Webinar:The First 100 Days
The First 100 Days: Preparing your portfolio for an unprecedented market environment.
Thank you, and good afternoon, everyone. I'd like to welcome everyone who has joined us for today's discussion. As I introduce our speakers today, you will see three poll questions rolling across your screen so we can see where the group stands on a few of the hot topics these days. We would really appreciate everyone's feedback on these polls, and we will discuss the results during the presentation. Thanks.
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Our first presenter, KC Matthews, is Executive Vice President and Chief Investment Officer for UMB Bank. As an industry veteran of more than 25 years, he oversees UMB's investment strategy and manages more than $8 billion in assets for the company. KC provides economic commentary on behalf of UMB, is a regular contributor on Bloomberg Radio, CNBC television, and TheStreet.com. As well as touring the US talking to investors about the state of the economy, the banking industry, and investing. We also have two individuals from the investment banking division. Steven DuMont is an Assistant Vice President with UMB Investment Banking Division. His responsibilities include developing investment portfolio strategies, identifying suitable fixed income investments based on risk tolerance, and asset liability management consulting. Bill Patterson is a Vice President with UMB Investment Banking Division, and offers transaction and portfolio services for banks, institutions, financial advisors throughout the southeast and Midwest, as well as investment and marketing analysis, asset liability management consulting, and balance sheet strategies for institutions. Now, I'll turn the call over to KC who will share his assessment of our current macroeconomic forces. Casey?
Thanks, Steve. Good afternoon, everyone. Great to be with you this afternoon, and we have lots to talk about. So I thought I'd start with taking a look at the consumer. So if you're following along on our webinar here, I put together a slide here, in just a moment, that talks about consumer confidence. As you all know, consumer confidence is critical to the economy. Almost 70% of the GDP is reliant on you and I, the consumer. So I want to see how healthy the consumer is, and that indicator is consumer confidence. But at the same time, I like to know how business feels about things. And when you look at the business environment, typically small business is the backbone to business. So I like to look at small business optimism to see how they feel about things. So on this slide here, the top pane is consumer confidence. And you can see since consumer confidence has been on the rise. People are feeling better about things. And over on the right hand side, you can see the level we're at, currently 113.7, which is the highest level we've seen since 2001. And what we look at is, does this support a robust economy? And the answer is yes. Typically when you see results this high, you've been in periods of, call it, moderate economic growth. Greater than 2.5%, and I'll talk about our forecast in just a minute. But when you think about the why, what is driving consumer confidence? I would argue there are a number of factors. One is the labor market. Typically if we're gainfully employed, and we're going to get raises and bonuses, we feel good about the economy, we spend money. And unemployment's at 4.7%, and I think it will be relatively constant throughout 2017. But last year, we created 180,000 jobs on average per month, well over I expect something similar in 2017. But there's also an alternative measure of unemployment that I like to look at, and that's the U6. That includes the unemployed, the marginally attached worker, and then the part-time worker. And part-time worker, for economic reasons, meaning they'd like to find full-time work but can't find it. And that stands at 9.2%. That's at a nine year low. So when you hear the media and others talking about, well, there's a problem with jobs and the quality of jobs. I don't buy that argument when you look at the data. Because even the U6, prior to The Great Recession, stood at 8%. So you can see how the labor market has truly recovered, being one of the drivers of consumer confidence.
Another driver would be interest rates. We'll get to my forecast in just a minute about interest rates. Clearly interest rates are going to be on the rise, but even with interest rates moving higher throughout the year, they're still at a relatively low level, especially relative to history. So consumers will feel good about things, consumers will feel good about taking on debt, and again, consuming, driving the economy. Low energy prices, even though you've seen energy prices on the rise, up 20% since the election. Again, as I drove around town this morning, gas prices are like $2.20 or something like that. They're reasonable and it won't spoil the way the consumer feels about things. Then lastly, I'll just mention housing. Housing prices are up about 5.1% year-over-year, that makes us feel good. I expect the same type of appreciation in 2017. So again, consumer confidence will remain stable and might move higher, depending on some of the pro-growth initiatives the president might execute on throughout the year.
So let's turn to small business optimism. At the bottom of this slide is the NFIB, the National Federation of Independent Business, small business optimism. They do a survey on how small business feels about things. And again, when you look at the lines since 2009, you can see that the chart has improved nicely. And then, all of a sudden, you're at a 12-year high at seeing a V-shaped rebound that typically you see when you exit a recession. Well clearly, we are far from exiting a recession. But small business feels good about things. Part of our research process, we spend a great deal of time conducting CEO roundtables, I just returned into town this morning after conducting two roundtables over the last two days. And sure enough, the anecdotal evidence is there that small business feels good about things. Now what's interesting is when you ask them what keeps them up at night, and even the NFIB puts a survey out to ask them what their biggest concerns are. Small business is concerned about taxes and regulation. And when you think about what President Trump ran on, his platform was all about, let's reduce taxes and remove regulation. And clearly, you've created kind of a nirvana type stage for small business. And lastly, I just want to point out what's interesting from the survey is the NFIB asked people how they feel about business going forward. And the outlook for business in the first half of 2017 has been the most optimistic that we have seen since 2002. So my point here is, with looking at all this data, clearly the economy has momentum. Forget about the new administration just for a moment. But in the second half of when you look at the evidence and the data, the economy is gaining momentum.
Now, if you move over to the right hand side of my slide here, you can just see I labeled a few of Trump's pro-growth initiatives. Clearly we're going to see some type of tax reform. It's kind of interesting that every Republican president that followed a Democrat administration has launched some type of tax reform. So history supports tax reform. And of course, President Trump has really said he's going to lower taxes. And I feel like he's going to get it done, since the Republicans control Congress as well. Regulation, clearly he's already tackling that. He's going to remove regulation, I'll talk more about that in just a minute. And then we'll see some type of infrastructure deal, and there's no doubt that we'll get that done. There's a bit of a timing issue there. So if the economy has momentum and President Trump executes on some of these initiatives, I think there's risk to the upside in our GDP forecast. I don't know if he can get to but could you get between 2.5%, up to 3% for a year or two? I think it is quite possible to do that when you dissect the data. The risks to the forecast is, of course, trade. Just today, I think there was a meeting canceled between President Trump and the president of Mexico. You don't know exactly what's going to happen there just yet. And then immigration. You cannot shut down our borders. Protectionism is bad for jobs, bad for ingenuity and creativity. We need some type of immigration policy that allows immigrants to come in legally, and really supply labor to our labor force. So those are some of the risks. But why don't we get more granular on some of President Trump's pro-growth initiatives.
Here's some of the things he's talking about, corporate tax reform and some type of tax holiday for the repatriation of foreign profits. I do believe that will get done, like I said. It has gotten done in history, and given who controls Congress, we will see that. What exactly it is, we don't quite know. But here's the one thing to think about. When you just look at the raw data, everyone cites, well, the US has the highest corporate tax rate, 35%. But the effective tax rate of the S&P 500 companies is 28%. So if you get down to 15% or 20% and remove loopholes and deductions and things like that, that will be beneficial to corporate America. If you move it down to 25% or something like that, and then remove the deductions and loopholes, you're really reshuffling the deck chairs. Nothing really changes, so we'll have to see how that plays out. But I do think it'll be beneficial. The other issue is fiscal spending. That's really infrastructure. I believe that will get done, it has bipartisan support. You may recall that in 2009, President Obama instigated the Recovery and Reinvestment Act, which was the infrastructure spending bill, $800 billion. The issue here is timing. When we talk to our construction sources and ask them, have you ever seen a construction-ready project, a shovel-ready project, excuse me. They say, OK, so I've heard of the shovel-ready projects, but I've never seen one in my career. So it just takes time to get through the planning and the funding and all that. So we might not see a huge benefit from infrastructure spending in 2017, that might be a 2018 stimulus. Lower tax rates for individuals, clearly beneficial for individuals and discretionary income. And typically when we have more discretionary income, we choose to consume rather than save. And I do think that will happen and it will probably be retroactive to the beginning of 2017.
Reduced regulatory burden. That's kind of interesting that there's a lot of think tanks out there that have put data out that suggest regulation costs our country-- remember, we have a $19 trillion economy-- costs our country $1.8 trillion a year. Now, I would think that most of us today would agree that some regulation is positive. Take lead paint, for example. Lead paint is bad. But then all of a sudden if you're in the paint business, you have to monitor it, provide evidence you don't have lead, have an audit. And all of a sudden, the costs go up and up. And all of a sudden it was, well, what happened to lead paint's bad? So whether you're in health care or banking or manufacturing, regulation has become an incredible burden. And the President has suggested we reduce regulation by 75%. I think he will get something done, to what extent it's hard to tell, but nevertheless it will be positive. Even if you just stop all the new regulations. Remember that we had, in the last eight years, we had twice as many regulations than we've seen in the past two administrations. So if we just stabilize regulations with no more, it will be a positive to our economy. Now, the repeal of the Affordable Care Act, or Obamacare, clearly a focal point for the President. We think this is actually a takeaway, because if you were to curb spending, it would be negative for the economy. So we don't know exactly if he is going to repeal and replace, the timing on that, we don't know if spending will be curbed, but this time we think it might be a bit of a takeaway. A relatively small takeaway from the economic growth at this time. Most of all, I want to talk about interest rates. Perhaps something that's top of mind for all of you on the phone. I'd like to first start with just thinking about the drivers of interest rates. So one is, of course, economic conditions. We already talked about that, I think improving conditions, momentum in the economy. But also a driver of interest would be inflation expectations. So I graphed here for you, is the five year forward break-even. And so you can see that, really since midyear, inflation expectations have been on the rise. And that really coincides with an improving economy. And then in November when we knew who the new president was going to be, you saw a bit of a spike there in inflation expectations.
So I do think that if President Trump is successful in implementing his pro-growth initiatives, I do think inflation expectations will modestly be on the rise. So I think it allows the Fed to manage interest rates higher. Our forecast right now is for the Fed to only get two hikes in. Now, I'm not criticizing the Fed, but you might recall at the beginning of 2016, they suggested four hikes and got one. At the beginning of '17, they're suggesting three hikes. So we think they get two hikes in. At the end of the year, Fed funds stand at 1.25%. And we think that the 10-year treasury will move up to about 3%. So the whole yield curve shifts higher a bit. What would spoil our forecast is some type of unexpected spike in inflation expectations, or runaway inflation. And I just think with the capacity you have in the global economy, I don't think you'd see runaway inflation. Now there might be a black swan out there that would create some temporary spike inflation expectations, but at this time I don't see it. And I think the Fed will be able to manage a glide path higher on interest rates. The next question you might have on your mind is, what do you think it does to the shape of the yield curve? So I just graphed for you here the slope of the yield curve. And the orange, or red line there at the end of the year 2016, and then that blue line is what we think we'll see at the end of 2017, the end of this year. And one thing is, you can see that, for the most part, the yield curve we think will just move higher. I think you could see a short-term steepening of the yield curve, and that's nothing more than timing. That if you were to get some inflation expectations that surprised the street, I think the bond vigilantes would move the long end of the curve higher, faster than the Fed can react, so you get a steepening of the yield curve. Like I said, I think that would be short-term and nothing more than a timing issue. I think, over time, you get a bear flattening of the yield curve. Very modest bear flattening, as you really prepare for the next recession. I don't think that recession is on the horizon for a number of years, but we're late in the business cycle. We all understand the business cycle, so at some point in time, I think the yield curve will flatten, really indicating the oncoming recession. And that might be three to five years. All right, so in summary here, I wanted to give you an idea of some of our forecasts. So on this slide here, I'll show you what happened in 2016 and what we anticipate will happen in 2017. So tomorrow, we'll get fourth quarter preliminary GDP. We anticipate that, for the year, it comes in at about And we anticipate, with the momentum of the economy and some of the pro-growth initiatives being executed on in the year, the economy will improve to about a 2.5% real GDP number. As I alluded to before, I do think there's some risk to the upside. Meaning that if President Trump really gets after it, could you see a higher number? I think in 2017 you could.
Is it sustainable to grow at 3%? I don't believe it is for a number of reasons. Unemployment, really, I think is going to be stable at around 4.8%. I think we're close to full employment. I think the only way to get more people in the labor force would either be through immigration, could be through higher wages, or it could be all of us working longer and then exiting the labor market. So some of that will happen, but I think for the most part, unemployment stays right around below it. Housing starts are important to our economy because it creates jobs. I think housing starts will grow 8% to 9% and that will be positive. Housing prices, I think, will go up another 5%. As I mentioned, ten-year treasury to 3% by the end of the year, 1.25% Fed funds. And just real quickly on the stock market, I do think the stock market will perform well. One reason is, remember last year, we were all worried about an earnings recession. We had two quarters of negative earnings growth and we thought the world was coming to an end. And we made 12% in the S&P 500 total return. I think you could see similar returns this year, that our price target for the S&P 500 is 2,440. And that is really driven by a 9% earnings growth, and I think that's modest. If you get some of these pro-growth initiatives executed on, I think your 9% earnings growth could go to 15% almost overnight. But just being conservative, If nothing else changes as far as multiples, that gets you 9% appreciation in the stock market, gets you to 11% total rate of return, similar to what we saw last year. So, bottom line, I think we have a lot of momentum in the economy. And President Trump, who is clearly focused on the private sector and not focused on government, could really boost the economy in 2017. That's awesome, KC. Thanks for the overview.
You know, this would be a great time to look at the results of our poll and see if they agree with you on the number of debt increases, how about that? Let's take a look. OK, we had-- oh yes. They agree with you. How about that? Did we plant that? Come on. That's awesome. How about interest rates? So we think, let's see. The tax rates, we think 25%. And again, I think that's where you came in. All right, that's interesting. So, so far, everyone is lined up with where you are. We're close. And let's look at the final one. OK, also yesterday was a great day in the markets. And the equity markets seemed to like a lot of the things that they're hearing. Business seems to be abuzz. You might talk about the Dow going through 20,000. Yeah, that's kind of interesting. Clearly, the market being a leading indicator, really would echo my comments. That with the pro-growth initiatives, it's going to be positive for the economy. And the market then discounts that. It moves long before we get the actual data. Now going past 20,000 on the Dow is very historic. It's kind of interesting. We went back and looked at what happens when we go through these milestones, these nice, big, round numbers. Typically, you continue to have momentum in the markets that, three months out, you have performance of about 3.5%, on average, to the upside after you go through those milestones. So a lot of things are pointing in favor of a decent stock market and a decent economy. That's awesome, thank you very much for your overview.
Now, I'd like to turn to the Investment Banking Division officers, Stephen DuMont and Bill Patterson, who will share their strategies on how you may prepare your portfolio for what's ahead. And I think it's nice to see that everyone tends to agree online to what you said, so this should flow very well. Stephen? Thank you, Steve. Thank you KC, as well. I agree with your assessment that this is an exciting time in the economy as the new administration enters office. Monetary policy has led the way out of the recession. And I think that, based upon your comments today and what we're seeing in the news every day now, fiscal policy might be more emphasized in the coming years and creating some positive growth in the economy. Now that we are well into the new year, a few things are plain to me. One of them is that there will likely be a difference between the rate paths of 2015, 2016 and 2017. And when all is said and done, 2016 contained a lot of volatility but ended the year with approximately only a 10 basis point improvement in yields, and with a steepness that characterizes the current curve.
Now, Bill, what do you think is ahead in 2017? Well, as KC mentioned, I think it's going to be a whole lot more exciting than 2016. As you mentioned, we went through a bunch of iterations and volatility over the year, but we basically only changed a net of 10 basis points. We're in a situation where the Dow's now beat 20,000, we've got some slope to the yield curve now. So we need to start thinking about, what does this mean as a fixed income investor? And that kind of poses some more questions about, what is ahead for fixed income investors?
Stephen? When we look into 2017, there's a couple things that I think we're keeping our eyes on pretty closely. And one of them is going to be how successful President Trump is in following the pledges that he made during the campaign. Clearly it's easy to see, from the get-go, he has rolled up his sleeves and gotten to work pretty quickly. And I think there's a question about how successful that might be. If he does succeed in this infrastructure build out and we have a lot of investment into our roads, bridges, and whatnot, could we possibly see a higher inflation level and a growth in GDP? I think that that's clearly a possibility. What kinds of headwinds do you see,
Bill? think it's right. We do need to sit back and look at the headwinds a little bit. The market has moved a good bit, and it's paused for a reason. And that's the fact that we've got to sit back and assess the fixed income standpoint, where is this going and what's going to move it in multiple directions? And one of the things that we have to worry about when we're managing a bond portfolio is the shape of the yield curve. So when you're looking at these headwinds, we've talked about a lot of domestic issues that KC has brought to the forefront. We've also got to remember what's going on in Europe, they tend to buy our market fairly heavily. It's going to take awhile to resolve the whole Brexit issue. There's a kind of a populist movement going on in Europe. We've got some fairly serious problems with the Italian banks. Now when you think about the problems in Greece and some of the Brexit issues and what that did to our market, and you sit back and look at the Italian banks. That's the third largest economy in Europe. Their banks, right now, have When we were at the bottom of our recession, our banks had 7% to 10%. So they're somewhere around twice as bad as we were, and they're the third largest economy. So that's going to create some looming problems. And what that does is, is it going to tamper our GDP growth or anything like that? Probably not a whole lot, it will affect us some from a trade perspective. But what it's really going to do is it's going to put a lot of money in our markets. Or not, depending on how this goes. So that's one of the things that we've got to pay attention to. And all of this is going to play into how the yield curve reacts, which is going to play into how you need to manage your bond portfolio. So the two yield scenarios, and the first one I'm basically reiterating what KC mentioned earlier, is a parallel up-shift. I think we all agree, that's kind of the most likely type of a scenario. And that's what the whole curve shifts upwards. The bigger part of the curve that we're concerned about is the 10 and in portion. We could see a little flattening beyond 10 years from fund flows from international forces, like Europe. Additionally, if some of the fiscal policy measures don't transpire fast as the administration would like to, that could bend us down a little bit. But overall, we think the curve is going to shift upwards, like what KC was mentioning. Another possible scenario we need to keep in mind is bearish steepening. That would be if some of these sources came into play relatively quick, and the whole curve shifted up and the long end outpaced the front end. And that will happen eventually. It's probably not a like a 2018 type situation. But you've got to keep at in the back of your mind when you're investing.
So those are the kinds of things that we're looking at, and we think is going to happen. And I think we to prepare for, as we move forward. I'm going to start off with discussing a couple of ideas, and I'm going to paint this picture using some amortizing securities. And basically what I'm talking about is creating a portfolio structure. With a goal to reduce exposure to longer term cash flows on these amortizing securities, I'm going to step back a little bit. This also works for long bullets [? hopeful's ?] and so forth. But I'll let you talk about that. The picture I'm going to paint is really using amortizing securities. But the goal is to reduce exposure to what could happen on the long end of the curve. Also, some of these securities tend to tail off. And when they tail off, they create liquidity, they're hard to sell later on. So that's kind of the goal of what we're trying to do. Bill, I sense an emphasis upon predictable cash flows. Based on where the economy is right now, just how important is that in terms of what may be ahead for interest rates and the economy? Well, I mean, buying predictable cash flows, I can't stress enough how important it is to start focusing on structure. For the last seven, eight years or so, we've been at the bottom of this trough. And rates really aren't doing anything, you can sacrifice structure for yields and you can get paid for it. And it works out fairly well. As the world changes, you have to refocus on that. And all anybody has to do is look at their most recent mark to market reports in the portfolio, and to see what's happened over the last quarter or so, to understand that we've got to start focusing on market value now. Yeah, I mean definitely. Let's look at structure over yield. So I'm going to look at two types of securities we're going to look at, here on this table. And the first one is, it says cell. And that's across the top row. Either you're going to sell it, or if you've already owned a bunch of these, or maybe avoid buying them. And this is a 20 year amortizing mortgage backed security. And if you look at a zero basis point move, it's going to be a seven-year duration, 7.6. More importantly, it's got a cash flow window that goes out to 2036. That's one of the things we're really concerned about. Instead of buying bonds like that and getting a little bit higher yield like folks have been doing along the bottom of the cycle, we're going to shift down and look at the bottom row. And that's what we're going to focus on purchasing. And in this specific instance, I used a 10-year VADM CMO, a 10-year amortizing mortgage backed will do the same thing. Or even a seasoned You look at the duration on that one, it's a little shorter. It's six years in end. More importantly, that payment window that sits out there, your final payment on this type of [? on ?] would be 20.6%, maybe 20.3%. But you want to keep them inside of that.
And I'm going to show you what this looks like, graphically, on the next slide here. If you look at the first one, we're calling that the negative structure. And that's that new backed I was talking about. And if you look at the cash flow graph, you'll notice it starts to kind of cash flow, and as the bond pays off, the cash flow picks up. And then it starts to tail on off to 2036. So you've got all of these cash flows, out past 26 and 30, that are going to be fairly illiquid. And they're going to have a fairly long duration. So that's the kind of stuff that we want to stay away from. What do we want to buy? What we want to buy looks a good bit different than that. This example I'm talking about is a VADM CMO, it stands for Very Accurately Defined Maturity. For those that don't buy CMO structures, you can use a 10-year mortgage backed. They're going to do essentially the same thing. This VADM has a little bit better cash flows than a mortgage backed, and you've got your reinvestment up front. This is what we're calling a positive structure. It's got a limited extension risk. This bond doesn't go after, pay after 2026. The duration of this bond doesn't really go up if interest rates rise. That's a good thing. You don't have those tailing off cash flows that are going to create illiquidity in the portfolio later on. But you're going to get to sit there and look at the mark to market report in ten years from now. And think about, you know, but furthermore, we talked about the yield curve doing different things earlier. We all kind of think we know what's going to happen. We think the Fed is going to move a little bit, two, three, four. Whatever your flavor is, we all think it's going to move a little bit. If you think that's going to happen, you want reinvestment opportunity. And these type of bonds, cash flow, get that early on so it gives you the ability that, even though you're buying a little bit lower yield than you bought before, on a relative scale, it gives you the ability to reinvest higher yields as interest rates move. So your overall return is actually going to outperform something that may have actually had a little bit higher yield to begin with. So that's kind of where we're going from a structural standpoint.
Now I'm going to step back a little bit and say, you know, there's a lot of carry over into bullets. And what are your thoughts? If you were looking at this from a bullet perspective, what would you do? Well, Bill, thank you very much. I think one of the priorities that both of us emphasizes is the importance of cash flow. And the flexibility that it provides in a dynamic economy, where interest rates are likely to go either direction. And similar to the amortizing note scenario, or bullet strategy that you might want to consider, is looking at the lower yielding, shorter duration, and perhaps negatively structured items in your portfolio. If you happen to be a bit lucky, there might also be minimal losses on those securities maturing in the next 18 to 24 months. Short tenured portions of the curve did not witness the same shift as the medium and longer portions of the curve in the last few months, and we'll get into that in a little bit here. Whether your institution follows an active or a passive strategy, you may wish to exit lower yielding positions at a minimal loss and pick up improved yields on securities with larger coupons and duration that's roughly similar to the average duration of your current portfolio. So to clarify, Stephen, one of the things you're saying, let's just say you're looking at two five-year securities. And one of them has a 2% coupon and the other has a 4% coupon.
Are you saying, that in a rising interest rate environment, that 4% coupon is going have less price volatility than the 2%? That's a great question, and especially since the larger coupons are likely coming in at premium. And we think that's a great time to consider paying that premium and having a price insensitivity, or price protection, that's supported the higher coupon securities in a rising rate environment. I couldn't agree more. And that happens, the same thing in mortgage backed, too. Absolutely. From a quick glance at the yield curve between November 1st and mid-January, there are a few things that we can quickly observe. One of them is how steep. The difference between the 10-year treasury yield and a two-year treasury yield remains well above 100 basis points, as we saw earlier in the presentation. And from a historical perspective, that might not seem that that's very, very steep. But for much of the last five years, we've seen a ten-two spread under 100 basis points, closer to 80 to 90 basis points. Exactly. And so we have a positive structure that will compensate investors for taking duration. And that's a very positive thing.
The second thing is that there's basically a rate shock over much of the curve. The shorter portions of the curve change very slightly, let's say four and in. But the five-year and longer portions witness about a 60 basis point rate shock following the election. Now this particular chart shows the beginning of November to mid-January, but a similar chart would be seen in a one-week pre and post-election impact on the curve. And third, it's worth noting that the decisions from the Fed tend to drive the short end of the curve. So if we see those two or three hikes this year, Bill, likely they're going to see that short end come up a little bit, while its inflation expectations tend to make a bigger difference on the longer end of the curve. And that's really why we had that pre- and post-election rate shock, as is higher inflation expectations that come with the Trump presidency. So basically what it means for you is that there's a prime opportunity to reinvest that above-average yields and maintain the current duration of your portfolio. So that begs the question, Stephen. When we're talking about this and we're looking at that curve that has a steepness that we haven't seen in awhile. What part of the curve do you like, and where would you invest? Well, I think there's three different portions of the curve that I see right now. The first is the short part that I mentioned, the four years and in. I think that if you're holding securities that are tied to a benchmark that is short, right now, it does not pay to get out of your position is that you might want to exit with minimal losses. And then the five to shows a very favorable incentive for duration, in terms of the yield provided. And beyond the think that's what we're going to see more of the volatility in the coming months and years with the different headwinds that you mentioned. The possibility of, how did I come down to perhaps, with the international dynamics right now. So you're saying steer a little bit, clear away from the longer end, kind of like what I'm saying. Yeah, and we think that there might be some lower yielding securities in the five to 10, than of course the but the incentive on having a cash flow, you're going to pick that up as rates move up. Absolutely. In terms of your specific portfolio, a few things you might want to consider in terms of this bullet strategy would be what your average yield is on the portfolio. And if you're holding securities that mature prior to 2019 that are below that average yield. You might also be holding securities that you're anticipating being called, but we're already seeing some of that calls not exercised in the rising rate environment. And rather than being left with a longer duration security than you intended, that's a great time to think about perhaps exiting that position.
Alternately when you're looking at where is the value in today's market, there are a few specific attributes you might want to prioritize. As we mentioned, higher coupons, those that have minimal extension risk, like a VADM structure, call protection, and duration roughly that of your current portfolio. And who knows, while it looks like rates are likely to rise, this unprecedented period of interest rates may throw us a few more curveballs.
OK, so we've thrown a lot at the crowd right now. But is there anything else that is popping on the radar screen right now, that we need other types of considerations we need to keep in mind? Well, as the poll question has been asked already, and you can see a large percentage of the audience expects a lower corporate tax rate. One of the things that we're keeping, really in terms of our view of the markets right now, and front center, is what would happen if the corporate taxes actually obtain a 15% or even a 25% tax rate, as President Truman pledged during the campaign. Now, [INAUDIBLE] the director of [? pre-cursor ?] will likely be the repricing of tax exempt securities. In fact, some suggest that this is already occurring in advance of such legislation. So who needs to be concerned about that? Basically anyone withholding tax exempt securities can expect to see perhaps weaker bids and volatile spreads on those securities. Good, good.
So to summarize, I think the common theme that we have here is, we need to avoid some of these trailing cash flows. Exactly, Bill. And you can review, the under-performing securities, or those outliers perhaps that underperform your expectations. Or extend significantly beyond the portfolio duration target right now. And another thing that we're trying to drive home is consider paying up in premium. Right now is buying premium types of securities, as opposed to par bonds and discounts. Things that will give you a nice yield, but at the same time perform a little bit better if rates work against us. Yeah, I think that we're in a little bit of a holding pattern, if you will. A post-election holding pattern before future interest rate hikes, or increase by the Fed. It's really giving you an opportunity of time. So we have a little bit of time to prepare. And bottom line, bond structure matters. And mining the portfolio composition prepares your institution for rising or falling rate environments. Bond structure matters, I like that.
OK, thank you gentlemen. Portfolio structure and cash flow is king, right? That's what we get. Well, thanks KC, Stephen, Bill. You guys did a great job, and I hope our audience appreciated that, and there was some good discussion.
OK, the question is, am I wrong to see some value in discount CMOs and MBS products in today's rate environment, as long as they are shorter than, let's say, five years? Well, that's not to say you're not going to find value. Most of that value is driven by the fact that people are actually starting to focus on premium bonds right now. So there is a little bit of an additional supply out there. But you've got to step back and think about how it's going to perform. We've seen this before. When rates came down and everybody was suffering from lower yields, because prepayments were hitting the CMOs so hard that people quit buying premium bonds. And then they started buying what are called stripped down bonds at the bottom of the rate trough. Everybody was buying stripped down bonds. Because they were scared of premiums. We started coming out, saying, all right, we're going to have this potential taper tantrum and all this stuff coming in the future. You know, we need to start looking at premium bonds. Nobody wanted to buy premium bonds, then the taper tantrum happened. And those that actually did buy premium bonds were fairly happy, and the folks who bought the par stripped down bonds, not so much. The folks that bought discount bonds, even less. So yeah, if you stay short enough you can, you could find a little bit of value. But I caution against how the bond could perform. I would look at that and really adjust that based on what your rate bias is and what you think is going to happen. As well as what your balance sheet is telling you. So there's mine. Thank you, Bill. I think it comes back to what we've been recommending, and that is structure in cash flow. And if you can find that in there, that's fine. But I think that's what you have to be worried about. Thank you for the question, appreciate it.
Well, thank you everyone for joining us today. I hope you find the information useful. If you have any questions, please feel free to give us a call. Have a great afternoon. Thank you.