December 27, 2014 Predictable

Risk/Reward Vol. 247

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

"So you don't have to call
Or say anything at all
You're so predictable."---lyrics from "Predictable" sung by Good Charlotte

"Let it grow/Let it grow
Let it blossom/Let it flow."---lyrics from "Let It Grow" sung by Eric Clapton

"Cover you in oil/Let me cover you in oil
I wanna cover you in oil/Cover you in oil."---lyrics from "Cover You In Oil" sung by AC/DC

I take one week off and WOW. Talk about a Santa Claus Rally! The spectacular two week performance began with Janet Yellen's press conference on December 17th. Since the market's close on December 16th, the Dow Jones Industrial Average (DJIA) has gained nearly 1000 points or 5.8%, a percentage increase mirrored by the S&P 500! Why you ask? The answer lies in the road map for interest rates that Chair Yellen outlined. Indeed, when it comes to rates, "you don't have to call/Or say anything at all. It's now so preditable" Here is what will happen. No rate increase will occur for at least two meetings (read June, 2015) and the increase(s) thereafter will be slight and gradual. So let's see: with historic low interest rates continuing and with China, Japan, Europe, Russia and the emerging markets in the tank, where can one get ANY return on one's money? Duh---there is only one place: US equites, assuming, of course, our economy continues to grow.

And continue to grow, it does. On Tuesday, the Commerce Department issued revised gross domestic product numbers showing the US economy grew in the Third Quarter at an annualized rate of 5%, the highest rate of growth in over a decade. That number blew the doors off market expectations. "Let it grow/Let it grow/Let it blossom/Let it flow." Indeed, GDP growth was so stunning one would have expected interest rates to sky rocket in anticipation of a sooner-rather-than-later tightening of monetary policy (the fear of which in recent years has caused equity markets to drop)---had not the Fed laid out its course of action just the week before. The rate on the bellwether 10 Year US Treasury Bond did rise to 2.25% by week's end, but this is well within its several month trading range. Indeed, securities tied to the 10Year rate (e.g. municipal bonds, preferred shares, real estate investment trusts, utility stocks) held steady all week, once again compliments of a clearly articulated monetary policy. Another factor keeping longer term US rates low is the spread between the two most stable debt issuing countries in the world---Germany and the US. The German 10Year Bund carries a rate below 0.6% compared to 2.25% on the US 10 Year a spread of nearly 1.7%--an historic high. As stated in the last edition ( Vol. 246 www.riskrewardblog.blogspot.com ) given a choice why would one buy a Bund and not a US 10Year? So again, with interest rates low, the US economy growing and the rest of the world in the tank, US equities are the best game in town.

Contributing to the good news is the incredible drop in the price of oil and natural gas. AAA estimates that with oil at $55/bbl. and gasoline nearing $2/gallon at the pump US disposable income could increase as much as 3 1/2% over last year. This should result in a big bump in consumer spending. From an investment perspective, one should not expect a turnaround in oil prices any time soon. The Saudi Oil Minister announced this week that OPEC will not reduce production even if the price of oil falls to $20/bbl. Clearly, Saudi Arabia sees the drop in prices as an opportunity to reduce competition from higher priced producers such as Russia, Nigeria, offshore drillers and the frackers here in the US. That said, the world runs on oil, and oil is a depleting asset. Someday the price will stabilize and start to rise. Those who have the stomach to invest in it will be rewarded handsomely. "I don't wanna cover you in oil/Don't let me cover you in oil"---not yet at least. But initiating a quarter or a half position in any established oil company at current price levels makes a great deal of sense. CVX, ETP and COP are recovering nicely, and KMI barely dipped at all. I bought some of each recently. However, holding one's powder on more speculative oil plays until a turnaround is confirmed seems prudent at this time.

Two weeks ago, the DJIA was languishing, up just 2% for the year. But thanks to Janet Yellen, the Dow shot "Back Into the Black" like it was "Thunderstruck." It was not such a "Long Way to the Top" after all. All it took was some unambiguous policy guidance from the Fed Chair. As AC/DC puts it:

"She's got style, that woman
Makes me smile, that woman
She's got balls."
(Think not? Check the accompanying photo)

December 13, 2014 Oil Trick Or Treat

Risk/Reward Vol. 246

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Now won’t you treat me, baby
I’ve been tricked so many times before
I can’t wait til Halloween to find out
If it’s trick or treat.”---lyrics from “Trick or Treat” sung by Otis Redding

“Now is the time/The time is right
We’ve got no reason to wait/Let’s do it tonight.”---lyrics from “Now Is The Time” sung by The Jefferson Airplane

“I go up/I go down
I go crazy/When you’re around.”---lyrics from ‘Up and Down” sung by The Pet Shop Boys

Eurozone deflation fears and domestic prosperity have been two of the three drivers of stock market performance for the past month. This week, however, both took a back seat to the third driver---the decline in the price of oil. On Friday, the price of domestic oil (WTI) fell below $58/barrel for the first time since the recession of 2009. Until this week, lower oil prices have been a boon to stocks (other than those in the oil patch). But, this week oil prices sank so low, so fast, many have come to believe that they are a harbinger of slowing economic growth worldwide and that they could lead to the collapse of oil dependent economies. Bears took control of the markets with the Dow falling 678 points (3.8%) and the S&P falling 73 (3.5%). So what DO lower oil prices mean? Are they a “trick or a treat?” I do not know. I DO know that “I’ve been tricked by oil prices many times before” and as a consequence I am out of the sector at present. That said, I doubt that we will have to “wait til Halloween to find out.”

Several subscribers contacted me this week to inform me that they believe “Now is the time” to start buying oil company stock. One is so convinced that “the time is right” and that “we’ve got no reason to wait,” he sold a substantial position in Apple (AAPL) (which he had held for years) and purchased Chevron (CVX) which hit a 52 week low on Wednesday. He views CVX’s decision, announced this week, to slash next year’s exploration budget as a shareholder-friendly move. Moreover, he likes being paid a 4% dividend while he waits for the stock price to recover. Other subscribers are buying Conoco and Shell. One of my fellow preferred stock devotees initiated a position in MHRpD which I have held from time to time over the years. It is trading so low that it yields a double digit return amortized monthly. Both of us saw MHR’s (Magnum Hunter) CEO on “MadMoney” where he made a compelling case that MHR should no longer be considered an oil play. Ninety percent of its revenues are from natural gas, and it can remain profitable so long as natural gas trades above $2.50/mmBTU. Natural gas currently trades at $3.70/mmBTU.

If oil drove the markets this week, news from the December meeting of the Federal Reserve will dominate next week. According to Jon Hilsenrath of the Wall Street Journal (see Vol 236 www.riskrewardblog.blogspot.com ), the Fed will consider dropping its assurance that short term interest rates will stay near zero for “a considerable time.” This would signal a rise in those rates in mid-2015. If the Fed retains that assurance, short term rates are likely to be zero bound until the fall of 2015 or after. So, if the assurance is dropped, what impact would it have on longer term rates including the rate on the bellwether US 10 Year Bond? Will longer term rates “go up/go down/or drive me crazy by going around?” As noted in earlier editions, the power of the Fed to affect longer term rates has diminished in recent times due to the persistence of low rates paid on comparable securities throughout the rest of the world. In the global bond market, given a choice, why would one own a German 10 Year Bund paying 0.68% or a French 10 Year bond yielding 1% when one can own a US 10Year yielding 2 to 3 times as much--- even at Friday's closing yield of 2.10%? Moreover, there are direct relationships between the price of oil and the rate of inflation, and between the rate of inflation and the yield on government bonds. Thus, if the price of oil continues to drop, the yield on bonds likely will continue to fall---at least according to newly crowned Bond King, Jeffrey Gundlach ( see Vol. 235 www.riskrewardblog.blogspot.com ). Gundlach opined this week that the yield on the US Ten Year could dip below 2% if the price of oil falls below $40/bbl. This would enhance the value of the interest rate sensitive portion of my portfolio.

Although I resisted buying oil stocks this week, the conviction shown by several subscribers is tempting me to re-enter the sector once a turnaround is confirmed. I am holding a lot of cash and am itching for an opportunity to profit. Last year, I bought preferred stock and municipal bond closed end funds when they were down---and to great advantage. Maybe oil is THE play as we head into 2015. When that sector does recover (and it will), I do not want to be singing Otis’ refrain:

“I was sittin' on the dock of the bay
Watchin' the tide roll away, ooh
I was just sittin' on the dock of the bay
Wastin' time”

December 6, 2014 Buy Backs

Risk/Reward Vol. 245

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

DUE TO THE PRESS OF OTHER BUSINESS, THIS WEEK’S FORMAT HAS CHANGED. ONE LYRIC AND ONE REFLECTION IS ALL YOU GET.

“I think you will find/When your death takes its toll
All the money you make/Will never buy back your soul.”---lyrics from “Masters of War” sung by Bob Dylan

Domestically, we see a good jobs report, an "ok" wage growth number and inflation in check. But internationally, China, the emerging markets and Europe are on downward trajectories. The US economy by itself may justify an average year in the stock market, say a 7% return. So why is the S&P 500 headed to another double digit gain in 2014? Moreover, how can the stock indices continue to rise year after year when equity (stock market) exchange traded funds and mutual funds have experienced a net OUTFLOW of over $100billion in the past five years? (See Friday’s Financial Times for these and other statistics cited herein) Why hasn’t this outflow of "all the money" “taken its toll” on share prices?

The answer lies, in part, in the number of massive share “buy backs” which are underway. These buy backs (corporations purchase their own shares on the open market thereby reducing the total number of shares outstanding and increasing their all important earnings per share) are how Corporate America has decided to deploy its excess capital. For example, Apple (AAPL) spent $45billion in share buy backs in just the past 12 months. And mega companies are not the only ones involved. In the third quarter of 2014 alone, one fourth of all of the companies constituting the S&P500 reduced their share count via buy backs by at least 4%! Assuming each’s multiple remained constant, this effort alone would account for a concomitant per share price increase. According to Friday’s Financial Times, Corporate America's buy back pace of $40-50 billion per month experienced during the first 10 months of 2014 is likely accelerating even as I write. So it's no wonder stock prices continue to rise.

How long will this continue? With cheap credit plentiful, with world wide economic growth faltering, with populations dwindling (did you read this week that the birthrate in the US is at an all time low of 1.86 births per woman of child bearing age) , with corporations balking at dividends as a means of returning capital and with increasingly pro-active shareholders, I see a protracted period of substantial share buy backs. The simple truth is that corporations are long on cash and short on product demand. Enjoy it while it lasts. But be mindful of what Dylan preaches,

"As the present now/Will later be the past/The order is rapidly fadin'
And the first one now/Will later be the last/The times they are a-changin' "

November 29, 2014 How Low

Risk/Reward Vol. 244

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“It hurts like hell/To be torn apart
And it hurts like hell/To be thrown around.”---lyrics from “Torn Apart” sung by Bastille

“Go low/Lower than you know
Go low, Go low/Lower than you know”---lyrics from “How Low”---sung by Ludicris

“Though I can't seem to let you go.
The one thing that I still know is that you're keeping me down”---lyrics from “Gravity” sung by Sara Bareilles

The big event this week occurred on Thanksgiving when our markets were closed. The oil ministers of OPEC met in Vienna that day and afterward announced that a majority had voted to maintain current levels of oil production despite a lessening of world demand and a glut in production. By Friday afternoon, the price of oil plummeted below $67/bbl., a drop of more than 30% since June. This is good news for oil consumers, but if you own the shares of domestic oil exploration companies or you are Nigeria, Venezuela or Russia (the economies of which are dependent on oil trading above $100/bbl.) “it hurts like hell.” They must feel “torn apart” and/or “thrown around.” Thank goodness I sold Breitburn (BBEP) and Linn (LNCO)) last week. Both experienced double digit percentage declines on Friday alone with LNCO plunging over 18% . Ouch!

Speaking of “going low/Lower than you know” the Eurozone continued its march toward deflation and recession this week. Reports issued Friday detailed that the annualized rate of inflation for November was 0.3%, down from 0.4% in October, and that the Eurozone unemployment rate remains at 11.5%. The concern, of course, is that if deflation takes hold and Eurozone consumers come to understand that they can achieve a better return from holding cash than from investing and/or that they can purchase goods at a lower price by simply waiting another day, week or month to buy, Eurozone economies will degrade from a downward trend into a tailspin. Look for the ECB to advocate even more aggressive quantitative easing in the coming days.

So what do lower oil prices and Eurozone deflation mean to me? “The one thing I know is, like Gravity, they will keep domestic interest rates down.” Indeed, on Friday after the full impact of the above described developments had been absorbed by the U.S. markets, the rate on the 10 Year U.S. Treasury Bond fell to 2.19%. The lower the rate on this bellwether, the better my interest rate sensitive, income securities do. Indeed, on what otherwise was a flat trading day Friday, my preferred stock closed end funds (FFC, HPF, HPS), each of which pays at least an 8% dividend, each gained at least 0.5%. Now that I am back in sync with my principles (see last week's edition www.riskrewardblog.blogspot.com ) I should do well with these for the foreseeable future.

The Dow Jones Industrial Average and the S&P500 remained remarkably steady this week, at or near record levels. How long can this last given the economic turmoil in Europe and Asia? Who knows, but it sure feels good. That said, if and when I see the market in general or any segment thereof falter (e.g. as oil has), I will be brave and hit the sell button. As Sara Bareilles admonishes:

“Say what I wanna say
And let the words fall out
Honestly I wanna see me be brave”

November 22, 2014 Say Something

Risk/Reward Vol. 243

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“These oldies but goodies remind me of you
The songs of the past bring back memories of you.”---lyrics from “Oldies But Goodies” sung by Little Caesar and The Romans

“These last few weeks of holding on
The days are dull/The nights are long
Guess it’s better to say
Goodbye to you/Goodbye to you.”---lyrics from “Goodbye to You” sung by Scandal (featuring Patty Smyth)

“Everybody’s got an opinion now, don’t they
I’m here to stay/I’m here to stay.”---lyrics from “Here To Stay” sung by Christina Aguilera

“Oldies but goodies.” They not only “bring back memories”; they also “remind me” of first principles. So this week I reread several past editions in which I summarized my investment philosophy including Vols. 1 and 156 (www.riskrewardblog.blogspot.com ). In those posts, I pledged my allegiance to Bill O’Neill’s 8% Rule ( he, of Investor’s Business Daily fame). That is; do not suffer an 8% loss on any position. That allegiance notwithstanding, in the past few weeks I have faced situations with American Realty Capital Properties (ARCP) and certain oil companies where the loss far exceeded 8% before I could exit. I did not sell in a panic, but it caused me to contemplate the following: assuming the positions do not fall significantly more, do I take a double digit loss or do I hold?

The mere passage of “these last few weeks of holding on” and rereading excerpts from Jack Schwager’s “Market Wizards---How Winning Traders Win” supplied the answer. Sell. The reason has little to do with logic and much to do with psychology. Holding losing positions makes “the days dull/and the nights long.” Winning wizards know this simple truth: looking at red on the computer screen saps one’s enthusiasm and infects one with negativity. The wizards are right; when it comes to losers “it’s better to say/Goodbye to you/Goodbye to you.” And so I did—and my focus improved instantly.

But what about the stock market? Monday through Thursday, both the Dow Jones Industrial Average and the S&P 500 continued to sit, rock steady, with little volatility. Once again, the positive impact of solid domestic economic data was tempered by troubling news from abroad. On Tuesday, Japan reported that its economy contracted for the second consecutive quarter and that it now, officially, is in a recession. On the European front, Standard & Poor’s chief economist stated on Wednesday that the Eurozone was in “dangerous territory,” facing the dual threat of recession and deflation if its central bank did not implement aggressive quantitative easing soon. Then came Friday. China's central bank lowered rates and the European Central Bank announced that it had begun aggressively buying assets. Both of the major stock indices reacted favorably, jumping 0.5% that day. As for me, these moves signal that interest rates likely will remain at historic lows well into 2015, and that the interest rate sensitive portion of my portfolio (e.g. leveraged closed end funds and preferred stocks) should fare well. So, “I’m here to stay/I’m here to stay.”

In closing, I want to thank one of my subscribers. He called to tell me that in recent postings he could feel my pain. I hadn’t noticed, but in rereading them I detected a decidedly negative vibe. That detection led me to question why, which in turn caused me to review whether my holdings matched my principles. As discussed above, clearly they did not, a situation I rectified this week. Thanks again for “saying something.” As the great Christina warns:

“Say something, I'm giving up on you
I'll be the one, if you want me to"

November 15, 2014 Rock Steady

Risk/Reward Vol. 242

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Rock steady, baby/That’s what I feel now
Let’s call this song exactly what it is.”---lyrics from “Rock Steady” sung by Aretha Franklin

“I’m a lonely little petunia in an onion patch
In an onion patch/An onion patch.”---lyrics from “Lonely Little Petunia” sung by Arthur Godfrey

“The best is barely enough
But if that’s it/Then it will have to do.”---lyrics from “Barely Good Enough” sung by John Kay (of Steppenwolf fame)

With the Dow Jones Industrial Average gaining 61 points and the S&P 500 gaining 8 points this week, “let’s call this market exactly what it is/Rock steady, baby.” That said, “rock steady is not what I (or any other investor) feels now.” But why? Russia’s further incursion into Ukraine and the mishigas that is the Mideast notwithstanding, there is no immediate threat of war. Corporate profits, at least in the US, are acceptable if not spectacular. Interest rates remain low. In addition we are on the cusp of energy independence. Who would have believed that gasoline would be selling for under $3/gallon in 2014? So why the unease?

Perhaps it arises from the realization that the US economy is a “lonely little petunia in an onion patch/ The onion patch” that is the world’s economy. In advance of this weekend’s meeting in Brisbane of the world’s twenty largest economies (“G20”), Secretary of the Treasury, Jack Lew, expressed frustration and disappointment in the fiscal and monetary policies of Europe and China. He considers them too conservative and thus incapable of spurring growth. Although I rarely find myself aligned with the current administration, I do agree with Mr. Lew on one point: to wit, continued reliance on the American consumer to drive worldwide demand is not a formula for sustainable economic growth.

Nevertheless, the US stock market continues to set record highs. As stated ad nauseam here and elsewhere, the reason is obvious; there is no alternative. Simply put, U S equities are the best investment around. “That’s it/It will have to do.” Even if “ the best is barely enough.” Really, where else can one achieve any return on an investment? Evidencing this grim reality is a conversation that I had this week with a slightly older contemporary (age 67) who is in the process of selecting a wealth manager. In a recent interview with the most conservative institution in our city, the assembled investment team ( led by a 61 year old) told him that it would allocate NOTHING, not a dime, not a penny, into bonds or bond funds. The team had concluded that with interest rates so low (the benchmark 10 Year Treasury Bond closed Friday at 2.32%) the paltry returns available in bonds are not worth the risk of principal depreciation before maturity. What! What happened to the 60%/40% Rule? And then it struck me. Perhaps the fact that US equities are the only game in town is the real source of investor unease---as well it should be. Because when all of the money flows one way, bubbles ensue.

When the Federal Reserve adopted its zero-bound interest rate policy (ZIRP) in 2008, it did so with the intent of temporarily inflating asset (read, stock) prices knowing that in so doing it would discourage capital from being allocated into traditional “safe” investment vehicles such as money markets and bonds, those favored by retirees. No one foresaw that 6 years later ZIRP would still be the order of the day with no end in sight. Given our demographics and Japan’s 20 year experience with ZIRP, perhaps someone should have. But, no one did and so today, risk assets continue to soar while safe investments languish. This situation is not ideal for someone on the cusp of retirement. In the words of the great Aretha:

‘I ain't no psychiatrist
I ain't no doctor with degrees
But, it don't take too much I.Q.
To see what you're doin' to me”

November 8, 2014 The Locomotion

Risk/Reward Vol. 241

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“A chug-a, chug-a motion like a railroad train
Come on baby, do the Locomotion.”---lyrics from “The Locomotion” sung by Little Eva

“You got me runnin' goin' out of my mind
You got me thinkin' that I'm wastin' my time
Don't bring me down, no no no no no”---lyrics from “Don’t Bring Me Down” sung by ELO

“Drums keep pounding rhythm to the brain
And the beat goes on/Yes the beat goes on.”---lyrics from “The Beat Goes On” sung by Sonny and Cher

Both the Dow Jones Industrial Average (DJIA) and the S&P 500 (S&P) continued to rise this week, albeit modestly, setting record highs along the way. After a volatile first few weeks of October, the indices have been running sure and steady of late-- “A chug-a, chug-a motion like a railroad train.” And with our elections over, I see little on the horizon to de-rail this “Locomotion.” Nothing on the Federal Reserve’s calendar should cause interest rates to rise. Indeed if anything, we may see more downward interest rate pressure given the fact reported last week that Japan has opened its credit floodgates with a new round of quantitative easing. Moreover, the European Central Bank has pledged to combat deflation with any and all of the ammunition it has at its disposal including its own round of quantitative easing should one prove necessary. This is all good news to rate sensitive income investors like me. Although the Middle East remains a mess, that condition is nothing more than SNAFU. And in Ukraine, the West has conceded Donetsk to Putin, a fact which should satiate his acquisitive appetite for a while. In short, I see calm market conditions through the end of the year with a slightly positive tilt.

That said, not all is rosy in my portfolio. News on Tuesday that Saudi Arabia was dropping the price of the crude oil that it sells into the United States (while raising prices to Europe and Asia) sent my domestic oil holdings sharply downward. Honestly, with crude now trading at below $80/bbl, I’m “goin’ out of my mind.” It’s “got me thinkin’ that I’m wasting my time” with the likes of Linn Energy (LNCO), Vanguard Natural Resources (VNR) and Breitburn Energy (BBEP). It seems that each morning I’m crying “no,no,no,no,no”—“don’t bring crude down.” But down it goes. That said, each of these domestic producers has given assurance that it can sustain its, now, double digit dividend even if the price of oil does not recover. Ironically, natural gas could be the cash cow savior for VNR, the production of which BBEP and LNCO have reduced in recent years. Distributions from those two should be protected by the hedging of 70% of their oil production through 2015.

If the drop in oil were not enough of a “drum that keeps pounding rhythm to my brain”, the “beat down” of American Realty Capital Properties (ARCP) “goes on/Yes the beat goes on.” On Monday, an ARCP affiliate announced that it was reneging on its agreement to purchase some non core assets that ARCP acquired as part of the Cole Realty acquisition. This news caused ARCP to fall to ridiculous depths, so ridiculous that I decided to add to my position. I may be doubling down on a loss, but I keep thinking of how solid the underlying business appears. ARCP owns a portfolio of triple net leased properties with a book value of $11 billion rented to investment grade tenants. Moreover, it pays a (now) double digit dividend amortized on a monthly basis. Yet, the market cap is only $7billion? Huh? Oh, well, I bought some more. I will either do well (up 10% so far on Tuesday's purchase) or “the beat will go on.”

The performance of the DJIA and the S&P in the past month once again is making passive index investors look like geniuses. They may attain a double digit return for the third year in a row. In contrast I may miss my more modest personal goal of 6-7% due to my overweight positions in oil companies and ARCP. That said, I do not see myself buying a basket of indexed ETF’s and then closing my eyes. What happened to passive investors in 2008-2009 still haunts me and will do so for the rest of my investing life. I remember like yesterday: “bang, bang, that awful sound/bang, bang investors hit the ground/bang, bang the indices shot them down.” That did not happen to me then, and it will not happen to me in the future.

November 1, 2014 Like A Heat Wave

Risk/Reward Vol. 240

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“You’re a heartbreaker, dream maker, love taker
Don’t you mess around with me.”---lyrics from “Heartbreaker” sung by Pat Benatar

“Got people here/Down on their knees prayin’
Hawks and doves are circlin’ in the rain.”---lyrics from “Hawks and Doves” sung by Neil Young

“Nowhere to run baby
Nowhere to hide.”---lyrics from”Nowhere to Run” sung by Martha and the Vandellas

Like most market watchers, I began my Wednesday morning tuned into “Squawk Box” believing that the most impactful news of the day would come in the press release following that day’s meeting of the Federal Reserve’s Open Market Committee (FOMC). But I nearly fell off my elliptical when word came across the wires that American Realty Capital Properties (ARCP), one of my favorite triple net lease real estate investment trusts, had discovered accounting irregularities and would be restating its results for the first and second quarters of 2014. Accounting irregularities, especially for a high yielding stock like ARCP, can be a death knell, and it certainly looked that way when the markets opened. From the start, my substantial holdings were down over 30% recovering somewhat by day’s end. My “dream maker” had become a “love taker, a heartbreaker.” Mr. Market was saying loud and clear “Don’t mess around with ARCP”. Down that far that fast, I decided to hold, having learned from past mistakes not to sell into a panic. Moreover, I received some solace from an early press release which indicated that ARCP’s handsome $1/share annual dividend would not be affected. Later that day I listened to a replay of the investor call-in hosted by ARCP’s CEO--- who was not implicated in any wrongdoing. Therein, he detailed the steps taken by ARCP’s audit committee and the professionals that that committee had hired to investigate and rectify the errors. Having represented both management teams and audit committees in similar situations and understanding the dictates of the Sarbanes-Oxley Act, I was impressed by the audit committee’s work as explained. I decided to hold my ground unless or until other unfavorable news emerges. Indeed, if none does emerge, I may add to my position if the price stays depressed.

It was not until Thursday that I focused on what the FOMC had done on Wednesday. Predictably, it announced the end of QE3. In addition, it stated that the foci of its dual mandate; to wit, employment and inflation (price stability) had both improved. This statement was interpreted by many in the equity markets as “hawkish” (meaning more likely that the Fed would raise interest rates sooner); at least by those that had been “down on their knees prayin’” for more “dovish” remarks. The bond market interpreted the statement differently as the yield on the benchmark 10Year US Treasury continued to hover around 2.3%. Bond (or fixed income) traders found solace in the FOMC’s pledge to “maintain the 0 to ¼% fed funds rate for a considerable time…especially if projected inflation continues to run below the Committees’s 2% longer run goal.” On Thursday, better than expected Q3 gross domestic product numbers caused the major stock indices to move upward. On Friday these indices skyrocketed to record highs on 1) news that Japan was expanding its quantitative easing program thus assuring investors that the world’s cheap money punch bowl would be replenished and 2) release of US personal consumption expenditure index numbers (PCE) (those relied upon most heavily by the FOMC) showing that inflation was running at 1.4% annually far below the 2% goal mentioned by the FOMC on Wednesday. In other words, any interest rate increase appears to be far away. This is good news for interest rate sensitive investors such as yours truly.

With interest rates at historic lows and growth prospects in Europe and China worsening, there is simply “Nowhere else to run, baby/Nowhere else to hide.” Whether you seek growth or you seek income, U.S securities are the only game in town. The following quote from Friday’s Wall Street Journal captures our situation: “…economic growth looks underwhelming compared to other post war cycles for the U.S. but it may prove to be the envy of other advanced economies.” And it is for this reason more than any other that the Dow Jones Industrial Average and the S&P 500 rose this week. Frankly, neither U.S. corporate profits nor U.S. corporate dividends warrant the prices that U.S. stocks garner at present, but there is no alternative unless you want to hold cash. That stated, cash is not a bad choice so long as inflation does not spike. I am 50% in cash at present and am more cautious than enthusiastic when it comes to securities of any kind---despite this week’s spike in stock prices

And so, what CNBC has termed “ the most hated stock rally in history” continues. We hit new records yet I don’t see anyone ”Dancing in the streets/ In Chicago/Down in New Orleans or even/Up in New York City.” That is because central banks now hold more sway than any other market input. And, at first glance, their concerns are counterintuitive. Instead of rejoicing that their traditional bête noire, inflation, is muted, central banks now adopt policies aimed at promoting it. On Friday, Japan, the most energy starved country in the world, actually cited lower imported oil prices as a DRAG on its economic goals! Huh? Talk about good news being bad news! Like Martha and the Vandellas “ Sometimes I stare into space/Tears all over my face/Don’t understand it/I ain’t never felt this way before” Does any of this make sense? Actually it does. But only after you realize that the greatest threat to the central bank of a debtor nation is deflation. Deflation means that such a nation will have to repay its mountain of debt with expensive currency; currency not debased by inflation. Unfortunately, deflation is the new normal in the aging societies of the developed world. Aging societies mean fewer children; fewer children means less demand; and less demand means deflation. Look at Japan (which is tantamount to crystal balling our own future) where more adult than children’s diapers are sold, and watch their central bankers sweat. “It’s like a heat wave”.

October 25, 2014 Come Back, Baby

Risk/Reward Vol. 239

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Like a rubber ball
I’ll come bouncing back to you.”---lyrics from “Rubber Ball” sung by Bobby Vee

“Buy a bag of balloons with the money we’ve got
Set them free at the break of dawn
‘Til one by one they were gone.”---lyrics “99 Red Balloons” sung by Nena

“I’m gonna let you pass/And I’ll go last
Then time will tell just who has fell
And who’s been left behind
When you go your way and I go mine.”---lyrics “Go Your Own Way and I’ll Go Mine” sung by Bob Dylan

“Like a rubber ball” the major stock indices came “bouncing back”, experiencing their best week of the year. The Dow Jones Industrial Average gained 425 points and the S&P 500 rose 4%. In large part, the bounce came from oil prices stabilizing and a spate of strong earnings reports. The positive price action gave me the confidence to buy several new positions. In particular, I expect a nice bounce from a host of general equity closed end funds ( e.g. EOI, CHY, CHI), especially GAB, Mario Gabelli’s flagship CEF which floated a price-deflating rights offering (See Vol. 236 www.riskrewardblog.blogspot.com ) just as the market swooned earlier this month. It currently trades substantially below its net asset value which is unusual for this fund thus presenting an excellent buying opportunity.

Another source of the uptick was the European Central Bank (ECB) which this week began its own version of quantitative easing in the form of covered bond and asset backed security purchases. In effect, the ECB is buying commercial loan portfolios from Eurozone banks (like the portfolios of mortgages that our Federal Reserve purchased during QE3) in an effort to spur additional lending which it hopes leads to economic development. In other words, the ECB is “buying a bag of balloons with the money it prints and/Setting them free” The ECB is also contemplating buying corporate bonds, an aggressive move that not even the Fed attempted during QE. What will the ECB do with these newly acquired assets once the program ends? Sell them “one by one til they are gone?” Or like the Fed, keep them until maturity. Will it work? Did QE 1, 2 or 3? The jury is still out. But, the ECB’s action is at least an attempt to combat the very real threat of recession in the Eurozone, and that attempt was rewarded with a rise in European stocks which in turn helped to boost equity prices in the US.

The impact of the ECB’s actions on our domestic markets highlights the fact that the world’s economies (and by extension its markets) are becoming progressively intertwined. Today, can a single economy, even one as large as ours, “go last/and let the others pass?” Can one country simply decide to let “others go their way and I go mine?” Can one or more be “left behind” or will they all rise or “fall” together. There is no doubt that the economies of emerging markets are heavily dependent on China’s demand for natural resources. In turn, China’s economy is heavily dependent on consumer demand in the US. The question we face today is whether the US can achieve its targeted 3% growth in gross domestic product as growth in the rest of the world slows. We will have an answer very soon.

Like Bobby Vee, I have decided to “Come Back, Baby” albeit slowly and with some trepidation. In times past, my “wide-eyed innocence/Has really messed up my mind.” So if you too re-enter do so of your own volition. Don’t rely on me. “I’d rather you get your very next heartache not from me, but/Somewhere else along the line.”

October 18, 2014 Welcome Back

Risk/Reward Vol. 238

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Those dreams have remained/And they’ve turned around
Welcome back/Welcome back/Welcome back.”---lyrics from “Welcome Back” sung by John Sebastian

“I’ll never look up/Never give up
And if it gets rough/It’s time to get rough
But now, falling, falling, falling.”---lyrics from “Falling” sung by Haim

“Please forgive me for rambling
I just wanted y’all to know/That I don’t know it all
Don’t be surprised.”---lyrics from “Surprise” sung by Gnarls Barkley (Cee-lo)

“Welcome back/Welcome back/Welcome back” from Italy---NOT. Holy Cannoli! I leave for two weeks, and the stock market yo-yo’s then drops like a rock. And as for my “dreams” of a nice, gentle ride into the end of the year, “they’ve turned around.” I am glad that I left the country 2/3rd’s in cash. That said, I suffered like the rest of you on the remaining 1/3rd. I found the task of managing my investments difficult while basking in the sun on Capri or touring in Rome; a task made even more difficult by the fact that I had a seven hour head start on cocktail hour (um, make that a nine, no more like a twelve hour head start). Oh well, I still am ahead of the game and have already compiled my “ buy” list if and when I am comfortable that a bottom has been reached. Cash is a very nice commodity to own right now.

Leading the “falling, falling, falling” has been the oil patch. Talk about “getting rough!” One month ago WTI crude traded at $95/bbl. On Thursday morning it traded below $80/bbl before rebounding. The reason: who knows? It could be that Saudi Arabia is trying to drive higher cost producers (e.g. U.S. frackers) out of business; it could be a slack in world wide demand; or it could be that several refineries around the world are shuttered for routine maintenance reducing daily demand by as much as 3million bbls/day. Whatever the reason(s), this precipitous drop began just before I left and caused me to exit BBEP as I was boarding the plane. I reduced my LNCO position by half upon my return. Nevertheless, I am ready to buy both back once I perceive some price stability. Indeed, at present, oil and natural gas stocks are so cheap, I am finding it difficult not to buy, with crude trading at what I perceive to be the bottom ($80/bbl). That said I have been Kardashianed (definition---fooled by a false bottom) in the past. I don’t need to buy at the nadir and will await a confirmed rally before re-entering. In addition to LNCO, I am still holding VNR, BBEPP, VNRBP and FEI each of which experienced a much needed spike on Thursday and Friday.

The one place that I found some relief these past two weeks was in fixed income; those securities most directly correlated to the yield on the 10 Year U.S Treasury Bond. This of course is the bellwether about which I have been “rambling” for more than a year (“Please forgive me.”). Just last month I predicted that the yield on the 10Year would be range bound for the remainder of the year between 2.45% and 2.75% ( See Vol. 236 www.riskrewardblog.blogspot.com ) As proof that “I don’t know it all”, during my sojourn in Italy, the yield plummeted from 2.45% to 2.09% at the close on Wednesday. It finished the week at 2.19%. “I just want y’all to know” that I was as “Surprised” by this as anyone. In any event, it kept the value of the fixed income portion of my holdings (e.g. FFC, DSL, OXLCO, MVF, HPF, EIM, VGM, HPS ) from falling (remember price goes up as yield goes down) even during the worst of the sell-off. This drop in rates results directly from a flight to safety caused by fear: fear that China will not meet even its reduced target of a 7.5% growth in gross domestic product; fear of deflation in the Eurozone; fear of ebola; fear of ISIS; fear of fear itself; fear that seems overblown in light of several good corporate earnings reports this week.

I am hopeful that the market’s action on Thursday and Friday signals that a bottom has been reached in both the value of equities and the price of crude oil. If this is confirmed next week, I see myself becoming an aggressive buyer. Unlike John Sebastian, I won’t have to be a “daydreamin' boy” when it comes to profits or to otherwise “Believe in Magic.” A confirmed rally will provide me with a reason “to have to make up my mind/To say yes to some and leave some others behind.”

September 27, 2014 Ball of Confusion

Risk/Reward Vol. 237

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Round and around and around we go
Where the world’s heading/Nobody knows
Great googalooga/Can’t you hear me talking to you
Just a ball of confusion.”---lyrics from “Ball of Confusion” sung by The Temptations

“Don’t you know things can change
Can you hold on for one more day
Things’ll go your way.”---lyrics from “Hold On” sung by Wilson Phillips

“Give me that old time religion
It’s good enough for me.”---lyrics from “Old Time Religion” sung by Everyone

“Round and around and around we go/Where the market’s heading/Nobody knows.” This week The Dow Jones Industrial Average was down triple digits, down triple digits, up triple digits, down triple digits, up triple digits. Is the stock market just a roulette wheel; “just a ball of confusion”? At first glance the answer appears to be “yes”; but a deeper look reveals that the market’s confusion is justified. Domestically, Mr. Market is struggling to digest the impact of an improving economy and the prospect of interest rates rising as early as Q1 2015. Meanwhile, he must consider the fact that economies elsewhere; notably in China and the Eurozone are staring at sluggish growth in one instance (weak domestic demand for goods and slowing exports in China) and recession in the other (Euro at multi-year low versus the dollar). In response, their central banks are adopting ever more accommodative monetary policies. In short, Mr. Market must determine if the US can continue to prosper and to tighten its monetary policy if the rest of the world’s economies continue to struggle and their banks continue to loosen their purse strings.

The cross currents buffeting the broader market also were felt this week in the income sectors that I fancy. Action on the 5Year Treasury Note exemplified this. On Wednesday, the 5Year experienced a weak auction with low coverage and a low bid, both facts signaling a belief that interest rates likely will increase sooner rather than later. This followed news earlier in the week that the spread on the 5Year Treasury Inflation Protected Note (TIP) was at a multi-year low signaling Mr. Market’s belief (that day at least) that inflation would average only 1.6% annually over the next five years; a situation that augurs against any interest rate increases. Huh? Adding to the confusion in the fixed income world was the shocking resignation on Friday of the Bond King, Bill Gross, from PIMCO, the company that he founded. Much disruption in the fixed income sector is possible in the days ahead as billions of dollars may follow him to his new home at Janus---or not. Through it all, the yield on the 10Year Treasury, to which I attach great significance, traded in a tight range---essentially holding pat; as did I. I bought very little this week. “You know that if you hold on (to your cash) for one more day/Things can change.” Indeed, “they may even go your way.”

In times like this, I seek guidance in “old time religion/It’s good enough for me.” So this week, I re-read portions of Benjamin Graham’s books Security Analysis (first published in 1934) and The Intelligent Investor (first published in 1949). And am I glad that I did. Ben Graham is considered the father of value investing and is remembered as Warren Buffett’s mentor and guru. But he is so much more than either of those sobriquets. If you have not read these, I suggest that you do (and if only one, make it The Intelligent Investor). The distinction he draws between investors and speculators, with the former’s insistence upon the receipt of regular and consistent income, reinforces the conviction I have in my approach. In a world of suppressed interest rates, balance sheets bloated by retained earnings and a love affair with share buy backs, it has become difficult to find solid streams of income. But, the difficulty of the search only makes the discovery more rewarding.


In editing this edition, it reads too didactic. I will resist The Temptation for “store front preachin’” in the future. That said, you may not hear from me for two weeks. I am heading to Italy with “My Girl.” And it is likely that

“I won’t have time to think about money
Or what it can buy
I’ll be a fella
With a one, a one track mind
And if it comes to thinkin’ about
Anything but my baby
I just won’t have the time.”

September 20, 2014 The Man

Risk/Reward Vol. 236

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Yeah, you can tell everybody
Go ahead and tell everybody
I’m the man, I’m the man, I’m the man.”---lyrics from “The Man” sung by Aloe Blacc

“You got me running, muttering, screaming each and every night
Faster and faster.”---lyrics from “Faster” sung by Janelle Monae

“The present has no ribbon
Your gift keeps on giving
We’re up all night to get lucky.”---lyrics from “Get Lucky” sung by Daft Punk

As I have written in the past (see Vols. 174, 205, 217, 220 and 224 www.riskrewardblog.blogspot.com ), “you can tell everybody/Go ahead and tell everybody” that when it comes to gauging the pulse of the Federal Reserve, Jon Hilsenrath of the Wall Street Journal is “the man, is the man, is the man.” And never has his position as the Fed’s designated leak been more on display than Tuesday morning during a webcast that he hosted and that I watched. At approximately 11:15 a.m., he predicted, confidently, that in the statement scheduled to be released the next day at the conclusion of its two day meeting, the Fed would not abandon its promise to forego raising short term interest rates for a “considerable time” after QE3 ends in October (see last week’s discussion). Almost instantaneously, both the Dow Jones Industrial Average (DJIA) and the S&P 500 (which had been languishing in negative territory for days in anticipation of the Fed’s statement) skyrocketed. The DJIA gained more than 100 points in a matter of minutes. Indeed, the release of the actual statement by the Fed on Wednesday afternoon, which confirmed Hilsenrath’s prediction, proved anticlimactic as the markets moved only modestly upward. Assured that the Fed’s easy money policy will remain intact for the next several months, the DJIA continued to cruise upward to new highs on Thursday and Friday.

That said, the Fed’s statement was not all rosy for the easy money crowd. Although Mr. Market has interpreted the phrase “considerable time” used in the statement to mean that short term interest rates will not be raised until mid-2015, the Fed’s statement also contained charts indicating that once rates do begin to rise, the pace will be “faster” than previously anticipated. This news caused “muttering and screaming” among fixed income investors as reflected in the yield on the bellwether 10 Year Treasury Bond which increased on the news, closing Thursday at 2.63% (highest since July 3) and Friday at 2.59%. (Remember a rise in yield means a drop in price.) For those like me who were agnostic as to the Fed’s course of action (since I was 2/3rds in cash), the statement and its impact have helped inform the actions I will take over the next few weeks and months. My read is that, absent exogenous events, the yield on the 10Year will remain range bound between 2.4% and 2.75% into the first quarter of 2015. This read gives me comfort sufficient to reinvest into the full complement of securities that I held prior to liquidating them at the end of July. Assuming my read is correct, these securities should provide me an additional 1 ½ to 2% gain by year end.

With so much attention focused this week on the Fed, Scotland and the Alibaba IPO, it would have been easy to overlook some “presents”, many of which came with “no ribbon.” One such present is a rights offering issued by Gabelli Equity Trust (GAB), market guru Mario Gabelli’s flagship equity closed end fund. Rights offerings (RO) are like secondary stock issuances, but limit the participants to existing shareholders thus reducing their dilutive effect. GAB’s offering has resulted in its stock trading at or below its projected post RO net asset value (NAV) something that rarely happens. This looks like “a gift” which will “keep on giving". I initiated a position late in the week. Sometimes, you don’t need to be “up all night to get lucky.” I also took advantage of a dip in ARCP, the nation’s largest single tenant triple net lease real estate investment trust. For those who want a lesser but more secure return, take a look at its preferred stock, ARCPP. And then there are the oil companies, all of which remain in the bargain bin. A broken record I may be, but one cannot look at the events occurring in the mid-east and the sanctions placed on Russia (the world’s second largest oil exporter) and not conclude that a bet on US domestic oil production, transport and/or supply is a good one. Pick any number of companies in these sectors, and I believe you will be a winner.

And so my search for a reasonable return in exchange for a reasonable risk continues. Earning such a return in today’s zero-bound interest rate environment, created and now perpetuated by the world’s central banks, is not easy. But, like Daft Punk, I believe the following:

“Work it, make it, do it, makes us
Harder, better, faster, stronger.

And work it, make it, do it, I will.

September 13, 2014 Worry,Worry

Risk/Reward Vol. 235

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Worry, worry, worry, worry
Worry just will not seem to leave my mind alone.”---lyrics from “Trouble” sung by Ray LaMontagne

“Slow ride/Take it easy
Slow ride/Take it easy.”---lyrics from “Slow Ride” sung by Foghat

“Love til you hate
Know that we all fall down.”---lyrics from “All Fall Down” sung by One Republic

This week’s drop in the stock market resulted from “Worry, worry, worry, worry” that the Federal Reserve (Fed) will amend its forward guidance at its meeting next week. Specifically, the “worry” is that the Fed will announce that it may not wait a “considerable time” (at least six months) after quantitative easing (QE3) ends in October before raising short term interest rates. On Friday one of my favorite market gurus, Mohamed El-Erian, handicapped at 50/50 the likelihood of a change in Fed guidance. As a consequence of this “worrying”, the bond market experienced a sell-off causing the yield on the benchmark US10 Year Bond to climb to 2.61% at Friday's close. (N.B. falling prices mean rising yields). This in turn caused yields to rise worldwide. Stocks took a breather as well, as investors mulled the potential consequences of the Fed’s first rate increase since 2006. As an income investor, thoughts of rising interest rates “will not leave my mind alone”---at least not until after next week’s Fed meeting.

One notable dissenter from the “worry” crowd is Jeffrey Gundlach. If Bill Gross is the Bond King, then Gundlach is the Crown Prince. During his webcast last Tuesday, Gundlach advised fixed income investors to “Take it easy.” He sees no reason for the Fed to change its forward guidance or to otherwise signal an increase in interest rates. He cites the following facts as evidence that economies worldwide continue on a “slow ride” which he believes will grow even “slower” if the Fed even hints of a rate increase next week:
• Wage inflation for the lower 70% of US wage earners is non-existent, and wage inflation is Janet Yellen’s major concern. The prospect of wage inflation appears even less likely in light of the most recent, disappointing jobs number and the increase in jobless benefit claims reported last Thursday.
• Other drivers of inflation are moderating with oil prices dropping 15% since June.
• Domestic new home starts, traditionally a Fed bellwether, continue to fall despite low interest rates.
• The Chinese economy which served as a major catalyst for the post 2008 worldwide economic recovery (See Vol. 74 www.riskrewardblog.blogspot.com ) has been downgraded and is scheduled to grow at only 7.4% annually, its lowest rate since 1990. Evidencing this is the 40% year-to-date decline in the price of iron ore. China buys 2/3rd’s of all of the iron ore mined in the world, and iron ore drives the economies of many emerging markets like Peru, Brazil and Australia.

Gundlach cites these facts as further reasons for fixed income investors to “take it easy”:
• Quantitative easing in the Eurozone and elsewhere makes US 10 Year rates look attractive---above or below 2.5%. In last Wednesday’s $21bn auction of US10Year Bonds, 53 % were purchased by “indirect purchasers”, a group that includes foreign central banks; the highest percentage since Dec. 2011
• Even if the Fed does raise short term rates, it will only flatten the yield curve. Longer term rates (e.g. 10Year Bonds and longer) will experience little if any disruption due to the unprecedented amount of liquidity worldwide; in other words there is just too much demand for safe haven securities.
I recommend that you listen to a replay of Gundlach's presentation which was closely followed in real time on Twitter. It can be found at www.doubleline.com/webcasts.php .

As noted above, the price of oil continues to “All Fall Down” with the world’s benchmark, Brent oil, below $100/bbl and the domestic benchmark, WTI, near $90/bbl. And demand continues to drop. China is the second largest consumer of oil in the world, and its crude oil imports fell 2.4% in August. Meanwhile, production continues to increase. Thanks to hydraulic fracturing (“fracking”), US domestic crude production is now at 8.5million bbls/day (up from 5million bbls/day in 2007) and is projected to rise to 9.5million bbls/day in 2015 (more than half of US daily consumption and equal to the daily production of Saudi Arabia). Oil stocks, like all securities, are ones that investors “love till you hate.” Well, if falling prices are a sign of hate, then the hatin’ has begun. That said, there are some excellent companies on sale at present. Last week I highlighted Vanguard Natural Resources (VNR). Next week take a look at Breitburn Energy (BBEP) an acquisitive exploration and production company that pays a 9% dividend as one waits for the price of oil (and BBEP stock) to recover. With all of the turmoil in the world today, I am confident both will occur. A safer way to play Breitburn is its preferred stock (BBEPP) which is less volatile but still yields over 8% annually, amortized monthly. If big oil suits your fancy, Jim Cramer and some of my readers are pushing Royal Dutch Shell (RDS).

With so much riding on what happens at next week’s Federal Reserve meeting, I added very little to my holdings this week and remain 2/3rd’s in cash. I like counting the dollars that I have earned so far this year. I don’t want to spend any restless nights living the following One Republic lyric:

“Lately I been, I been losing sleep
Dreaming about the things that we could be
But baby, I been, I been prayin' hard
Said no more counting dollars
We'll be counting stars”

September 6, 2014 Can You Do It

Risk/Reward Vol. 234

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“You can go your own way
Go your own way."---lyrics from “Go Your Own Way” sung by Fleetwood Mac

“Come on people. Can you do it, can you do it, can you do it
Can you do it, can you do it, can you do it
Can you do it, can you do it”---lyrics from “Cool Jerk” sung by The Capitols

“My boyfriend’s back/He’s gonna save my reputation
If I were you/I’d take a permanent vacation.”---lyrics from ‘My Boyfriend’s Back” sung by The Angels

On Thursday, as expected the ECB embarked on a new round of quantitative easing (QE) announcing that it will purchase asset backed securities and covered bonds (bonds with an added layer of security). In a bit of a surprise, the ECB also lowered the rates at which it lends to its member banks and raised the penalty for parking money that it holds on deposit for those same institutions. The ECB is doing all of this in order to spur economic activity in the economically moribund Eurozone which is spiraling toward recession and deflation. In so doing, the ECB is "going its own way/its own way" at least in comparison to the U.S. Federal Reserve. With the US economy showing continued improvement, the Fed is winding down its QE program which is scheduled to end in October. Moreover, it has pledged to raise short term interest rates if future data points reveal steady job growth and increased momentum toward its goal for inflation of 2%. The personal consumption expenditure index (PCE), the Fed's preferred inflation measuring stick, is currently at 1.6%.

With the above central bank divergence now a reality, the hypothetical I posited last week (“Can the Fed expect to increase the 10Year Treasury rate by tightening its short term interest rate reins if the European Central Bank loosens its belt and embarks on a new round of quantitative easing?” www.riskrewardblog.blogspot.com ) has become a real question. “ Can you do it, can you do it, can you do it/ Can you do it, can you do it, can you do it/ Can you do it, can you do it” So far, the answer is unclear with the 10 Year yield rising this week but coming to rest well below 2.5% at the close. The disappointing job numbers reported on Friday lessened the likelihood that the Fed will signal any acceleration in its decisional timetable at this month's meeting which is scheduled for Sept. 16-17. Still, I remain cautious; 2/3rds in cash. The stock markets are also digesting the impact of this divergence. Both the S&P 500 and the Dow Jones Industrial Average traded flat for most of the week, but ended with a flair, obviously adopting the adage that bad news (job numbers) is good news at least when it comes to keeping interest rates low and stock prices high.

Those that invest in the oil patch likely have encountered Kevin Kaiser, the energy sector analyst for Hedgeye. Hedgeye describes itself as “a bold, trusted, no-excuses provider of actionable investment research.” In times past, Kaiser has bashed Kinder Morgan and Linn Energy only to be proven wrong. Despite this, Hedgeye has not sent Kaiser on a “permanent vacation.” And now he has attacked Vanguard Resources (VNR) which he states is “worth (only)a small fraction of its current price.” (Small fraction? Really?) Kaiser’s track record notwithstanding, VNR’s stock has plummeted 12% since July 29th. Admittedly, VNR’s dividend is not sustainable at its current coverage ratio, but its outlook is good, and management is on record that its 8.5% yield is not in jeopardy. That said, until VNR’s “boyfriend” or some defender other than management emerges to “save its reputation”, its price likely will continue to languish. I see this as a buying opportunity.

This week, one of my favorite market mavens (see Vol. 173 www.riskrewardblog.blogspot.com), Howard Marks of Oaktree Capital Management, published his latest memo. It can be found at www.oaktreecapital.com and I recommend it to your attention. Therein, he discusses various market risks. One risk he identifies is FOMO, the fear of missing out. FOMO is a silly reason to invest, but a real one nonetheless. Having booked a 7% return so far this year, I wonder if my foray back into the market is driven less by intellect and more by FOMO. I would hate like hell to have my year devolve into a pathetic Fleetwood Mac lyric:

“I climbed a mountain and I turned around
And I saw my reflection in the snow-covered hills
Till the landslide brought me down”

I don’t think FOMO is the reason I am back in the market, but it is something against which I must guard.

August 30, 2014 Reachin'/Low

Risk/Reward Vol. 233(2)

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“And I know the sky may be high
But, Baby, it ain’t really that high
Reach for the stars
Let’s reach for the stars.”---lyrics from ‘Reach For The Stars” sung by Will.I.Am

“How low can you go?
I could go low/Lower than you know.”---lyrics from “How Low Can You Go” sung by Ludacris

“You got no guts/You get no glory
And I’m bettin’ my money on an ace in the hole
Think I’m getting’ out of control.”---lyrics from “Out of Control” sung by The Eagles

For the month of August, the Dow Jones Industrial Average is up over 3% and the S&P 500 is up nearly 4% with each index fully recovering from July's correction and each hitting record highs this week. Truly, “the sky may be high/But, Baby, it aint’ that high” when markets “reach for the stars”. And, “reachin’ for the stars” is what the stock markets are doing. Indeed, prices are so high, I had to be very selective as I began my re-entry this week. Municipal bond closed end funds, preferred stock funds and some oil plays still look attractive.

Aiding the stock market’s “reach for the stars” has been the falling yield in the bond market, most notably the yield on the all-important 10Year Treasury Bond. Traditionally, as bond yields fall, stocks become more attractive. This certainly has held true recently as the cyclically adjusted price/earning ratio for the S&P 500 (CAPE, see Vol. 226 www.riskrewardblog.blogspot.com for a discussion of this) has been stretched to historic levels. With the US 10Year yielding only 2.34% at yesterday’s close, one is left to wonder “How Low Can It Go?” “Lower than you know”, or at least lower than the experts know. Indeed, at the start of the year, any suggestion that the yield on the 10Year would be below 2.35% on Labor Day would have been deemed “Ludacris.”

And now these very same experts are questioning whether the Federal Reserve has lost the ability to raise interest rates if and when it decides the time is right. A provocative opinion piece written by George Melloan in the August 26, 2014 edition of the Wall Street Journal suggests that interest rates indeed may be “getting’ out the the Fed’s control.” I recommend the piece to your attention. Therein Melloan analyzes each of the Fed’s traditional tools for raising rates (e.g. reverse repos, raising interest rates paid on reserves, and its “ace in the hole” raising the Fed funds rate). He then concludes that none of these may be effective in a world awash in liquidity---liquidity made available through accommodative monetary policies adopted by central banks world wide. Can the Fed expect to increase the 10Year Treasury rate by tightening its short term interest rate reins if the European Central Bank loosens its belt and embarks on a new round of quantitative easing? Forty percent of U.S. government issued debt is owned by foreign interests currently, and that percentage continues to increase. And why not, when the German 10 Year Bund yields only 0.89% and the Spanish 10Year yields only 2.2%. Given a choice, who wouldn’t rather own the US 10Year, even at a 2.3% yield?

How valuable are the opinions of so-called experts in this “Desperado” world, anyway? None has provided me with a “Peaceful, Easy Feeling." How about you? None can say with any conviction whether stocks will continue to climb and/or interest rates will continue to fall. Even if one were to predict “How Long” this “Life in the Fast Lane” will continue, I, for one, would not believe their "Lyin' Eyes." The only approach an individual investor can take is to remain nimble, reserving to oneself the ability “to check out anytime you want.” That’s what I did, and what undoubtedly I will decide to do again “One of These Nights.

August 23, 2014 Do What You Say

Risk/Reward Vol. 232

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Why don’t you do what you say
Say what you mean
One thing leads to another.”---lyrics from “One Thing Leads to Another” sung by The Fixx

“We bounce to this track
Hands to the sky/And throw your hair back
Bounce, bounce, bounce.”---lyrics from “Bounce” sung by Calvin Harris

“Listen children, all is not lost
All is not lost, oh no, no
Can you dig it?/Yes I can
And I’ve waited such a long time
For the day.”---lyrics from “Saturday in the Park” sung by Chicago

On August 9th, when last I wrote, I noted that from my vantage point on the sidelines, prices throughout the oil patch had fallen significantly and that several stocks including master limited partnerships KMR, KMP and ETP (each of which is controlled by Kinder Morgan (KMI)) were “very attractive.” Sadly, although I “said what I meant”, I had no time to “to do what I said.” “One thing (low prices) led to another (a buyout).” Indeed, the very next day, Sunday August 10th, Richard Kinder, the chairman of KMI announced a reorganization effectively collapsing KMR, KMP and ETP into KMI under terms very favorable to KMR, KMP and ETP shareholders. The shares of these skyrocketed when the market opened on August 11th and are now up 30% in just two weeks.

Kinder Morgan shares were not the only stocks that shone brightly these past two weeks. The lessening of tension in both Ukraine and the Gaza Strip caused investors to put “Hands to the sky/And throw their hair back” as the Dow Jones Industrial Average gained nearly 500 points and the S&P 500 entered record territory. Aiding this “Bounce, bounce, bounce” was a return to the belief that the Federal Reserve would maintain its zero-bound monetary policy. Indeed, on Friday August 15th the rate on the US 10Year Treasury Bond fell to 2.35%, its lowest point since the “taper tantrum” began on June 19, 2013. The rate has remained suppressed closing at 2.40% yesterday.

Despite broad gains in the market in general, however, the income securities that I favor still have not recovered to where they were earlier this summer. What “I’ve waited such a long time for is the day” when a clearer read on future interest rates can be had. And that day may have occurred yesterday when, at the much anticipated Jackson Hole conference, both Fed Chair Janet Yellen and ECB President Mario Draghi reiterated their devotion to low rates. Her comments in particular were interpreted as supporting a slight rise in short term rates next summer and a measured move upward thereafter. “Can you dig it?/Yes, I can.” So, “listen children, all is not lost/All is not lost” when it comes to more 2014 profits. I am reviewing and revising my buy list. Likely, I’ll be invested again once the impact of Jackson Hole is fully digested by the market---which could be as early as next week.

In retrospect and upon reflection, I am comfortable with my decision to lock-in my 7+% gain for the year on July 31st--- including the sale of KMP, KMR or ETP . “Does Anybody Really Know What Time It Is?” when it comes to predicting mergers, acquisitions or reorganizations? That said, participation in Kinder’s meteoric rise during the past two weeks would have “Colour(ed) My World” very green indeed. After Richard Kinder made the announcement, I received emails from several subscriber/Kinder shareholders to the effect of “Wishing You Were Here.” I must admit, these notes did not ease the pain, but they did “Make Me Smile.”

August 9, 2014 Musical Chairs

Risk/Reward Vol. 231

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“You don’t know what you’ve got
‘Til it’s gone
They paved over paradise
And put up a parking lot.”---lyrics from “Yellow Taxi” sung by Joni Mitchell

“And now my baby’s playing musical chairs
Round and round
And when the music stops
She’s not there.”---lyrics from “Musical Chairs” sung by Yung Berg

“Nobody gets too much heaven no more
It’s much harder to come by
I’m waiting in line”---lyrics from “Too Much Heaven” sung by the Bee Gees

As noted last week, my sell signal came on July 30th in the form of a nine basis point spike in yield on the 10Year Treasury Bond(10Year) to which much of my portfolio was correlated. Since that time, those nine basis points have retrenched, and as of Friday's close the yield on the 10Year was at a year-to-date low of 2.42%. So why have I not repurchased that portfolio? The answer is simple---because the securities comprising that portfolio continued to drop in price despite a rally in the 10Year. Does this mean the correlation no longer applies? Is Joni right that “You don’t know what you’ve got/Til it’s gone?” Yes and no. I believe that the correlation holds, but not in the presence of the current combination of exogenous threats: the continued unrest in the Gaza and Iraq, the threat of retaliation by Russia and most importantly the ever weakening economies in Europe and South America. I am not alone in this belief. In an article in Thursday’s edition of the Financial Times, market guru Mohamed El Erian blamed last week’s across-the-board sell-off on the “…cumulative impact of multiple causes …cover(ing) geopolitical, financial, economic and policy factors,…(which caused) conventional correlations among asset classes to break down.” Safety became and remains paramount. Investors seeking to park funds in a safe place have few, if any, alternatives to Treasury securities. The only real alternative, the German bund, is ridiculously more expensive in comparison. Thus, now more than ever, the US is the financial world’s “paved paradise” and the 10 Year is the world’s “parking lot.” Not so, the securities otherwise priced in relation thereto such as high yield bonds, senior loans and closed end funds. Check the last 10 trading days of activity in the relevant exchange traded funds (ETF): JNK (high yield bonds), BKLN (senior loans) and PCEF (closed end funds).

Why not? Here’s my take. When the yield on the 10Year spiked on July 30th and its price correspondingly fell, those securities priced in relation thereto fell much more quickly and much more precipitously. Indeed, those of us who use limit orders found them going “round and round.” It was like playing “musical chairs” and when the “music stopped”, buyers at or above the limit price “were not there”. I had to sell at the price that Mr. Market bid—something I dislike. The very situation about which I had written in Vol. 227 (www.riskrewardblog.blogspot.com ) had occurred. Due to Dodd-Frank and other regulations, commercial banks were not there as backstop buyers. News articles over the next several days noted the absence of backstop buyers (a/k/a market makers) and the resultant lack of liquidity in these sectors. It is small wonder that the very investors that had driven the prices of these securities so high (and their yields so low) are continuing to exit. Indeed, Friday's Wall Street Journal reported that, as of Wednesday, junk bond funds experienced the largest weekly net outflow in history---$7.1billion eclipsing by a mile the previous weekly net withdrawal record of $4.6billion experienced during the "taper tantrum" of June 2013. To give some perspective on this, in May these same funds had a net inflow of $2.61billion. I have no doubt that I will own these securities again, but not until prices stabilize at a level that rewards me for this liquidity risk.

Remember just a few short years ago when our lament was that “Nobody gets too much oil no more/It’s much harder to come by/I’m waiting in line.” The recent drop in the US domestic (WTI) price of oil suggests that this is no longer the case. XOP, the domestic oil exploration and production ETF, has fallen 11% in value since its June high, and the price of AMLP, the master limited partnership ETF (which should be insulated from price swings) has fallen 6% since then. That stated, VNR, LINE, LNCO, KMR, KMP, BBEP and ETP (all which I sold last week) have stabilized and have begun to regain this week. Some commentators suggest that next month, once a refinery in Coffeyville, KS comes back on line, WTI should rise again. In any event, prices throughout the oil patch are very attractive.

Friday's action turned an otherwise bad week positive. Until then it seemed that nothing worked---not even market correlations. It is for this reason that I remain on the sidelines. But whether you join me there, you hold pat or you buy, remember the investors credo (with attribution to the Brothers Gibb):

“Whether you're a brother or whether you're a mother,
You're stayin' alive, stayin' alive.
Feel the city breakin' and everybody shakin',
And we're stayin' alive, stayin' alive.
Ah, ha, ha, ha, stayin' alive, stayin' alive.
Ah, ha, ha, ha, stayin' alive.”

August 2, 2014 Na Na Hey Hey

Risk/Reward Vol. 230

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Six o’clock already
I was just in the middle of a dream
It’s just another manic Monday.”---lyrics from “Manic Monday” sung by The Bangles

“Waiting for Wednesday
My stomach doesn’t hurt bad enough
Pain always is the sign
Waiting for Wednesday.”---lyrics from “Waiting on Wednesday” sung by Lisa Loeb

“I wanna see you kiss him
I’m gonna see you kiss him/ Goodbye
Na na na na/Na na na na
Hey hey/Goodbye.”---lyrics from “Na Na Hey Hey” sung by Steam

Last week’s edition evoked a flurry of responses including one that I circulated. That loyal reader advised me to liquidate because I had surpassed my annual goal (6%) and because holding for more bespoke a lack of discipline. So what is my discipline? To answer that question, I reread several past editions (as I am wont to do) and found guidance in Vol. 221 (www.riskrewardblog.blogspot.com ). Therein, I stated that “I have come to believe that one can construct a non-diverse portfolio correlated to a market singularity with movement by that singularity providing clarity on when to buy, hold or sell.” That singularity, for me of course, is the yield on the 10 Year Treasury Bond. As the trading day began on “manic Monday”, the yield on the 10Year held steady and by “six o’clock” it had risen hardly at all. Thus, I did not sell. Come Tuesday, the continuing conflict in the Mideast spurred a further flight to safe investments, and the news from Europe was that the yield on the Spanish 10 Year bond was LESS than that on the US 10 Year. These factors resulted in an increased demand for the 10Year which in turn raised its price and lowered its yield. This action increased the value of interest rate-sensitive securities many of which I hold. Thus, on what was a down day for the Dow Jones Industrial Average and the S&P 500, the portfolios that I manage reached all time highs.

And then came Wednesday—a day which all market watchers were “waiting for” On Wednesday came the release of second quarter gross domestic product (GDP) numbers, of the quarterly personal consumption expenditure index (a/k/a PCE--- the inflation indicator deemed most reliable by the Federal Reserve) and of a statement at the conclusion of the Fed’s monthly meeting. Coming off a great Tuesday, “my stomach didn’t hurt.” But the combination of a blockbuster GDP report (up an annualized 4% in Q2) and a spike in inflation (core PCE up 1.7%--close to the Fed’s target of 2%) led Mr. Market to believe that it is now more likely that the Fed will raise interest rates sooner than expected; this despite protestations in the Fed’s press release to the contrary. This belief manifested in the yield on the 10Year spiking a whopping 9 basis points, its largest one-day move since last November. Its price fell accordingly. (N.B. A rise in yield means a drop in price) The value of those securities priced in relation to the 10Year (closed end preferred stock funds, high yield bond funds, etc.—you know, the kind I like and own) dropped as well.

Per my discipline, this was the movement in the 10Year yield which told me to sell. So come Thursday morning, it was “Na na na na/Na na na na/Hey, hey/Goodbye” to the interest rate-sensitive portion of my portfolios. I was not alone in “wanting to kiss him (Mr. Market, that is) good bye’ as the DJIA fell nearly 200 points as I sold and 316 points by day’s end. In so doing, the DJIA gave back all of its year to date gains. Meanwhile, the S&P shaved 39 points (2%!). The bloodbath continued on Friday, albeit at a slower pace due in part to the fact that Friday's jobs report was lukewarm thus lessening fears of an even sooner hike in interest rates. Would I have retained more profit had I sold on Monday or Tuesday? Yes, but that would have been undisciplined. I waited for a clear signal, the type which Wednesday provided. My one mistake was not exiting Wednesday before the market closed. Had I done so, I would have avoided a reduction in profits incident to the mass exodus on Thursday. That said, I escaped with the vast majority of my year to date gains and remain very pleased with my approach--- and my results.

I don’t know how quickly I will redeploy the considerable amount of cash I raised this week. But that does not mean I will sit idle. I will continue to study and to test. When the time is right, like The Bangles, I will

Slide my feet up the street
Bend my back
Shift my arm and pull it back.
Then, I will walk like an Egyptian

back into the fray.

July 26, 2014 A Moment Like This

Risk/Reward Vol. 229

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“I say we can dance/We can dance
Everything’s out of control
Oh, it’s a safety dance
Ah yes, it’s a safety dance.”---lyrics from “The Safety Dance” sung by Men Without Hats

“I wanna be high, so high
I wanna be free to know
The things I do are right”---lyrics from “Easy” sung by The Commodores

“I can’t believe it’s happening to me
Some people wait a lifetime
For a moment like this.”---lyrics from “A Moment Like This” sung by Kelly Clarkson

By the time our flight from Seattle landed last Friday afternoon, I had completed the first draft of what was to be last week’s Risk/Reward. It was one day after the downing of the Malaysian Airliner, an event that predictably had caused the markets to do a “Safety Dance.” The Dow Jones Industrial Average had fallen 162 points on Thursday (the day the airliner was shot down), and the yield on the 10 Year Treasury had fallen from 2.54 to 2.47. My theme was how investors react when they perceive that “Everything’s out of control”; to wit, they sell equities and buy Treasuries. You can imagine my surprise when I checked my iPhone as we taxied to the gate and learned that the markets had recovered most of the previous day’s losses and that the 10 Year yield had stabilized---this despite no resolution of the Ukraine situation and a worsening of matters in Israel. How could this be? What happened to the ‘safety dance/yes, the safety dance?” I deleted the draft and began to ponder.

And ponder I continue to do. Another week has passed and if anything, the situations are worse in both hot spots. Yet, apparently on the strength of so-so domestic economic news and less than sterling earnings reports, the US stock markets just “wanna be high, so high.” They reach for new records virtually every day except yesterday of course. Meanwhile, the yield on the 10Year holds steady around 2.5%. Each financial news story that I read or report that I hear features someone warning of a coming stock market correction and/or a collapse of the bond market. But, Mr. Market seemingly just doesn’t care. And lest we forget, Mr. Market is the only one who matters. He is “free to know/The things he does are right”---each time and all of the time.

So what does a rational investor do? No economic or financial data justifies the stock market’s unceasing march upward or the year to date performance of the securities priced in relation to bonds (the kind I favor). That said, I am up nearly 10% year to date. Literally, “I can’t believe it’s happening to me.” Until yesterday, it’s been another day, another gain; a situation for which “Some people wait a lifetime.” And yet I am exceedingly uncomfortable. Was Friday's triple digit loss on the Dow an ephemeral reaction to disappointing news from Amazon and VISA or is it a harbinger of things to come? My rational self tells me to sell and to head to the sidelines with my outsized profits in tact (remember I only seek an annual return of 6%). But my competitive self is caught in the euphoria of the day and urges me to stay. Why liquidate at “A Moment Like This”?

In sum, I am living a Kelly Clarkson greatest hits album. One side tells me to “Just Walk Away.” Another side asks “Don’t You Wanna Stay Here a Little While?” A moderate drop wouldn’t kill me and I know “What Doesn’t Kill You Makes You Stronger.” But if I were unable to recover from such a drop by year’s end, “My Life Would Suck.” I solicit input from you, my Loyal Readers. That way, whatever course I choose, I can say it was “Because of You.” In the meantime, I ponder on.

July 12, 2014 Woman To Blame

Risk/Reward Vol. 228

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Come Monday
It'll be alright
Come Monday
I'll be holding you tight”---lyrics from “Come Monday” sung by Jimmy Buffett

“Portuguese love
Won’t you say it to me
Say it to me
You love me baby.”---lyrics from “Portuguese Love” sung by Teena Marie

“No need to be complacent
There’s chaos across the border
And one day it could happen to us.”---lyrics from “Blood on the World’s Hands” sung by
Iron Maiden

When last I wrote, I was giving consideration to paring my holdings this week in interest rate sensitive securities due to a spike in the yield on (and concomitantly a drop in the price of) the US 10 Year Treasury Bond (10Year). In Vol. 221 www.riskrewardblog.blogspot.com , I explained the correlation between these securities and the 10Year. But one thing that I have learned over the past few years is the value of patience. Before making a significant purchase or sale, I re-read previous editions of Risk/Reward that discuss similar moves in the past. I do so as a double check against what could be an emotional as opposed to a studied decision. This time I found Vols. 80, 99 and 174 www.riskrewardblog.blogspot.com instructive. Another thing I have learned is to avoid large moves “Come Monday.” Monday markets reflect an entire weekend’s worth of euphoria and/or anxiety and in my experience overshoot, to the positive and to the negative, actual market sentiment. “Come this past Monday”, I decided to “hold tight”---and I am glad that I did.

In addition to my reticence to act on Monday’s in general, my review this past Monday of the world bond market influenced me to stand pat. As also discussed in Vol. 221 www.riskrewardblog.blogspot.com, bond markets are global and interconnected. As such, the prevailing rates last Monday for the 10Year bonds of France (1.585%), Germany (1.264%), Italy (2.698%) and Spain (2.673%) led me to conclude that the rate on the US10Year would not move much higher than the previous Friday’s close of 2.65%. Why would a rational investor buy Italian bonds with their inherent risk of default at a yield of 2.698% when one can purchase the safest bonds in the world at a yield of 2.65%? I was proven right as the US10Year yield moderated to 2.62% on Monday and fell steadily through Wednesday’s close of 2.55%. Due to the correlation between my portfolio and the 10Year, that movement translated into some excellent gains for me. And as Thursday dawned, I received even more positive vibes; this time in the form of “Portuguese love.” News of possible financial trouble from that small nation sent tremors throughout the Eurozone. The resulting flight to safety by bond buyers caused the price of the US 10Year (and those securities priced in relation thereto) to rise as its yield dropped to 2.53% by that day’s close and to 2.52% at week's end.. It was like Europe was ‘saying to me/love me baby.”

For those who pay attention to financial news, investor “complacency” and its cohort, the lack of volatility, continue to be hot topics. Commentators warn that the steady upward momentum in asset prices, nurtured by highly accommodative monetary policies, has created asset bubbles in every financial market. The ”q and a” session last week between Fed Chair Janet Yellen and IMF President Christine Lagarde has heightened this concern. In that session, Chair Yellen stated that tightening monetary policy was NOT the first line of defense against “financial excesses” (bubbles); macroprudential policy was; in the form of capital and lending requirements imposed on regulated institutions as coordinated by and between central banks. Good luck with that one, Janet. Very recent history has shown that there can be “chaos across the border.” Just look at the Eurozone sovereign debt crisis of 2011 which at the time was chronicled each week in this publication. (See May through December, 2011 editions). And as interconnected as the financial world has become, that chaos “one day could happen to us.” In the meantime, the ECB contemplates more accommodation in the form of its own quantitative easing; our zero bound policies keep our rates at historic lows; and investors the world round continue to venture further out the risk curve in search of yield. Someday the resultant bubbles will burst, and there will be no doubt this time as to who has “blood on their hands.”

Unlike Jimmy Buffett, I “know the reason” I stayed invested this week. I am not sure I will remain so “all season.” Any type of “pop top” could cause me to “blow out my flip flop” and sell, most notably a rise in interest rates. One thing is for sure. If I fail to preserve my year to date profits, “some people could claim that there’s a woman (Janet Yellen) to blame”, but “I know it will be my own damned fault.”

July 5, 2014 Measure of a Man

Risk/Reward Vol. 227

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“Back on the beat/Back to the start
Trust in your heart
That’s the measure of a man.”---lyrics from “The Measure of a Man” sung by Elton John

“Cause the fire don’t fear the water
And the night don’t fear a thief
Here we are/We are/We found euphoria”---lyrics from “Euphoria” sung by Usher

"There's no way out of this dark place
No hope/No future
Tell me where did I go wrong?"---"No Way Out" sung by Phil Collins

The second quarter came to an end last Monday so it is time to take "The Measure of the Man." Through the first six months of 2014, the two portfolios that I manage earned a total return (appreciation plus dividends, pre-tax but net of all expenses) of 9.6% and 8.4% respectively. It is satisfying to know that by "trusting in my heart", I have surpassed my annual goal of 6-7% in just two quarters. Come next Monday the choice I face is whether to be "back on the beat" or to liquidate and lay "back until the start" of 2015. With the yield on the 10 Year Treasury Bond (10Year) spiking to 2.65% following the excellent jobs reports of Thursday and Friday, the latter may be the wiser choice for an income investor like me, even as the Dow Jones Industrial Average (YTD total return of 4%) and the S&P 500 (YTD total return of 8%) hit record highs.

Will the seemingly endless string of new highs continue or are there difficult times ahead? A report recently issued by the Bank for International Settlements (BIS), the central bank for central banks, warns that current asset prices are not sustainable. The BIS characterizes the current market as "Euphoric", buoyed by central bank monetary policies which foster a belief that interest rates forever will be zero bound. According to the BIS, one consequence of such a belief is market complacency; a condition in which "the fire don't fear the water/And the night don't fear a thief." In support of its thesis, the BIS cites the fact that junk bonds now yield, on average, 4.8% (an all time low) and the fact that investment grade corporate bonds trade at a spread of less than 1% to Treasuries. According to the BIS, neither rate reflects an appropriate risk premium.

Whether or not the BIS's concerns are justified, one thing is for certain: as a result of new banking regulations, if interest rates do rise quickly, those seeking to exit bonds or bond funds may find "there's no way out/No hope/No future." Allow me to "tell you where the regulators went wrong." In the wake of the 2008-9 banking crisis, Congress and the Federal Reserve mandated that institutions covered by FDIC insurance (virtually every bank) curtail many non-core functions, one of which was making a market for bonds. Until this change, most large financial institutions maintained active bond trading departments that literally served as the bond buyer of last resort. Banks were deemed to have sufficient capital to inventory the bonds they purchased until prices rose to a profitable level. With today's more restrictive capital requirements, those departments have been disbanded, and no effective replacement has been devised. Thus, should the price of bonds fall (because interest rates increase), the sharpness of the decline will be magnified by the absence of ready buyers a/k/a market makers. This is an additional reason to pare at least the bond fund portion of my income producing portfolio.

With new records being set each week, I find myself praying for just "One More Night" of gains. But with recent spike in the interest rate on the 10Year, "I can feel it (a drop in the value of income producing securities, that is) coming in the air tonight, oh Lord." And if that drop becomes too pronounced, like Phil Collins, "I can (and will) just walk away/Just leave without a trace."

June 28, 2014 Superman's CAPE

Risk/Reward Vol. 226

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“You don’t pull on Superman’s cape
You don’t spit in the wind”---lyrics from “You Don’t Mess With Jim” sung by Jim Croce

“Feel like jumpin’ baby/Won’t ya join me please
I don’t feel like beggin’/But I’m on my knees
So be my guest/You got nothin’ to lose
Won’t ya let me take you on a sea cruise.”---lyrics “Sea Cruise” sung by Frankie Ford

“This old man/He played nine
He played knick-knack on my spine
With a knick-knack paddy whack
Give a dog a bone
This old man came rolling home.”---lyrics from “This Old Man” sung by Everyone

Although the major stock indices continue to flirt with record highs, financial commentators characterize investor sentiment as jittery. One factor contributing to this sentiment is the following: much of the gain in stock prices over the past year has resulted from an increase in stock multiples as opposed to an increase in corporate earnings. Recall that a primary determiner of a stock’s value is its price to earnings or p/e ratio which is otherwise termed its multiple. For example, Google, which trades at $575 per share, had earnings over the past twelve months of 19.09 per share, and thus has a p/e ratio or multiple of 30.12 ($575/$19.09= 30.12). Nobel prize winner, Robert Shiller, who is viewed as a “Superman” when it comes to economic trends (e.g. the Case-Shiller Home Price Index) measures the health of stock markets by calculating an average “Cyclically Adjusted Price to Earnings Ratio” or CAPE for all of the stocks comprising the S&P 500 Index (S&P) or predecessor indices. Since 1881, Superman's CAPE has averaged a multiple of 17. Today, the CAPE multiple of the S&P is 26, a number that has been exceeded only three times: in 1929, 2000 and 2007, just before significant market downturns. CAPE has been criticized because it does not take into consideration interest rates which are currently at historic lows. Nevertheless, his observations are more than just “spittin’ in the wind.”

Domestic oil producers and oil services companies “felt like jumpin’” this week. After years of “beggin’” from “on their knees”, the Commerce Department approved the applications of Pioneer Natural Resources (PXD) and Enterprise Products (EPD) to export condensate. Condensate is a petroleum product that is lighter than crude oil, but is capable of being refined into diesel and jet fuel. Condensate is found in large quantities in the oil fields of West Texas and North Dakota. It is better suited to foreign refineries than to US refineries which are engineered to crack heavier oil imported from the mid-East, Nigeria and Venezuela. This fact supported sending condensate “on a sea cruise” since many of our domestic refiners can not refine condensate and thus “got nothin’ to lose”. As noted previously (see Vol.193 www.riskrewardblog.blogspot.com ), US producers have been precluded from exporting unrefined petroleum products since 1973 so the potential associated with exporting condensate is significant. On news of the approval, stocks in the oil patch rose generally, and the stock of oil services companies such as HCLP and TRN skyrocketed.

As loyal readers know, I have had a love/hate relationship with ARCP, the triple-net-lease real estate investment trust (REIT) founded by the not so “Old Man”, Nick Schorsch. “(K)Nick” has a “knack”of upsetting stockholders by overpaying himself and by making massive acquisitions funded by disruptive secondary stock offerings . The former problem was eliminated Friday last when Nick took a “paddy whack”, stepped down as CEO and went “rolling home”. The latter problem likely has been resolved by an announcement accompanying the resignation that ARCP will eschew acquisitions for the remainder of the year and instead will rely upon organic growth to improve its already handsome monthly dividend. Due in part to “Nick’s knack”, ARCP has lagged the REIT sector this year, but I believe these recent developments and its 8+% dividend will give this “dog a bone” and will propel ARCP’s stock higher. I added to my position.

If you read financial news reports, you know that the markets have shown little, if any volatility. Indeed, the market indices have closed above their 200 day moving averages for more than 400 consecutive days. That said, investors are nervous because they know (like Jim Croce) that one cannot “Put Time in a Bottle”. Someday a bear market will come roaring back, “badder than old King Kong/Meaner than a junk yard dog.” Thus, I, for one, remain vigilant; ever ready to exit should I see a clear bearish signal. For my income weighted portfolio, that signal will be in the form of a spike in the interest rate on the 10Year Treasury Bond. Currently, that rate remains in a range between 2.5 and 2.65%. Should it suddenly spike and head toward 3%, I will sell. I may be a market timer, but I am not a gambler (although like Bad, Bad Leroy Brown “I like my fancy clothes!”).