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How “Tapering” Will Affect Income Investors

“We are in a very interesting period in which poor economic data is actually viewed somewhat favorably by equity investors (as was the case following Monday’s PMI news) in that weak stats suggest that Ben Bernanke & Co. will delay the start of the tapering of its Quantitative Easing program,...

“We are in a very interesting period in which poor economic data is actually viewed somewhat favorably by equity investors (as was the case following Monday’s PMI news) in that weak stats suggest that Ben Bernanke & Co. will delay the start of the tapering of its Quantitative Easing program, while fears of having to ‘Fight the Fed’ increase when positive economic numbers are released. Illustrating the latter, stocks plunged on Wednesday, due in part to the ISM Non-Manufacturing report.

“This gauge of activity (also known as the NMI) in the service sector, which is far larger than the manufacturing sector, came in better than expected: ‘The NMI registered 53.7 in May, 0.6 points higher than the 53.1 registered in April. This indicates continued growth at a slightly faster rate in the non-manufacturing sector.

“Happily, we suppose, much of the economic data in recent weeks has been mixed, just like the two ISM reports, with a few pundits throwing around the term Goldilocks to describe the state of affairs. By this, they mean that the economy is not too hot for the Fed to tighten and not too cold to slip back into recession. For another illustration of the point, we need look only at Friday’s all-important employment report.

“Arguably the most important economic statistic of them all, Uncle Sam announced that 175,000 new jobs were created during the month of May, modestly better than the 163,000 or so that the prognosticators were projecting and relatively good news on the health of the U.S. economy. Of course, as the report from the Bureau of Labor Statistics stated, ‘The change in total nonfarm payroll employment for March was revised from +138,000 to +142,000, and the change for April was revised from +165,000 to +149,000. With these revisions, employment gains in March and April combined were 12,000 less than previously reported.’ And, the potential Fear of the Fed was further tempered by the fact that the unemployment rate actually ticked up to 7.6% in May, from 7.5% in April, as 182,000 people rejoined the labor force during May even though they had yet to find work.

For what it’s worth, we struggle with the idea that a strengthening economy and an eventual Fed tapering will be a big headwind for the prices of our undervalued stocks, especially as it is likely that corporate profits would come in better than currently expected in such a scenario and the likely exodus out of bond funds could provide plenty of fuel to stoke the equity fire. ...

“As The New York Times reported on Saturday, ‘Mututal funds that invest in long-term United States Treasury bonds lost an average 6.8% in May, according to Morningstar, with the loss in principal wiping out years of interest payments. But that’s not the worst-hit sector. Higher-yielding bonds and fixed-income securities, to which investors have turned in droves in recent years, have suffered even more, especially mortgage-backed securities and emerging market debt, as well as just about anything that uses borrowing to increase returns.’

“That said, we’ve really yet to see much in the way of excitement for stocks when compared to bonds, at least in terms of mutual fund flows. Indeed, for the week ended May 29, the Investment Company Institute (ICI) reported that a net $1.7 billion flowed out of domestic equity funds while a net $1.4 billion flowed into bond funds. Also, data provider Lipper had numbers out on Friday showing that equity fund (including ETFs) net outflows were $2.3 billion for the week ending June 5 vs. outflows of $591 million for the week ending May 30.”

John Buckingham, The Prudent Speculator, www.theprudentspeculator.com, 877-817-4394, 6/10/13

John Buckingham leads a team that scours the equity markets in search of undervalued stocks for money management clients and newsletter subscribers. He is equally resolute in his management of Al Frank’s proprietary mutual funds. Mr. Buckingham has been a part of Al Frank Asset Management since 1987 and is the company’s largest shareholder. He has served as the firm’s Director of Research since 1989 and Chief Portfolio Manager since 1990. Mr. Buckingham graduated magna cum laude from the University of Southern California in 1987 with a B.S. degree in computer science and a minor in business administration. His opinion is widely sought: he has appeared on numerous television and radio programs, is frequently interviewed by publications and conducts workshops at investment seminars.