FDLIC Corporate Officers blog about current issues in the preneed industry and in funeral service, providing insight, commentary, and news updates.
What to Expect from Financial Markets in 2012
Wednesday, January 4, 2012
First of all, if I knew what financial markets would do in 2012, I wouldn't be bothering to write this article. Instead, I would be off playing the futures market like a madman. So, we have to be like the newsletter writers and talk about what to expect. The most important financial market for FDLIC is the bond market. The level of interest rates available in the bond market determines interest income for us, which determines what growth rates we can afford to pay on our policies, after allowing for commissions, expenses, etc. Those of you who keep up with this sort of thing know that interest rates have generally been falling ever since 1981. That's a long time! In fact, it encompasses the entire amount of time that FDLIC has been in business. There have been periods of time when rates rise, but the overall trend is relentlessly down.
The graph below shows the overall trend of yields on 10-year Treasury bonds for the past two years.
Yields have hovered around 2% since last August, having fallen from 3.5% last spring. That means interest income on 10-year treasuries has fallen by 43% since last spring!! (Note that FDLIC has maintained its growth rates constant throughout this year's unexpected decline.) Unfortunately, there is no expectation that bond rates will rise in 2012. In their meeting this December, the Federal Reserve Open Market Committee reiterated four existing policy stances:
- Keeping the federal funds rate between 0% and 0.25%.
- Moving ahead with Operation Twist, lengthening the average maturity of its holdings to bring longer term interest rates down (!).
- Continuing to reinvest in mortgage-backed securities to support that segment of the market.
- Forecasting that these policies are likely to remain in place until at least mid-2013 (!).
Add to that the fact that troubles in Europe are causing a flight from the Euro. A lot of that money flows into US dollar denominated bonds, pushing the yield rates down. In other words, about the only thing that is expected to change in the bond market next year is that yields might fall on longer term securities. Not good news for savers and investors. On the other hand, if you need to borrow money to expand a business or refinance a mortgage, now is a great time.
What about investing in stocks? FDLIC does not currently do that, but we have dabbled a bit in the past. Returns are just too volatile and unpredictable in that market. The fundamentalists are predicting a good 2012 for stocks. Interest rates are low, inflation is low, PE ratios are low and we are coming out of a recession (sort of). All that should be great for stocks. On the other hand, much of the world may be heading back into recession. If that happens, the US stock market will not do well because it can not operate in a vacuum. World economies are intricately entwined these days. Also, stock cycles are not favorable, if you give credibility to that sort of thing. I think cycles do tend to repeat in general, just not in detail. Below is a graph that shows the 20-year annual rate of return on the Dow Jones Industrials. Currently, stocks are in the middle of a "low return" cycle. The implication is that stocks will not begin a long-term sustained rise until the 2020's. I don't think my 401k can wait that long.
Another completely different cyclical analysis that comes to the same conclusion can be found at www.advisorperspectives.com. Also, some of the Elliott wave disciples are predicting a coming crash. So, good fundamentals coming up against bad technicals may be why we are getting whiplash in the stock market on a regular basis lately.
So, how will FDLIC invest in 2012? Very carefully! We will probably avoid stocks due to the uncertainty and volatility. Also, we can't just go out and put all our money in 30-year bonds with the highest yields. We must "ladder" our investments so we have sufficient cash flow available every year to pay claims and expenses. So, we will buy the highest yielding bonds available that are both good quality and match the maturities we need. Finally, we will look to expand our funeral home mortgage lending program. What better way to invest our money than to invest in the needs of our funeral home clients? If we can help a funeral home expand its business or lower its costs, everyone is a winner. In short, we will do what we always have--look for the highest returns possible consistent with safety. After all, we are not only investing for ourselves, but for our funeral homes and their customers as well.