Spring is finally here! At least, for now it is. Spring time usually means an uptick in the housing market, as the warm weather and end of the school year entices more people to move. That means increased prepayments on mortgages, and faster pay down on mortgage-backed bonds like the ones in Cooper Capital portfolios. This spring, however, has been hampered by a few factors.
First, there was the Nor’easter. Then the next Nor’easter. And the next… The persistent winter weather delayed the start of the busy season in the housing market. Additionally, as the Fed has raised their benchmark interest rate, mortgage rates have also moved higher. This slows refinances and real estate purchasing, as homeowners choose to stay in their existing homes rather than pay higher mortgage rates.
These circumstances have kept us from seeing the increase in principal payments we typically see at this time of year. As summer comes on, though, we should start to see an improvement. Prepayments will probably not reach levels we’ve seen in previous years, but there is likely to be an increase from the current slow speed.
We have seen an abrupt and drastic move in the bond market since the start of the year. Ten year Treasury yields are approaching 3%, which many see as a significant threshold leading toward a bond bear market. The corresponding drop in bond prices has had an effect on Cooper Capital portfolio values. This progression, however, is a necessary evil to get us to higher yields. As long term investors, we are happy to see yields finally moving, and are even “giddy at the prospect of a selloff in bonds that would push rates back up to the levels of yesteryear,” as an article in Bloomberg BusinessWeek puts it.[1] Rates have been low for so long that it had a detrimental effect on returns. Rising interest rates means a drop in portfolio value, but given our intention to buy and hold, the benefit of higher yields is much more important.
Because the bond market moved so dramatically in the first quarter, we are unlikely to see another big adjustment anytime soon. We anticipate portfolio values will remain depressed for the next six months, but as we are able to supplement with higher yielding bonds we should start to see an improvement in interest rate returns. Because rates are moving uphill, reinvestment will remain slow in order to keep cash available for future purchases.
Our strategy has always benefited most at the edges of the interest rate cycle. When rates will hit their peak is unclear currently, but the future should sharpen some as we get further into the tax cuts and Federal Reserve meetings of 2018. As the turmoil of the tax changes and budget deficit settles down, we should be able to get a better idea of the resiliency of the economy, and that will help dictate the pace of our purchasing.
[1] https://www.bloomberg.com/news/articles/2018-02-06/this-bond-market-could-get-uglier
This information is not intended to be used as the only basis for investment decisions, nor should it be construed as advice designed to meet your particular needs. You are advised to seek the advice of your financial adviser, legal or tax professional, prior to making any investment decision based on any specific information contained herein.
