market place. While this statement may seem self evident, profits derived for both U.S. and International companies have an increasing global reach. This broadening of the marketplace combined with ever increasing levels of productivity is providing the catalyst for profit growth this year. These factors should provide a solid foundation for growth into the new year.


In this Edition

  • Determined Not to Yield
  • Bond Market History Lessons
  • 2005 Home Stretch

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

28 - 10.03.05
The Pennant Race
Just the Facts
Fourth Quarter Implication

27 - 08.11.05
Back to the Future
Reports of Demise
Greenspan Countdown

26 - 06.09.05
Measured Conundrum
Possible Explanations
Implications of an Uncoupled Market

25 - 04.13.05
1st Quarter 2005:
Up, Down, Sideways
Calm on Top, Turbulence Below
What's on Deck?

24 - 03.09.05
Housing: Priority
#1 for the Federal Reserve
Calling the Top Again
Policy Implications

23 - 02.11.05
Interest Rates and the Federal Reserve
A New Demand Paradigm
No-Traditional Buyers
4% Looks Good
Chicken & Egg Market

22 - 12.02.04
Drooping Dollar
Not Everyone is an Investor
Implications for 2005
Putting the Euro in Perspective

21 - 11.04.04
Personal Savings
Absence of Rising Tide
US Elections

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

   11/30/05 09/30/05 06/30/05 03/31/05 12/31/04 12/31/03
DJIA US 10805.9 10568.70 10275.00 10503.80 10783 10453.9
S&P 500 US 1249.48 1228.81


1180.59 1211.92 1111.92
Nasdaq US 2232.82 2151.69 2056.96 1999.23 2175.44 2003.39
EAFE Int'l Equity 1606.14 1618.84


1503.85 1515.48 1288.77
5 Yr Treasury 4.415 4.207 3.731 4.21 3.649 3.231
5 Yr AAA Muni 3.510 3.26


3.29 2.79 2.45
10 Yr Treasury 4.531 4.368 3.972 4.512 4.257 4.225
10 Yr AAA Muni 3.910 3.720 3.54 3.920 3.64 3.6
30 Yr Treasury 4.665 4.522 4.163 4.731 4.817 5.01
30 Yr AAA Muni 4.520 4.47 4.3 4.580 4.58 4.54
EUR Currency 1.1777 1.2052 1.2053 1.2958 1.3652 1.2612
JPY Currency 119.51 113.39


106.88 102.48 106.92
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