December 27, 2014 Predictable

Risk/Reward Vol. 247

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

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

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

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

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

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

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

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

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

December 13, 2014 Oil Trick Or Treat

Risk/Reward Vol. 246

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

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

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

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

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

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

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

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

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

December 6, 2014 Buy Backs

Risk/Reward Vol. 245

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

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

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

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

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

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

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