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The Current Economic Climate

We have enclosed articles (see links below) that highlight some interesting aspects of the current economic climate. They discuss the current extremely low interest rate environment (courtesy of the Fed).

The common theme on these articles is the unintended consequences arising out of policy decisions made by the Federal Reserve and by Congress. Through the end of August, the summer has been characterized by renewed fears of a “double dip” recession. As a result, investors have been fearful of investing in businesses in favor of investing in long-term, government bonds. To a great extent, investors are responding to their fears arising out of their recent traumatic experiences in investing in equities – both over the last few years, as well as, over the long-term (last 10 years). In prior commentaries, we have noticed that the bond market (particularly on the long-end) may be a bubble that may ultimately create issues down the road.

The articles below suggest that in manipulating rates (in an effort to “goose” economic activity), the Federal Reserve is creating winners and losers. In the losing column are the millions of retirees and savers who are earning little or nothing on their cash and bank balances while, at the same time, being fearful of equities and high yielding securities. As a result of this, we’ve noticed that certain dividend paying stocks seem attractive relative to the alternatives.

In the winning column, however, are borrowers. Corporations are refinancing their obligations at a rapid rate. For example, On August 12, 2010, Johnson & Johnson raised $1.1 billion in new borrowings. Half of the notes mature in 10 years and carry a rate of only 2.95% per year. The other half mature in 30 years and carry a rate of only 4.5%. Investors who are loaning money to them at these rates may be surprised (especially with respect to the 30 year notes) if, as is likely, inflation rises unexpectedly.

On the other hand, it is an excellent time to refinance a mortgage (if you qualify under today’s somewhat tighter underwriting standards). At The Ridgewood Group, we eat our own cooking. I just refinanced my own mortgage about 30 days ago and got a 30 year amortizing mortgage at the rate of 4.375% with very low (approx 1%) points. (BTW, compare this rate to what you are quoted by your bank or mortgage broker – for the benefit of our clients, we believe we have found 2 of the lowest cost mortgage lenders in the country and we find that their rates (for borrowers with good credit) seem to be better than most of the other alternatives. If you are thinking of refinancing and want a referral to these lenders, email or call us back to find out how you might be able to take advantage of their programs.

As a result of the above, my borrowing rate on the new mortgage is only slightly higher than what Johnson & Johnson has to pay! For the astute among you, you’ll notice that the rate I pay on my 30 year mortgage is actually slightly lower – however this is not an apples to apples comparison – because my mortgage is amortizing and the J&J bond is not, the weighted average life of my mortgage is closer to 20 years than to 30 years, so the imputed rate that I pay is actually higher on an adjusted basis. Also I had to pay a small amount upfront to buy down the rate slightly, but my payback on the buy down is less than 2 years given the savings in the form of the lower interest rate.

Ken Majmudar, JD, CFA

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