Saturday, May 31, 2014
May 31, 2014 Treasure
Risk/Reward Vol. 223
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Honey, you’re my golden star
You know you can make my wish come true
If you let me treasure you.”---lyrics from “Treasure” sung by Bruno Mars
“If you believe in magic/Come along with me
We’ll dance until the morning/Just you and me.”---lyrics from “Do You Believe in Magic” sung by The Lovin’ Spoonful
“Category 6 as I storm in
Take this as a, take this as a warning
Welcome to, welcome to global warming.”---lyrics from “Global Warming” sung by Pitbull
If, at the start of the year, you gambled that the bond market would rally, your “golden star wish has come true.” And how! Combine the following: 1) a sluggish domestic economy (revised numbers this week indicate that the US economy actually shrank in the first quarter of 2014); 2) a rise in unemployment in Europe’s crown jewel, Germany; 3) a regulatory environment that has banks clamoring for Treasury securities and eschewing loans ; 4) the recent parliamentary gains made by anti-EU parties throughout Europe; and 5) the likelihood that next week the European Central Bank will lower interest rates--- and you have the recipe for a robust bond market. In fact, according to Friday's Wall Street Journal, high grade US corporate bonds have returned 5.8% year to date compared to a 4.7% return from the S&P500 and a 1.5% return from the Dow Jones Industrial Average (DJIA) (each number inclusive of principle appreciation plus interest/dividend payments). And as for the bellwether US 10 Year “Treasury” Bond (10Year), it hit an eleven month high on Wednesday as its yield fell to 2.44% (remember the lower the yield the higher the price.)
If you “believe the magic” of low interest rates will continue, then you should consider “coming along with me” and increasing your bond sensitive investments. As noted two weeks ago (Vol. 221 www.riskrewardblog.blogspot.com ), one investment closely correlated to the yield on the 10Year Bond is preferred stock which I like to own through leveraged, closed end funds (CEF’s). Interestingly, although directionally aligned, the angle of decline in the 10Year yield has yet to be mirrored in the yields paid by preferred CEF’s, a situation which I believe presents an excellent buying opportunity. If and when these angles align (and they typically do), a significant price increase will result. I like preferred stock CEF’s that trade below net asset value, pay dividends on a monthly basis and carry at least a Bronze rating by Morningstar. HPS fits this bill, and I bought some this week. If the 10Year stays at or below 2.5% over the next several days, I see HPS rising in value even as it continues to pay me a 8+% dividend. If so, “We’ll dance until the morning/Just you and me (and anyone else who owns HPS).”
Next week, the EPA will release draft “global warming” carbon dioxide emission standards specifically aimed at coal fired electric power plants. It is anticipated that these regulations will cause a “Category 6 storm” in the coal and utility world. Don’t forget, in the US, coal still generates 40% of all electricity. “Take this as a, take this as a warning" if you own coal stocks and keep a watchful eye on electric utilities. That said, one energy source’s hurdle is another’s slide. Effectively, the only alternative to coal is natural gas. As a consequence, I bought more Kinder Morgan (KMR, KMP or KMI) which owns the largest natural gas pipeline system in the US and thus stands to gain as more natural gas is produced and consumed. I like Kinder Morgan because it pays a healthy dividend and because its stock remains depressed after a Barron’s article published in February which questioned some of Kinder’s accounting practices. On any pullback, I intend to add to my holdings in HCLP which mines franking sand used in natural gas and oil drilling. HCLP is up 54% since I repurchased it in October, 2013 and 34% since I added shares in February, 2014.
Another week, another record close for the S&P 500 and the DJIA---and another stellar performance by the bond market. The yield on the bellwether 10Year continues to fall; now hovering below 2.5% (which of course means the price of the bond continues upward). As I wrote last week, some day soon this movement in tandem by the stock and bond markets likely will end. But with the German 10Year at 1.35%, that of Spain at 2.86%, that of France at 1.74%, that of Italy at 2.95% and that of Japan at 0.57%, the US 10Year still looks like a bargain. No one---I mean no one--- predicted this. Indeed, most market savants opined that the 10Year yield would be above 3.25% by now. I took the counter bet, but not even I saw 2.44% coming. Events next week (e.g. the jobs report) may cause a reversal of fortune for me, but I really like my interest rate sensitive portfolio at this juncture. Absent some massive market upheaval I intend to stay pat. Like the great Bruno Mars
“Today I don’t feel like doing anything
I’m going to kick up my feet and stare at the fan
Cause today I swear I’m not doing anything
Nothing at all.”
Monday, May 26, 2014
May 24, 2014 Turn Down For What
Risk/Reward Vol. 222
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Turn down for what?/Turn down for what?”---lyrics from “Turn Down For What” by DJ Snake
featuring Lil Jon
“Don’t go chasing waterfalls
Please stick to the rivers and the lakes
That you’re used to”---lyrics from “Waterfalls” sung by TLC
“Don’t look back/But if you don’t look back
We’re only learning then
How to make the same mistakes.”---lyrics from “Same Mistakes” sung by One Direction
News on Friday that the housing market improved in April sent the S&P 500 over the 1900 mark for the first time and propelled the Dow Jones Industrial Average over 16,600. Typically, such a growth-oriented stock stimulus would cause bond prices to fall. But on Friday, the price of the bellwether US Treasury 10Year Bond rose and its yield “Turn(ed) Down”. (Remember when bond prices rise, bond yields fall.) This led many to wonder “Turn(ed) down for what/Turn(ed) down for what?” Perhaps the answer lies in a closer examination of the housing numbers. True, existing house sales did improve over March, but they remain 7% lower than in April, 2013. Equally discouraging was a report earlier in the week that despite low mortgage rates, 40% of all homes are either 1) worth less than their outstanding mortgage or 2) have insufficient equity to cover the cost of the mortgage plus a broker’s commission should the owner desire to sell. Obviously, the bond market read the data to suggest that the Federal Reserve will continue its efforts to keep interest rates (which directly impact mortgage rates) low for the foreseeable future.
With interest rates so low, income investors continue to search for yield in progressively risky pools, in other words, in “rivers and lakes/That they’re (not) used to.” Indeed the spread between the 10Year Treasury and the lowest rated junk bond (CCC) is at an all time low. One alternative to junk bonds are collateralized loan obligations (CLO’s). CLO’s are a subset of collateralized debt obligations (CDO’s). You may recall that all CDO’s were tarnished by the collapse of the subprime mortgage market which dominated CDO’s prior to 2008. In contrast, CLO’s (comprised of senior loans to reputable mid-sized companies whose balance sheets are too small to warrant investment grade status), for the most part, remained solvent throughout the debt crisis. Moreover, CLO's underwritten after 2009 have performed as advertised. In a nutshell, CLO sponsors acquire senior loans from banks, and re-bundle the obligations into tranches. Tranche A is the most secure because current obligations are paid in full before any obligations to succeeding tranches are addressed. As more payments are received from the underlying senior loans, they are used to defray the obligations to Tranches B in total, then to C, then to D, etc. in what is called a payment “waterfall.” The lower the tranche, the riskier the investment is deemed, even though recently any default "chasing waterfalls" has been rare. Oxford Lane Capital is a closed end fund that invests in Tranches F and lower. I own the preferred shares of it (OXLCO) which currently pay a 7.8% annual dividend on a monthly basis.
For years now (see Vol. 102 www.riskrewardblog.blogspot.com ), I have advised you, Dear Readers, that the optimum time to purchase shares in pass through entities such as business development companies, master limited partnerships and especially real estate investment trusts is at the time any secondary stock offering is priced. The larger the secondary offering, the more dilutive its immediate effect, the greater the stock discount. This axiom is part of my DNA. I “don’t (have to ) look back.” Or do I? With the announcement by ARCP that it was doing a very large secondary offering, I “didn’t look back.” I bought before the pricing. Why you ask? Because the stock’s decline in anticipation of the pricing was precipitous, and I thought that the market had overshot the dilutive impact. WRONG! So I overpaid. The lessons that I have learned these past four years must be observed! “If we don’t look back/We’re only learning/How to make the same mistakes.”
It was a good week for growth and income investors alike. I see a day soon, however, when the interests of these two investment approaches diverge. I am betting that growth stalls, interest rates stay low and income securities benefit. If I am wrong, I will exit before my holdings (in the words of that marvelous lyricist, Lil Jon) “Skeet, skeet/Get low/Get low.”
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Turn down for what?/Turn down for what?”---lyrics from “Turn Down For What” by DJ Snake
featuring Lil Jon
“Don’t go chasing waterfalls
Please stick to the rivers and the lakes
That you’re used to”---lyrics from “Waterfalls” sung by TLC
“Don’t look back/But if you don’t look back
We’re only learning then
How to make the same mistakes.”---lyrics from “Same Mistakes” sung by One Direction
News on Friday that the housing market improved in April sent the S&P 500 over the 1900 mark for the first time and propelled the Dow Jones Industrial Average over 16,600. Typically, such a growth-oriented stock stimulus would cause bond prices to fall. But on Friday, the price of the bellwether US Treasury 10Year Bond rose and its yield “Turn(ed) Down”. (Remember when bond prices rise, bond yields fall.) This led many to wonder “Turn(ed) down for what/Turn(ed) down for what?” Perhaps the answer lies in a closer examination of the housing numbers. True, existing house sales did improve over March, but they remain 7% lower than in April, 2013. Equally discouraging was a report earlier in the week that despite low mortgage rates, 40% of all homes are either 1) worth less than their outstanding mortgage or 2) have insufficient equity to cover the cost of the mortgage plus a broker’s commission should the owner desire to sell. Obviously, the bond market read the data to suggest that the Federal Reserve will continue its efforts to keep interest rates (which directly impact mortgage rates) low for the foreseeable future.
With interest rates so low, income investors continue to search for yield in progressively risky pools, in other words, in “rivers and lakes/That they’re (not) used to.” Indeed the spread between the 10Year Treasury and the lowest rated junk bond (CCC) is at an all time low. One alternative to junk bonds are collateralized loan obligations (CLO’s). CLO’s are a subset of collateralized debt obligations (CDO’s). You may recall that all CDO’s were tarnished by the collapse of the subprime mortgage market which dominated CDO’s prior to 2008. In contrast, CLO’s (comprised of senior loans to reputable mid-sized companies whose balance sheets are too small to warrant investment grade status), for the most part, remained solvent throughout the debt crisis. Moreover, CLO's underwritten after 2009 have performed as advertised. In a nutshell, CLO sponsors acquire senior loans from banks, and re-bundle the obligations into tranches. Tranche A is the most secure because current obligations are paid in full before any obligations to succeeding tranches are addressed. As more payments are received from the underlying senior loans, they are used to defray the obligations to Tranches B in total, then to C, then to D, etc. in what is called a payment “waterfall.” The lower the tranche, the riskier the investment is deemed, even though recently any default "chasing waterfalls" has been rare. Oxford Lane Capital is a closed end fund that invests in Tranches F and lower. I own the preferred shares of it (OXLCO) which currently pay a 7.8% annual dividend on a monthly basis.
For years now (see Vol. 102 www.riskrewardblog.blogspot.com ), I have advised you, Dear Readers, that the optimum time to purchase shares in pass through entities such as business development companies, master limited partnerships and especially real estate investment trusts is at the time any secondary stock offering is priced. The larger the secondary offering, the more dilutive its immediate effect, the greater the stock discount. This axiom is part of my DNA. I “don’t (have to ) look back.” Or do I? With the announcement by ARCP that it was doing a very large secondary offering, I “didn’t look back.” I bought before the pricing. Why you ask? Because the stock’s decline in anticipation of the pricing was precipitous, and I thought that the market had overshot the dilutive impact. WRONG! So I overpaid. The lessons that I have learned these past four years must be observed! “If we don’t look back/We’re only learning/How to make the same mistakes.”
It was a good week for growth and income investors alike. I see a day soon, however, when the interests of these two investment approaches diverge. I am betting that growth stalls, interest rates stay low and income securities benefit. If I am wrong, I will exit before my holdings (in the words of that marvelous lyricist, Lil Jon) “Skeet, skeet/Get low/Get low.”
Saturday, May 17, 2014
May 17, 2014 Rainbow Connection
Risk/Reward Vol. 221
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Some day we'll find it
The rainbow connection
The lovers, the dreamers, and me”---lyrics from “Rainbow Connection” sung by The Muppets
“Hands on your knees/Hands on your hips
Hands on your shoulders/Hands on your head
Up, down, turn around.”---lyrics from “Up, Down, Turn Around” sung by The Wiggles
“And don’t speak too soon for the wheel’s still spinnin’
And there’s no tellin’who that it’s namin’
For the loser now will be later to win
For the times they are a changin’”---lyrics from “Times They Are A Changin’” sung by Bob Dylan
Modern portfolio theory posits that an investor can maximize his/her return and minimize risk through asset diversification. In other words, by creating a portfolio of assets that move in different (even opposite) directions in response to any given market stimulus one can lower one’s risk and still profit. I get the theory. But, it just isn’t right for “ lovers, dreamers or me.” 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. I believe that my “some day to find” that singularity, the “rainbow connection” if you will, has arrived. No surprise to my readers, the singularity of which I write is the yield on the 10Year US Treasury Bond (10Year). I further believe that by maintaining daily vigilance, adhering to strict principles and fearing not, the buying and/or selling, in short order, of some or all of one’s portfolio, one can prosper. In sum, predictability is more important to me than diversification.
Allow me to elaborate As loyal readers now know,” hands on your knees/hands on your hips/hands down” the benchmark interest rate against which all income securities are priced or spread is the yield on the 10Year. Based upon observation and study over the past three years, “hands on your shoulders/hands on your head/ hands down” the asset class most correlated to movement in the 10Year yield or rate is preferred stock. This is understandable since preferred stocks are a pure interest rate play and absent credit risk are unaffected by the performance of the underlying issuer. Stated alternatively, any change in the price of a credit worthy preferred stock is driven almost exclusively by the interest rate on the 10Year. Indeed, on most days I can tell whether my preferred stocks are “up or down” by simply looking at what happened to the yield on the 10Year. or vice versa Moreover, having studied and confirmed this correlation, I have increased my preferred stock income by buying preferred stock closed end funds (e.g. FFC, HPF, JPC) which enhance returns through leverage. To me, the risk associated with these leveraged funds is no greater since the correlation to the 10Year remains the same. Similar correlations to the yield on the 10Year obtain for mortgage real estate investment trusts, triple net lease investment trusts, leveraged bond funds, leveraged senior loan funds, leveraged municipal bond funds, leveraged utility funds and a host of other income securities. On average this portfolio pays an 8% annual dividend. In addition, I look for stocks or funds that distribute dividends monthly because a corollary to owning a portfolio singularly correlated to the yield on the 10Year is that one must be prepared to sell everything once the prevailing winds shift, and the yield on the 10Year starts to rise. This is what happened during the “taper tantrum” last summer when the yield on the 10Year went from 1.63% on May 2 to 2.16% on May 31 to 2.6% on July 5. Once the upward direction of that movement was confirmed (remember: upward yield means downward price), liquidation of the portfolio was in order (See Vol. 172 www.riskrewardblog.blogspot.com ). That wholesale departure was made more palatable by the receipt of monthly dividends which meant that I was not leaving a juicy quarterly dividend behind. In time, the yield on the 10Year stabilized, the typical spreads returned and I re-entered en masse. (See Vol. 200 www.riskrewardblog.blogspot.com ) If and when the 10Year yield begins to inflate in the future, I will sell and await stability again. It's a win/win because all that I have wanted from the beginning of this journey is a decent rate of return on government bonds (see Vol. 1 www.riskrewardblog.blogspot.com )
Some observations on the week:
1)Speaking of winds shifting (and metaphor mixing), the “times they are a changin’” in the oil patch. This week Energy Secretary Ernest Moniz and White House Senior Counselor John Podesta each confirmed that the President is considering lifting the 40 year ban on exporting crude oil. I’m not “speakin’ too soon for the wheel’s still spinnin’/And there’s no tellin’ who that it’s namin’.” But, it appears that “losers now” (namely the producers of light sweet crude not universally suited for refining in the US) “will be later to win” if they are allowed to export. Indeed, the news caused oil and oil related shares (e.g. pipelines, oil services and especially frac sand miner, HCLP) to soar on Wednesday even as most of the market fell.
2)Thursday's Wall Street Journal reported that "central bankers and investors" are "confounded by the persistently sluggish economy" and the drop in yield on the US 10Year. Really? An economy needs demand before it can grow, and consumers drive demand. Where are the consumers? This week, respected bond fund manager Jeff Grundlach and last week, Bond King Bill Gross each restated the obvious. Consumer demand declines as populations age and shrink. Look at Japan and Europe. We are not far behind. As for the yield on the US 10Year, please understand the following: 1)the bond market is global and 2)demand for bonds drives prices up and yields down. One third of all bonds issued by the United States are owned by US agencies which are required by law to keep their reserves in Treasury securities (e.g. Social Security, Federal Reserve, Military Pension Fund, etc.), 1/3rd are owned by US citizens and institutions (the guidelines of which also require a large percentage of assets be held in bonds) and 1/3rd are owned by foreign nationals and governments. If you are required (or of a mind) to own bonds, would you rather own the US 10Year paying 2.5% or Italy's 10Year paying 3.06% or Spain's paying 2.95% or France's paying 1.78% or Germany's paying 1.33% or Japan's paying 0.57%?
3)I was in the car most of Thursday listening to CNBC and Bloomberg Radio. One would have thought the financial world was collapsing---two days after record highs on both the Dow Jones Industrial Average and the S&P 500. Financial news stations are convenient, but like all 24 hour news outlets, they are given to hyperbole.
4)Although the headline news on Friday was that new housing permits jumped in April, the gain came exclusively in multifamily construction. Single family home construction remains in the dumps. Long term, this does not bode well for the economy.
Year to date, including dividends, the Dow Jones Industrial Average is even and the S&P 500 is up only 2%. The stock market is range bound. In contrast, my non diverse portfolio of income securities correlated to the 10Year (plus some oil/gas stocks) has exceeded my annual goal of 6%. That said, like Dylan,
“I ain't lookin' to compete with you
Beat or cheat or mistreat you
Simplify you, classify you
Deny, defy or crucify you
All I really want to do
Is, baby, be friends with you.”
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Some day we'll find it
The rainbow connection
The lovers, the dreamers, and me”---lyrics from “Rainbow Connection” sung by The Muppets
“Hands on your knees/Hands on your hips
Hands on your shoulders/Hands on your head
Up, down, turn around.”---lyrics from “Up, Down, Turn Around” sung by The Wiggles
“And don’t speak too soon for the wheel’s still spinnin’
And there’s no tellin’who that it’s namin’
For the loser now will be later to win
For the times they are a changin’”---lyrics from “Times They Are A Changin’” sung by Bob Dylan
Modern portfolio theory posits that an investor can maximize his/her return and minimize risk through asset diversification. In other words, by creating a portfolio of assets that move in different (even opposite) directions in response to any given market stimulus one can lower one’s risk and still profit. I get the theory. But, it just isn’t right for “ lovers, dreamers or me.” 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. I believe that my “some day to find” that singularity, the “rainbow connection” if you will, has arrived. No surprise to my readers, the singularity of which I write is the yield on the 10Year US Treasury Bond (10Year). I further believe that by maintaining daily vigilance, adhering to strict principles and fearing not, the buying and/or selling, in short order, of some or all of one’s portfolio, one can prosper. In sum, predictability is more important to me than diversification.
Allow me to elaborate As loyal readers now know,” hands on your knees/hands on your hips/hands down” the benchmark interest rate against which all income securities are priced or spread is the yield on the 10Year. Based upon observation and study over the past three years, “hands on your shoulders/hands on your head/ hands down” the asset class most correlated to movement in the 10Year yield or rate is preferred stock. This is understandable since preferred stocks are a pure interest rate play and absent credit risk are unaffected by the performance of the underlying issuer. Stated alternatively, any change in the price of a credit worthy preferred stock is driven almost exclusively by the interest rate on the 10Year. Indeed, on most days I can tell whether my preferred stocks are “up or down” by simply looking at what happened to the yield on the 10Year. or vice versa Moreover, having studied and confirmed this correlation, I have increased my preferred stock income by buying preferred stock closed end funds (e.g. FFC, HPF, JPC) which enhance returns through leverage. To me, the risk associated with these leveraged funds is no greater since the correlation to the 10Year remains the same. Similar correlations to the yield on the 10Year obtain for mortgage real estate investment trusts, triple net lease investment trusts, leveraged bond funds, leveraged senior loan funds, leveraged municipal bond funds, leveraged utility funds and a host of other income securities. On average this portfolio pays an 8% annual dividend. In addition, I look for stocks or funds that distribute dividends monthly because a corollary to owning a portfolio singularly correlated to the yield on the 10Year is that one must be prepared to sell everything once the prevailing winds shift, and the yield on the 10Year starts to rise. This is what happened during the “taper tantrum” last summer when the yield on the 10Year went from 1.63% on May 2 to 2.16% on May 31 to 2.6% on July 5. Once the upward direction of that movement was confirmed (remember: upward yield means downward price), liquidation of the portfolio was in order (See Vol. 172 www.riskrewardblog.blogspot.com ). That wholesale departure was made more palatable by the receipt of monthly dividends which meant that I was not leaving a juicy quarterly dividend behind. In time, the yield on the 10Year stabilized, the typical spreads returned and I re-entered en masse. (See Vol. 200 www.riskrewardblog.blogspot.com ) If and when the 10Year yield begins to inflate in the future, I will sell and await stability again. It's a win/win because all that I have wanted from the beginning of this journey is a decent rate of return on government bonds (see Vol. 1 www.riskrewardblog.blogspot.com )
Some observations on the week:
1)Speaking of winds shifting (and metaphor mixing), the “times they are a changin’” in the oil patch. This week Energy Secretary Ernest Moniz and White House Senior Counselor John Podesta each confirmed that the President is considering lifting the 40 year ban on exporting crude oil. I’m not “speakin’ too soon for the wheel’s still spinnin’/And there’s no tellin’ who that it’s namin’.” But, it appears that “losers now” (namely the producers of light sweet crude not universally suited for refining in the US) “will be later to win” if they are allowed to export. Indeed, the news caused oil and oil related shares (e.g. pipelines, oil services and especially frac sand miner, HCLP) to soar on Wednesday even as most of the market fell.
2)Thursday's Wall Street Journal reported that "central bankers and investors" are "confounded by the persistently sluggish economy" and the drop in yield on the US 10Year. Really? An economy needs demand before it can grow, and consumers drive demand. Where are the consumers? This week, respected bond fund manager Jeff Grundlach and last week, Bond King Bill Gross each restated the obvious. Consumer demand declines as populations age and shrink. Look at Japan and Europe. We are not far behind. As for the yield on the US 10Year, please understand the following: 1)the bond market is global and 2)demand for bonds drives prices up and yields down. One third of all bonds issued by the United States are owned by US agencies which are required by law to keep their reserves in Treasury securities (e.g. Social Security, Federal Reserve, Military Pension Fund, etc.), 1/3rd are owned by US citizens and institutions (the guidelines of which also require a large percentage of assets be held in bonds) and 1/3rd are owned by foreign nationals and governments. If you are required (or of a mind) to own bonds, would you rather own the US 10Year paying 2.5% or Italy's 10Year paying 3.06% or Spain's paying 2.95% or France's paying 1.78% or Germany's paying 1.33% or Japan's paying 0.57%?
3)I was in the car most of Thursday listening to CNBC and Bloomberg Radio. One would have thought the financial world was collapsing---two days after record highs on both the Dow Jones Industrial Average and the S&P 500. Financial news stations are convenient, but like all 24 hour news outlets, they are given to hyperbole.
4)Although the headline news on Friday was that new housing permits jumped in April, the gain came exclusively in multifamily construction. Single family home construction remains in the dumps. Long term, this does not bode well for the economy.
Year to date, including dividends, the Dow Jones Industrial Average is even and the S&P 500 is up only 2%. The stock market is range bound. In contrast, my non diverse portfolio of income securities correlated to the 10Year (plus some oil/gas stocks) has exceeded my annual goal of 6%. That said, like Dylan,
“I ain't lookin' to compete with you
Beat or cheat or mistreat you
Simplify you, classify you
Deny, defy or crucify you
All I really want to do
Is, baby, be friends with you.”
Saturday, May 10, 2014
May 10, 2014 Never Can Tell
Risk/Reward Vol. 220
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"If I listened long enough to you
I'd find a way/To believe that it's all true."---lyrics from "Reason to Believe" sung by Rod Stewart
"It was a teenage wedding/ And the old folks wished them well
You could see that Pierre/Did truly love the mademoiselle
C'est la vie say the old folks
It goes to show you never can tell"---lyrics from "Never Can Tell" sung by Chuck Berry
"Pardon the way that I stare
There's nothing else to compare."---lyrics from "Can't Take My Eyes Off of You"---sung by The Four Seasons
According to Federal Reserve economists, after previous recessions, pent up demand for residential housing has led economic recovery. Not so this time. That is why housing and, in particular new home construction, dominated the news this week. It started on Monday with Warren Buffett's expression of surprise at how sluggish that sector has been. That comment was followed by an article in the New York Times reporting that housing has been a net drag on the economy. Later, noted investor Jeff Gundlach stated in his speech at the Sohn Conference that any hope that housing would lead the recovery this time around was "overbelieved." But what really focused concern was Janet Yellen's testimony to Congress on Wednesday and Thursday that the "flattening in housing activity could be protracted." This is troubling considering that the Federal Reserve has bid upon and purchased over $1.6TRILLION in conventional home mortgages since January, 2009. Indeed, it now owns 17% of ALL currently outstanding home mortgages. Like bonds, the interest rates on mortgages fall if the prices paid therefor increase. Thus, the Fed's upbidding has kept mortgage rates artificially low in an attempt to jump start this traditional recovery bellwether. It hasn't worked. We’ve been “listening long enough” for a "Reason To Believe" that it will rebound. The fact remains that housing is in the dumps---even if Warren finds it hard to “believe that it’s all true.”
I predict that housing will not only fail to lead the recovery, it will not recover at all. The reason has nothing to do with the economy, and everything to do with demographics. According to the US Census Bureau, between 1997 and 2006, on average 1,350,000 net new households (independent living units with one or more persons) were formed each year. Since 2007, annual net household formation has averaged 550,000 and is declining. Meanwhile, the total number of family households (e.g. husband+wife with or without children) has fallen. In other words, today when "Pierre truly loves the mademoiselle" there is no wedding even if the "old folks wish them well." With home ownership proving to be a poor investment, why would any single person or any couple, for that matter, buy a house unless they have children? Note the following two points. First, as reported on Thursday, 43% of all existing home sales in Q1 2014 were cash sales. Believe me these are not first time buyers which is the group the Fed wants to attract with low interest rates. Second, as noted in Vol. 218 (www.riskrewardblog.blogspot.com ), as a nation we are reproducing at less than a population replacement rate. Do you think I'm off target regarding the impact of demographics? Take a look around. When Barb and I were 33 we had four children, had bought and sold one house and had purchased, remodeled and furnished a second one. We lived in a neighborhood of similarly situated couples. How many 33 year olds do you know with four children, how about three, how about two, how about one? How many are even married? I make no societal judgments here, but you have to be blind (or the Federal Reserve Chair) not to see that housing, particularly single family home construction, is not going to rebound. “C’est la vie says this old folk/It goes to show you never can tell.”
So what does this mean for investors? The answer was supplied by Fed insider Jon Hilsenrath in an article published in Thursday’s Wall Street Journal headlined “Housing Doldrums Worry Fed Officials.” Therein, Hilsenrath wrote: “If housing fails to revive as expected and holds back the broader recovery, Fed officials could decide to take even more time on an already slow path to eventual interest rate increases.” Believe me that is not speculation on Hilsenrath’s part. That tidbit came straight from Yellen’s lips to Hilsenrath’s ear to WSJ’s front page. As a consequence my overweight position in income securities priced in relation (or spread) to the interest rate on the all important 10 Year Treasury Bond continues to look good (remember lower interest rates mean higher prices). So, “Pardon the way that I stare” at the interest rate on that all important security as it continues to trend downward. It now hovers around 2.6% ; this despite the consensus prediction last fall, last winter and this spring (except by yours truly—see Vol. 186 www.riskrewardblog.blogspot.com ) that at this juncture, it would be well over 3%. And continue to stare at the yield on the 10 Year I will, because there is “nothing else to compare” when it comes to predicting how income stocks will fare. I "Can't Take My Eyes Off Of It."
Even if historically it has led the way out of recessions, the sale of new and existing houses only represents 4-5% of annual GDP. So why is the Fed so obsessed with it? I suspect there is another reason why Ms. Yellen has “Got It Under Her Skin”, one about which she has spoken in the past. (Google: "Yellen speech Feb.11, 2013). A house has been the average American’s largest investment for generations, and no generation sunk more of their net worth into housing than the Baby Boomers. We were weaned on the belief that houses never depreciate. Mortgage interest was our only tax break, and we used home equity as our piggy bank. So, if housing prices fall (which is more likely if mortgage interest rates go up), a huge percentage of Baby Boomer wealth will evaporate just as they enter retirement. This prospect carries significant deflationary implications. I suggest this is her greater concern and one more reason why she will keep interest rates low indefinitely
“In spite of a warning voice that comes in the night
And repeats, repeats in her ear
Don’t you know you fool/You never can win
Use your mentality/Wake up to reality.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"If I listened long enough to you
I'd find a way/To believe that it's all true."---lyrics from "Reason to Believe" sung by Rod Stewart
"It was a teenage wedding/ And the old folks wished them well
You could see that Pierre/Did truly love the mademoiselle
C'est la vie say the old folks
It goes to show you never can tell"---lyrics from "Never Can Tell" sung by Chuck Berry
"Pardon the way that I stare
There's nothing else to compare."---lyrics from "Can't Take My Eyes Off of You"---sung by The Four Seasons
According to Federal Reserve economists, after previous recessions, pent up demand for residential housing has led economic recovery. Not so this time. That is why housing and, in particular new home construction, dominated the news this week. It started on Monday with Warren Buffett's expression of surprise at how sluggish that sector has been. That comment was followed by an article in the New York Times reporting that housing has been a net drag on the economy. Later, noted investor Jeff Gundlach stated in his speech at the Sohn Conference that any hope that housing would lead the recovery this time around was "overbelieved." But what really focused concern was Janet Yellen's testimony to Congress on Wednesday and Thursday that the "flattening in housing activity could be protracted." This is troubling considering that the Federal Reserve has bid upon and purchased over $1.6TRILLION in conventional home mortgages since January, 2009. Indeed, it now owns 17% of ALL currently outstanding home mortgages. Like bonds, the interest rates on mortgages fall if the prices paid therefor increase. Thus, the Fed's upbidding has kept mortgage rates artificially low in an attempt to jump start this traditional recovery bellwether. It hasn't worked. We’ve been “listening long enough” for a "Reason To Believe" that it will rebound. The fact remains that housing is in the dumps---even if Warren finds it hard to “believe that it’s all true.”
I predict that housing will not only fail to lead the recovery, it will not recover at all. The reason has nothing to do with the economy, and everything to do with demographics. According to the US Census Bureau, between 1997 and 2006, on average 1,350,000 net new households (independent living units with one or more persons) were formed each year. Since 2007, annual net household formation has averaged 550,000 and is declining. Meanwhile, the total number of family households (e.g. husband+wife with or without children) has fallen. In other words, today when "Pierre truly loves the mademoiselle" there is no wedding even if the "old folks wish them well." With home ownership proving to be a poor investment, why would any single person or any couple, for that matter, buy a house unless they have children? Note the following two points. First, as reported on Thursday, 43% of all existing home sales in Q1 2014 were cash sales. Believe me these are not first time buyers which is the group the Fed wants to attract with low interest rates. Second, as noted in Vol. 218 (www.riskrewardblog.blogspot.com ), as a nation we are reproducing at less than a population replacement rate. Do you think I'm off target regarding the impact of demographics? Take a look around. When Barb and I were 33 we had four children, had bought and sold one house and had purchased, remodeled and furnished a second one. We lived in a neighborhood of similarly situated couples. How many 33 year olds do you know with four children, how about three, how about two, how about one? How many are even married? I make no societal judgments here, but you have to be blind (or the Federal Reserve Chair) not to see that housing, particularly single family home construction, is not going to rebound. “C’est la vie says this old folk/It goes to show you never can tell.”
So what does this mean for investors? The answer was supplied by Fed insider Jon Hilsenrath in an article published in Thursday’s Wall Street Journal headlined “Housing Doldrums Worry Fed Officials.” Therein, Hilsenrath wrote: “If housing fails to revive as expected and holds back the broader recovery, Fed officials could decide to take even more time on an already slow path to eventual interest rate increases.” Believe me that is not speculation on Hilsenrath’s part. That tidbit came straight from Yellen’s lips to Hilsenrath’s ear to WSJ’s front page. As a consequence my overweight position in income securities priced in relation (or spread) to the interest rate on the all important 10 Year Treasury Bond continues to look good (remember lower interest rates mean higher prices). So, “Pardon the way that I stare” at the interest rate on that all important security as it continues to trend downward. It now hovers around 2.6% ; this despite the consensus prediction last fall, last winter and this spring (except by yours truly—see Vol. 186 www.riskrewardblog.blogspot.com ) that at this juncture, it would be well over 3%. And continue to stare at the yield on the 10 Year I will, because there is “nothing else to compare” when it comes to predicting how income stocks will fare. I "Can't Take My Eyes Off Of It."
Even if historically it has led the way out of recessions, the sale of new and existing houses only represents 4-5% of annual GDP. So why is the Fed so obsessed with it? I suspect there is another reason why Ms. Yellen has “Got It Under Her Skin”, one about which she has spoken in the past. (Google: "Yellen speech Feb.11, 2013). A house has been the average American’s largest investment for generations, and no generation sunk more of their net worth into housing than the Baby Boomers. We were weaned on the belief that houses never depreciate. Mortgage interest was our only tax break, and we used home equity as our piggy bank. So, if housing prices fall (which is more likely if mortgage interest rates go up), a huge percentage of Baby Boomer wealth will evaporate just as they enter retirement. This prospect carries significant deflationary implications. I suggest this is her greater concern and one more reason why she will keep interest rates low indefinitely
“In spite of a warning voice that comes in the night
And repeats, repeats in her ear
Don’t you know you fool/You never can win
Use your mentality/Wake up to reality.
Saturday, May 3, 2014
May 3, 2014 Blame It On The Rain
Risk/Reward Vol. 219
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"And you feel like such a fool
Gotta blame it on something
Blame it on the rain."---lyrics from "Blame It On the Rain" lip-sync'd by Milli Vanilli
"So look at me now/I'm just makin' my play
Cause I'm back/Yes I'm back
Well, I'm back in black."---lyrics from "Back in Black" sung by AC/DC
"We just want to dance here/Someone stole the stage
They call us irresponsible/Write us off the page
We built this city/We built this city on rock and roll."---lyrics from "Built This City" sung by Starship
On Wednesday, the Commerce Department released a report on first quarter (Q1) 2014 gross domestic product (GDP), the broadest measure of how the US economy has performed. For the first three months of 2014, GDP grew at a woeful 0.1% annualized rate, far short of the 2.6% annualized rate reported for Q4 2013 and well below 1.1%, the consensus estimate from economists before the report's issuance. The GDP report preceded a press release of the Federal Reserve which also was issued on Wednesday. In that press release, the Fed referenced the sharply lower Q1GDP number but attributed it to weather and cited its expectation of much better numbers in Q2 as a justification for further tapering its asset purchase program (QE3). Really? Really? Instead of owning up to the fact that its accommodative monetary policies have failed to jump start the Main Street economy (see last week's edition Riskrewardblog
So if the GDP report was a disappointment, why did the Dow Jones Industrial Average (DJIA) record a new high on Wednesday--- and drop after Fridays' seemingly positive jobs report? (Note: the DJIA dropped before any details came from Ukraine, news which admittedly contributed to Friday's negative close.) Here is my take. The employment report is a mixed bag. The headline gain in jobs (288,000) and drop in the unemployment rate (6.3%) is encouraging, but a deeper dive into the report reveals that the labor force (job participation rate) is shrinking. Only 62.8% of working age persons are employed or unemployed and looking for a job. This is the lowest labor participation rate in 35 years---a time when women did not participate in the work force in the numbers that they do now. As discussed last week, an aging and shrinking labor force (800,000 people dropped out of the pool in April alone!) carries long term and lasting negative implications for economic growth. Fewer workers means less demand, and less demand means less growth. Moreover, minimal wage gains were reported which signals that the new jobs that were added are lower paying ones. I submit that any positive movement in the market this week had less to do with lower unemployment OR the expectation of future growth and more to do with another statement in the Fed's press release; to wit, that the Fed will keep the Fed Funds rate low as long as inflation remains below its 2% target. This could be a very long time since 1) inflation is currently below 1%, and 2) the greatest driver of inflation, wages, remains stagnant. The bond market obviously agreed as the yield on the 10Year US Treasury Bond did not rise above 2.68% during the entire week and fell to 2.59%% at Friday's close. So what does this have to do with stock prices? Low interest rates make borrowing inexpensive for credit worthy companies such as those comprising the DJIA. This cheap and plentiful credit promotes mergers, acquisitons and stock buy backs. Thus, it is not surprising that currently Pfizer is in the hunt for AstraZeneca , AT&T is pursuing DirecTV and Exelon is buying Pepco, all at huge premiums to their market price. In addition, Apple sold $12billion in bonds this week and intends to use the proceeds to fund in part its announced $90billion share buy back program. The entire purpose of buybacks is to keep stock prices elevated. Like AC/DC, "look at Apple now/Just makin' its play" It's "buyin' stock back/ Yes, it's buyin' stock back/Well it's buyin' stock back/Puttin' its shareholders more into the black." Accordingly, in my humble opinion, it was the prospect of more mergers, acquisitions and buybacks fueled by continued cheap credit that drove the stock market higher for the week.
Last summer's spike in the 10Year Treasury rate, a concomitant drop in the price of all securities that trade in relation thereto and the ripple effect of Detroit's bankruptcy made 2013 a terrible year for municipal bonds. Many investors wrote this sector completely "off the page." But the prospect that Detroit, the "irresponsible" "city built on rock and roll (and automobiles)" may actually forge a workable solution to its problems, combined with improved tax receipts in cities nationwide, investor desire for tax advantaged investments and most importantly low and stable interest rates has made muni's a big winner so far this year. Having "stolen the stage", they are beginning to be spotlighted. I own some muni bonds outright but prefer the returns available through leveraged closed end muni bond funds. I own EIM, MNP, MQT, MUS, MVF, MYD, OIA, PMO and VGM.
I know that I sound like a broken AC/DC record, but "Hells Bell" if you remember nothing else from these epistles, remember that the most accurate stock market barometer is the interest rate on the10Year Treasury Bond. The 10Year drives the credit markets, reflects market sentiment and is the closest instrument we have to the hypothetical risk free security against which all risk adjusted returns are measured. Those that thought that the stock market would explode like "TNT' in the wake of Friday's jobs headlines simply failed to appreciate this fact. Those that watched what happened to the 10Year were not fooled. Markets can move on the "Flick of a Switch", but miscalculating which signals to follow is the surest path to the "Highway to Hell." Contrary to what Michael Lewis asserts, I believe we CAN make money in the stock market without resorting to "Dirty Deeds Done Dirt Cheap" But we must keep studying, observing, recording and learning. "It's A Long Way to the Top (If You Wanna Rock and Roll).
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"And you feel like such a fool
Gotta blame it on something
Blame it on the rain."---lyrics from "Blame It On the Rain" lip-sync'd by Milli Vanilli
"So look at me now/I'm just makin' my play
Cause I'm back/Yes I'm back
Well, I'm back in black."---lyrics from "Back in Black" sung by AC/DC
"We just want to dance here/Someone stole the stage
They call us irresponsible/Write us off the page
We built this city/We built this city on rock and roll."---lyrics from "Built This City" sung by Starship
On Wednesday, the Commerce Department released a report on first quarter (Q1) 2014 gross domestic product (GDP), the broadest measure of how the US economy has performed. For the first three months of 2014, GDP grew at a woeful 0.1% annualized rate, far short of the 2.6% annualized rate reported for Q4 2013 and well below 1.1%, the consensus estimate from economists before the report's issuance. The GDP report preceded a press release of the Federal Reserve which also was issued on Wednesday. In that press release, the Fed referenced the sharply lower Q1GDP number but attributed it to weather and cited its expectation of much better numbers in Q2 as a justification for further tapering its asset purchase program (QE3). Really? Really? Instead of owning up to the fact that its accommodative monetary policies have failed to jump start the Main Street economy (see last week's edition Riskrewardblog
So if the GDP report was a disappointment, why did the Dow Jones Industrial Average (DJIA) record a new high on Wednesday--- and drop after Fridays' seemingly positive jobs report? (Note: the DJIA dropped before any details came from Ukraine, news which admittedly contributed to Friday's negative close.) Here is my take. The employment report is a mixed bag. The headline gain in jobs (288,000) and drop in the unemployment rate (6.3%) is encouraging, but a deeper dive into the report reveals that the labor force (job participation rate) is shrinking. Only 62.8% of working age persons are employed or unemployed and looking for a job. This is the lowest labor participation rate in 35 years---a time when women did not participate in the work force in the numbers that they do now. As discussed last week, an aging and shrinking labor force (800,000 people dropped out of the pool in April alone!) carries long term and lasting negative implications for economic growth. Fewer workers means less demand, and less demand means less growth. Moreover, minimal wage gains were reported which signals that the new jobs that were added are lower paying ones. I submit that any positive movement in the market this week had less to do with lower unemployment OR the expectation of future growth and more to do with another statement in the Fed's press release; to wit, that the Fed will keep the Fed Funds rate low as long as inflation remains below its 2% target. This could be a very long time since 1) inflation is currently below 1%, and 2) the greatest driver of inflation, wages, remains stagnant. The bond market obviously agreed as the yield on the 10Year US Treasury Bond did not rise above 2.68% during the entire week and fell to 2.59%% at Friday's close. So what does this have to do with stock prices? Low interest rates make borrowing inexpensive for credit worthy companies such as those comprising the DJIA. This cheap and plentiful credit promotes mergers, acquisitons and stock buy backs. Thus, it is not surprising that currently Pfizer is in the hunt for AstraZeneca , AT&T is pursuing DirecTV and Exelon is buying Pepco, all at huge premiums to their market price. In addition, Apple sold $12billion in bonds this week and intends to use the proceeds to fund in part its announced $90billion share buy back program. The entire purpose of buybacks is to keep stock prices elevated. Like AC/DC, "look at Apple now/Just makin' its play" It's "buyin' stock back/ Yes, it's buyin' stock back/Well it's buyin' stock back/Puttin' its shareholders more into the black." Accordingly, in my humble opinion, it was the prospect of more mergers, acquisitions and buybacks fueled by continued cheap credit that drove the stock market higher for the week.
Last summer's spike in the 10Year Treasury rate, a concomitant drop in the price of all securities that trade in relation thereto and the ripple effect of Detroit's bankruptcy made 2013 a terrible year for municipal bonds. Many investors wrote this sector completely "off the page." But the prospect that Detroit, the "irresponsible" "city built on rock and roll (and automobiles)" may actually forge a workable solution to its problems, combined with improved tax receipts in cities nationwide, investor desire for tax advantaged investments and most importantly low and stable interest rates has made muni's a big winner so far this year. Having "stolen the stage", they are beginning to be spotlighted. I own some muni bonds outright but prefer the returns available through leveraged closed end muni bond funds. I own EIM, MNP, MQT, MUS, MVF, MYD, OIA, PMO and VGM.
I know that I sound like a broken AC/DC record, but "Hells Bell" if you remember nothing else from these epistles, remember that the most accurate stock market barometer is the interest rate on the10Year Treasury Bond. The 10Year drives the credit markets, reflects market sentiment and is the closest instrument we have to the hypothetical risk free security against which all risk adjusted returns are measured. Those that thought that the stock market would explode like "TNT' in the wake of Friday's jobs headlines simply failed to appreciate this fact. Those that watched what happened to the 10Year were not fooled. Markets can move on the "Flick of a Switch", but miscalculating which signals to follow is the surest path to the "Highway to Hell." Contrary to what Michael Lewis asserts, I believe we CAN make money in the stock market without resorting to "Dirty Deeds Done Dirt Cheap" But we must keep studying, observing, recording and learning. "It's A Long Way to the Top (If You Wanna Rock and Roll).
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