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”.