Article By Joshua E. BetancourtPortfolio Manager/Financial Planner Quantum Capital Investments

Portfolio & Market Recap

In May, interest rates climbed aggressively and investment grade bonds and US Treasuries bonds were dealt a sound beating. Prior to the selloff, QCI (Quantum Capital Investments) felt that both Treasuries and Investment grade corporates did not offer the best bond opportunities given the historically low interest coupon payments (yield) and their lengthy bond maturity date (date when the bonds come due). We decided to sell out of most of our US treasuries, investment grade corporates, and utility positions on May 2, 2013. This was a well-timed move as shortly thereafter US Treasuries, Investment grade corporates, and utilities crumbled. We did opt to stay in our high yield bond investments. During a rising interest rate environment, high yield bonds tend to perform favorably vs. investment grade corporates, US treasuries, and utilities. High Yield bonds are also less sensitive to a large rise in interest rates versus Treasuries, Investment Grade Corporates, and Utilities because of their higher coupon payments and shorter time to maturity. Floating rate bonds and High Yield short term bonds are examples of high yield bonds that are less sensitive to rising interest rates.

Unfortunately, even the best bond sectors will take a dip during a rising interest rate environment as new higher coupon-paying bonds are issued and lower coupon bonds are sold or adjust to the current market rates. For this reason we believe it is very important to remain tactical in this new rising interest rate environment. The best potential bond option is a shorter time to maturity bond paying a Higher Yield.  For investors focusing predominately on income, our recommendation calls for investments in shorter duration high yield bonds and preferred stocks (stocks that pay higher interest coupons, are subordinate to bondholders and are redeemed at par). We also favor higher yielding international Sovereign debt and International investment grade corporates with short maturities of 1 to 3 years. We believe the rising rate environment will force investors into the equities markets as longer dated bonds continue to trend lower for many years to come. We are long term bearish on Treasuries, utilities and long dated investment grade bonds of 4 years or more.

The spike in interest rates will have a severe negative effect on real estate. The recent boom recovery in real estate was fueled by the low interest rate borrowing environment and precipitous decline in rates prior to May of this year. This low rate environment fueled refinancing and consumer spending, creating a wealth effect by making consumers feel positive and loosening the purse strings as their mortgage payments were reduced via lower mortgage rates. With the rise in interest rates, the refinance boom will slow dramatically. The stock markets will most likely retreat as it digests the slowdown in real estate caused by higher borrowing costs. We could see a potential 5% to 7% US stock market decline stemming from an end to the refinancing boom which placed extra dollars in consumers’ pockets. However, we would expect a recovery within the year and thus remain bullish for stocks in the long term.

It is important to discuss the US Dollar Index and its ramifications on the stock market. We have a stable forecast for the dollar in the short term (2 to 3 months). In a stable or strong US Dollar environment, US corporations which import their products & US corporations who employ outside the US will tend to profit from the favorable currency cross rate. Historically, the US corporations which tend to outperform the general market during rising rates and a strong dollar are: consumer retailers, software, semiconductors, and chemical producers. Corporations that are highly leveraged will tend to do poorly as they service and refinance their debt under less favorable terms. Our favored sectors have already begun their out-performance in April and May of 2013. Our XRT etf position (retailers) and XLY etf position ( consumer discretionary) have outperformed the broader markets. In our larger accounts, our April stock purchases of Metro PCS (now T-Mobile), Macys, Kohl’s, McDonalds, Intel, Microsoft and Cisco have been rewarding. We believe these sectors trends will persist during a rising interest rate and stable to strong dollar environment.

Equity Sector Forecast

We have a positive outlook for the energy and the natural gas exporting business. The United States has made tremendous strides in 2013 towards energy independence, allowing for the exportation of our energy resources to China and abroad. For long term double digit growth, we favor shipping and railroads companies that will service this industry in years to come. Clean energy companies will also get a long term boost from industry favorable energy policies taking hold on Capitol Hill. We believe an overweight allocation in energy shipping, clean energy and leading US natural gas producers are a prudent long term growth investment strategy.

Despite the negative media coverage on the European economy, the underlying numbers are telling a different story. The Eurozone purchasing managers’ index (PMI) for May rose to 48.3, up from 46.7 in April and the highest since February 2012. The largest PMI gains came from Spain, spiking to 48.1 in May, up from 44.7 in April thus reaching its highest level in two years. In the UK, the PMI beat expectations at 51.3, indicating that the UK economy is beginning to expand as it crossed the 50 PMI expansion mark. A fast rebounding PMI indicates recovery and ecomic expansion. QCI believes there to be tremendous long term ( 5 to 10 years) deep value opportunity with potentially high double digit returns in the Eurozone as this economy recovers. We favor sectors in the financial, banking, insurance, as well as media and consumer retailers.  We are very bullish on European stocks in the short to medium term and recommend an overweight for the region versus Emerging markets and Asian markets.

In summary, the equities markets have greater long term prospects over bonds. However, we believe that in order to capture additional stock market upside, we must look abroad to recovering economies as our own US economy slows or enters a correctionary period. We believe that certain Eurozone economies, technology and the US energy exporting businesses will outperform the broader local market and thus will seek to overweight these sectors. The bond market will remain a very difficult evironment going forward given a shift toward rising interest rates. We reccomend shifting to shorter duration higher yielding US bonds with further diversification from international higher yielding fixed income markets.

Kindest Regards,

Joshua E. Betancourt

Founder, Financial Planner, Chief Portfolio Strategist