January 25, 2014 Holy Biebs

Risk/Reward Vol. 205

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

"I'm in with the in-crowd/I go where the in-crowd goes
I'm in with the in-crowd/I know what the in-crowd knows."---lyrics from "The In-Crowd" sung by Dobie Gray

"Oh, no no, Oh no no/She's confident
Oh, no no, Oh no no/And I'm down with it."---lyrics from "Confident" sung by Justin Bieber

"How do we re-reverse the chemistry
I don't want us to be the end of me
This love is taking all my energy
Energy, my energy"---lyrics from "Energy" sung by Keri Hilson

As devotees of "House of Cards" know, in DC, journalists rely on being "in with the in-crowd"; "going where the in-crowd goes"; and "knowing what the in-crowd knows" or at least what the in-crowd wants them to know. And no one is more "in" with Ben Bernanke than Jon Hilsenrath of the Wall Street Journal. Thus on Tuesday, no one had to speculate as to the identity of his source when Hilsenrath reported on the front page of the WSJ that at its meeting on January 28th and 29th, the Federal Reserve likely will 1) taper (reduce) its asset purchases (a/k/a QE3) in February by another $10billion and 2) will give forward guidance that short term interest rates will stay at or near zero even if unemployment falls below 6.5%. It was clearly a trial balloon floated by Uncle Ben to ascertain the market's reaction. In the past, such stories caused the all important 10Year Treasury Bond to fall in price (which in turn caused its yield to rise). However this time the 10 Year actually rose in price, and correspondingly the yield dropped to its lowest point in six weeks. Clearly, Bernanke is now free to advocate this course of action in what will be his last meeting as Fed Chair. I, for one, hope he does. It is time to ween the markets from QE3, this week's MISERABLE market activity notwithstanding.

Indeed, the stability of the 10Year yield made fixed income investors "Confident" even in the face of an otherwise disappointing market. They are now "down with" the fact that the continued tapering of QE3 will not cause a precipitous rise in interest rates and that, unlike last year, they will not be crying "Oh no no/Oh no no" every time the word taper is mentioned. Once again take a look at all of the green numbers in the year-to-date column found on the closing table for preferred stock ( http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html?mod=mdc_h_usshl#C ). The performance of these preferreds is representative of the ytd performance of fixed-income/interest-rate-sensitive securities generally. Indeed these securities (preferred stocks, business development companies, real estate investment trusts) held firm and some even rose as the Dow Jones Industrial Average (DJIA) suffered its worst week since November, 2011, losing 579 points on disappointing earnings reports, news of a possible economic slow down in China and anxiety over emerging markets.

Likewise, with the exception of drilling stocks, the large losses absorbed by the broader market this week were not felt in the "energy, my energy" sector. Another dose of the polar vortex is "taking all our energy", a fact demonstrated by a draw down of natural gas and propane reserves. This coupled with news that annual domestic consumption of oil rose in 2013 for the first time in several years and reports that the US may "re-reverse" its ban on exporting crude has caused many energy stocks to rise this year. My holdings in this sector include SDRL,SFL, HCLP, APU, ETP, KMP, KMR, FEI, TRN, VNR, VNRP, MHRpD, GRHpC, and GSTpA. But no stock in the energy patch has outperformed my largest holding in the sector, Linn Energy (LINE). Having been brutalized by short interest and the subject of rumors of accounting irregularities for much of last year, LINE now is hitting its stride. LINE is up over 9.5% in the past month and up over 20% in the past 90 days. With a dividend still in excess of 9% and the accretive impact of the Berry Petroleum acquistion yet to be felt, LINE could have more to gain. I for one, "don't want this to be the end" of LINE's run. I used Friday's massive downturn in drillling stocks to add to my position in SDRL.

Due to the makeup of my portfolio, I weathered this week's bloodletting better than most. No doubt, however, the 3.5% drop in the DJIA left many investors feeling about as secure as Justin Bieber's booking agent. That said, we must remain mindful that investing remains our greatest opportunity for financial independence. As the Bieb says, investing

"... can take you places you ain't never been before
Baby take a chance or you'll never ever know
I got money in my hands that I'd really like to blow
Swag swag swag, on you"

January 18, 2014 Early Bird

Risk/Reward Vol. 204

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

"There is so much waiting for you/Listen here is all you must do
Play the field/You gotta look around
Lovin' is so real/Don't just settle down."---lyrics from "Play the Field" sung by Debbie Gibson

"Baby's got a lot of baggage/It don't seem to matter
Where do I have to go/To find a honey with a little soul
Tokyo/Tokyo"---lyrics from "Tokyo" sung by The Imagine Dragons

"Always was an early bird/With something on the side
Better buy this, better buy that/Maybe let that baby ride."---lyrics from "Early Bird" by Mark Knopfler (of Dire Straits fame)

So how does one "Play the field" when one does not want to "just settle down" on one stock within a sector? For any number of reasons, an investor may want to diversify throughout a sector; may prefer to "look around" especially when "there is so much waiting for you." A case in point is this week's performance in and among those stocks comprising the financial institutions sector. Most financials reported earnings in line with expectations; a few, such as Citigroup, reported disappointing numbers. Investing in the whole sector worked; investing in just one stock could have turned out badly. To gain exposure to a variety of stocks within that sector, "here is all you must do." Buy an exchange traded fund (ETF) comprised of financial institutions. I own XLF for large institutions and KRE for regional banks. Indeed ETF's have revolutionized diversification. With one push of the "Enter" button one can buy the entire S&P 500 Index (SPY), the Dow Jones Industrial Average (DIA), the Nasdaq (QQQ), the Russell 2000 (IWM), exposure to Europe (HEDJ) or exposure to Japan (DXJ). Or, one can access any number of sectors within each index such as XLF. With the onset of ETF's, "Lovin' (a diversified portfolio) is so real."

On Wednesday, International Monetary Fund chief Christine Lagarde and Chicago Federal Reserve President Charles Evans independently spoke to the threat to developed economies (US, Japan and EU) posed by deflation. Previously, I have written of my concern regarding deflation ( Vol 201 www.riskrewardblog.blogspot.com ), and I suspect it will be discussed here throughout the year. Deflation comes "with a lot of baggage", and there is no more instructive example than what has occurred in "Tokyo/Tokyo" over the past 15 years. There, people have deferred purchases with the knowledge that prices will remain stable or even fall. Add to this the lessening of demand incident to Japan's shrinking population and the result is an entire economy that is in the doldrums even after its central bank adopted highly accommodative policies such as zero interest rates and quantitative easing. In a word, Japan's economy is stagnant and Europe's may become so, as well, as the Eurozones's annualized inflation rate was only 0.8% in the fourth quarter of 2013. The US rate was only 1.2%, well below the 2% target. Pressure on the ECB and the Federal Reserve to continue inflationary responses to these deflationary trends is just one more reason why I see a continuation of easy money policies which in turn means that the yield on the all important 10 Year Treasury Bond likely will stay at or below 3% for quite some time. Deflation is bad news for the economy, but good news for those who purchase fixed income assets that have been priced in anticipation of the 10 Year yield exceeding 3.5% in the near term (e.g. preferred stocks, real estate investment trusts, business development companies, etc.)

Speaking of preferred stocks, it often pays to "be an early bird." Indeed, that is why I always keep "something on the side"; just in case desirable new preferreds are issued. I don't want to "let those babies ride". Instead, I had "better buy this/and better buy that." The recent issuance of Series P preferred shares of American Capital Realty Partners (ARCPP) provides an excellent illustration. ARCP is an aggressively acquistive triple net lease real estate investment trust about which I have written in the past (See Vol. 184 www.riskrewardblog.blogspot.com ). I have done very well with its common stock in recent days as it has just completed its largest and most accretive merger to date. To help finance its acquistions without overly diluting its common shareholders, ARCP recently issued ARCPP, a preferred stock which is scheduled to pay a 6.7% annual dividend amortized monthly based on a par value of $25. In its first few days of trading, ARCPP was not well received. I purchased some on Tuesday at $20.60 (providing me an 8+% yield!). By Friday, ARCPP had gained 5% in just four days! This is not unusual in the preferred stock world. The "early bird" often does get the worm. I monitor preferred issuances via the IPO section of Quantum on Line (www.quantumonline.com ), a valuable site for fixed income investors.

Although the start of the year has been a mixed bag for the indices, my fixed income portfolio has done well primarily because the 10 Year has remained stable. That said , I firmly believe (like Mark Knopfler) that "I shoulda learned to play the guitar" or "I shoulda learned to play the drums" because "That ain't workin' that's the way to do it" You may "get a blister on your little finger" or "a blister on your thumb", but "playin' guitar on MTV" sure beats working the stock market. I, too, would like "Money for nothin' and my chicks for free.."

January 11, 2014 Ireland's Call

Risk/Reward Vol. 203

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

"If your heart's been shattered/The pieces are scattered
All across the ground of loneliness
Just reach for the phone/I'll be there at home
My name is Fix-it/And I'll be there---lyrics from "Mr. Fix It" sung by UB-40

"Ireland,Ireland/Together standing tall
Shoulder to shoulder/We'll answer Ireland's call"---lyrics from "Ireland's Call" sung by The Celtic Thunder

"It just comes natural
Seasons change, rivers wind
Tumbleweeds roll and stars shine."---lyrics from "It Just Comes Natural" sung by George Strait

As it awaits the next round of earnings reports and amidst disappointing (if conflicting) jobs numbers, the stock market has stalled, with the Dow Jones Industrial Average and the S&P 500 both down over 0.5% year to date. However, during that same time period, several fixed income securities have done well---- having had their "heart's shattered/The pieces scattered/Across the ground of loneliness" much of last year. Take a look at the closing tables for preferred stocks (http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html?mod=mdc_h_usshl#C ) and closed end funds (http://online.wsj.com/mdc/public/page/2_3024-CEF.html?mod=topnav_2_3002), and you will see lots of green. As longtime readers know, I am Mr. Fix(ed Income). I am very much "at home" in fixed income because the securities comprising that sector pay handsome dividends (6-10% or more) often on a monthly basis. At this stage of my life, predictable income is what I desire.

As explained ad nauseum in recent editions, fixed income does well in low and/or stable interest rate environments. To the surprise of many, interest rates have remained low (historically speaking) and reasonably stable so far this year even in the wake of the Federal Reserve's decision last month to taper its purchases of Treasury bonds and mortgages (the program known as QE3). As you will recall, I predicted back in September that once QE3 tapering began, the rate on the all important 10 Year Treasury Bond would not breach a 3% ceiling (see Vol. 186, www.riskrewardblog.blogspot.com ), a prognostication which has held true (for the most part) with the 10Year sitting at 2.86% at the market's close on Friday. The reasons are many, but one that is often overlooked is the fact that the bond market is international. And in that regard, one must look to the action this past week in "Ireland, Ireland." No country in Europe (other than Greece) suffered more from the 2008-2009 recession than Ireland. For the past few years, the Irish government has met its commitments solely because of a life line of credit extended by the European Central Bank, the European Union and the International Monetary Fund (see Vol. 43 www.riskrewardblog.blogspot.com ). Indeed, because of its poor credit rating, Ireland has been unable to issue any of its own bonds---until this week. On Tuesday, the bond world "stood tall/Shoulder to shoulder" and "Answered Irelands' call" by buying its 10 Year bonds at a yield of 3.57%, a rate that fell even lower in the secondary market. By comparison, in 2011, Irish 10 Year bonds traded at a yield of over 14%! If the risk associated with an Irish 10 Year bond warrants only a 3.5% rate of return, then surely the risk associated with a United States 10 Year Treasury warrants one much lower. Thus it is not surprising that the US 10Year now trades at a rate below 3% (Remember, the lower the interest rate, the higher the bond price.) Indeed with the 10 Year bonds of Spain trading at 3.8%, those of Italy at 3.9% , those of France at 2.4% and those of Germany at 1.9%, there is a real possibility that in the near term the rate on the 10 Year U. S. Treasury Bond will remain closer to 2.9% than to 3%----and that would be very good for interest rate sensitive fixed income securities (e.g. real estate investment trusts, business development companies, utilities, preferred stocks, etc.) which have been oversold in anticipation of rates on the U.S. 10 Year going to 3.5% or higher.

Just as "rivers wind/Tumbleweeds roll and stars shine", the "Seasons change." And, boy, did they change this year with record cold descending from Canada thanks to a polar vortex. But one person's discomfort is another's profit---and this time "it (profit that is) just comes natural"---to natural gas that is. Over the past several years, a growing percentage of the nation's energy needs has been met by natural gas which is a much cleaner alternative to coal and which has become plentiful thanks to the wonders of hydraulic fracturing (a/k/a fracking). Two of the largest players in the natural gas space happen to be two of my favorite holdings, Linn Energy (LINE) and Vanguard Natural Resources (VNR) each of which pays an annualized dividend of over 8.5% on a monthy basis, and each of which is up over 5% in the past month. LINE was shorted much of last year due to accounting questions and problems with its acquisiton of Berry Petroleum, but those issues appear to be resolved. If so, it has considerable room to run. VNR recently completed an acquisition which should place it in good stead should the demand for natural gas continue to increase.

As this year progresses, may we have as much success in our investments as George Strait has had in country music. He has recorded over 60 Number One records. Few of his titles resonate with me. But, if "x" marks the spot for success, may many of "My Ex's Live In Texas"---the home of Linn Energy, Vanguard Natural Resources and several more of my energy related holdings.

January 4, 2014 Smooth Sailing

Risk/Reward Vol. 202

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

"We've got smooth sailing, sailing/Looks like every drop of rain is gone,gone,gone
Smooth sailing, sailing/And a blue sky full of rainbows from now on."---lyrics from "Smooth Sailing" sung by Ella Fitzgerald

"Everything is so clear you can see it/And everything is so real you can feel it
And it's real, so real, so real, so real/Can you dig it?"---lyrics from "Grazing In The Grass" sung by The Friends of Distinction

"No return, no return, no return/I'm at a point of no return."---lyrics from "No Return" by Eminem

I subscribe to three daily financial newspapers and to a variety of weekly newsletters published by brokerage firms. Without exception, each is predicting "smooth sailing, sailing" for the stock market for the foreseeable future. With no threat from a fiscal cliff, a sequester, a debt ceiling, a Chinese slowdown, a Eurozone debt crisis and with QE3 tapering already underway, to these writers it "looks like every drop of rain is gone,gone,gone/And a blue sky full of rainbows from now on." I don't disagree as the Dow Jones Industrial Average ended the week on a positive note after stumbling on a slow trading day Thursday. We should see decent earnings in the coming weeks and more importantly upbeat guidance. I am adding to my index funds.

So if "Everything is so clear you can see it/And everything is so real you can feel it" are there any sectors of the market where one can achieve outsized returns? After all, as an active manager, shouldn't I be on the look out for these? I am, and I believe there are. If the recovery is "so real, so real, so real", then the demand for natural resources should rebound from what was a dismal 2013. FCX has experienced a decent recovery over the past few months while other mining/natural resource companies (oil stocks notwithstanding) continue to lag. Recently, I bought GGN, a closed end fund comprised of mining ("Can you dig it?") and natural resource stocks which is trading at a significant discount to its net asset value (NAV). It can and does pay a handsome double digit dividend by writing covered calls on its portfolio.

Although 2013 was a record year for stocks, bonds fared poorly, and many bond fund managers (including the "Bond King", PIMCO's Bill Gross) saw "No return, no return, no return" at all. This poor performance resulted from a spike in interest rates (remember, bond prices fall as interest rates rise) and was mirrored by most fixed income securties which are also interest rate sensitive. The sectors that reached "a point of no return" included mortgage real estate investment trusts, business development companies (BDC's), preferred stocks and municipal bond funds. As discussed in several recent editions (see e.g. Vol 200 http://www.riskrewardblog.blogspot.com/ ), so long as interest rates remain steady or rise slowly and gradually ( note how the all important yield on the 10 Year Treasury has continued to hover around 3%), many oversold, interest rate sensitive stocks will provide a decent return. I recently increased my holdings in two of my favorites, FFC ( a preferred stock closed end fund) and MAIN (a BDC which on Friday gave very encouraging guidance for 2014). I also recently added to my municipal bond fund holdings.

Speaking of Ella Fitzgerald, "Baby, It's Cold Outside." Record cold weather persists countrywide. Wow, I long for some "Summertime". Unfortunately, we will not be experiencing "A Heat Wave" anytime soon. But "Rain or Shine", we must attend to our investments, even when they leave us "Bewitched, Bothered and Bewildered." Happy New Year!