Because of the government shutdown, the Bureau of the Census of the U.S. Department of Commerce was unable today to release its report on October housing starts and building permits.

Earlier this week I promised that, if the flow of economic information dried up, I would try to fill the void with some articles about using economic data to help in making decisions about your personal investments. This is the first such article.

My personal portfolio management approach calls for varying the allocation of funds between stocks and cash according to estimates of the appreciation potential of the stock market. Up until July I was holding my cash allocation in a money market fund. Along about that time, short-term interest rates had stalled out: the federal funds rate was trending sideways, the 3-month T-Bill rate was trending slowly downward, as was the rate of return on my fund. Then, on July 6, the Federal Reserve Open Market Committee (FOMC) met and voted to lower the federal funds rate.

When this happened, I switched the cash portion of my portfolio from the money market fund to a fund invested in mortgage securities issued by the Government National Mortgage Association [Ginnie Mae]. This increased the yield on my cash by 1.5%. Now, you might think that this sounds exotic and risky. And, you might ask " What the heck is a Ginnie Mae?" Well, I'll explain in a little bit why analysis of the economic situation indicated that the risk was low. But, first, I'll present an explanation of Ginnie Mae securities.

The Government National Mortgage Association [GNMA], known affectionately as Ginnie Mae, is an agency of the U.S. Department of Housing and Urban Development. GNMA guarantees the monthly principal and interest payments on GNMA securities representing pools of residential mortgages insured by or guaranteed by the Federal Housing Administration, the Farmer's Home Administration, or the Department of Veterans Affairs. GNMA funds invest in a portfolio of these mortgage-backed, government-guaranteed securities. There are other kinds of mortgage-backed securities that mortgage security funds invest in. But, none of them are backed by the full faith and credit of the U.S. government. So, GNMA securities are the safest investment in mortgages you can make.

Now let's talk a little about the characteristics of GNMA's. Mortgage securities are a lot like long-term bonds. When interest rates rise, the price goes down. When interest rates fall, the price goes up. And, of course, when interest rates stay the same, the price is unchanged. So, my switch to GNMA's was predicated on the belief that interest rates would either stay the same or go down. Why did I believe that this would happen?

1. Between March of 1994 and February of 1995 the Fed had racheted interest rates up six times, and these rate hikes were beginning to take their toll on economic expansion. Around the first of the year many of the economic indicators we talk about in this column either slowed considerably, stopped growing, or began to trend downward.

2. The long term bond market began to anticipate the economic down-turn as early as November, 1994. At the time of the July, 1995 FOMC meeting, long-term bond yields had been trending down for nearly eight months. The financial forces that move the bond markets saw that the economy was slowing down and lowered the cost of borrowing accordingly.

3. Inflation pushes interest rates up and bond prices down. But, there was no evidence of inflation anywhere on the economic horizon. Producer prices were flat. Consumer price rises had been low and essentially constant for the past four years. Real wages had been flat for a year and a half.

4. The Fed, in the face of all this evidence, must have concluded that maybe it had overdone things. So, at its July meeting the FOMC voted to lower the federal funds rate. In the past, the Fed has seldom acted in haste. And, once the Fed has committed to a course of action it has usually stuck to it.

The reasons cited in 1. through 3. above were probably sufficient to warrant my switch to the GNMA fund. But, I'm pretty conservative when it comes to money. So, it took the commitment by the Federal Reserve to a policy of not allowing interest rates to rise any further to finally convince me that it was safe to switch to the higher-yielding, GNMA fund.

Since I switched, the FOMC has met twice and voted on both occasions to leave the Fed Funds rate unchanged. The price of a share of my GNMA fund is the same now as it was the day I bought it. The fund is yielding slightly more than 7%, compared with a yield of 5.5% on the money market fund I switched from. Economic conditions now are much the same as they were in July, with the added kicker that consumer spending is showing signs of slowing. So, the chances of interest rates rising seem slim and my GNMA investment still looks like a safe way to earn a good yield on my cash with a chance of a capital gain.

Byline: Lafferty (MF Merlin)