Risk/Reward Vol. 256
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Come on, all you people, say
W-O-R-D up/W-O-R-D up"---lyrics from "Word Up" sung by Cameo
"And I ain't no democrat
And I ain't no republican
I am/I am/I am a patriot."---lyrics from "I Am a Patriot" sung by Jackson Browne
"Pump it up/Show me love
Pump it up/Let me see what you workin' wit' "---lyrics from "Pump It Up" sung by Missy Elliott
As predicted, Fed Chair Janet Yellen's testimony before Congress dominated the financial news this week. Although she hinted that the "W-O-R-D" "patience" would be eliminated in future Federal Reserve communiques regarding the timing of any rate increase, the yield on the bellwether 10Year US Treasury Bond ("10Year") did not go "up" as many had predicted. Instead it fell to 2% where it hovered for the remainder of the week. Why, you ask? Because the key determinant of any rate increase now has shifted from the unemployment rate to the rate of inflation/deflation; a switch this writer foresaw a few weeks ago. (See Vol. 254 www.riskrewardblog.blogspot.com ). Here is the portion of her testimony that signaled this switch: "Provided that the labor market conditions continue to improve and further improvement is expected, the committee anticipates that it will be appropriate to raise the target range for the federal funds when, on the basis of incoming data, the committee is reasonably confident that inflation will move back over the medium term toward our 2% objective."
Accordingly, now more than ever, income investors (those with holdings priced in relation to the 10Year) must be students of the presence or absence of inflation. On this point "I ain't no democrat/And I ain't no republican". I just want to know the direction. The data reported this week indicates that we are still nowhere near 2% inflation. Both existing and new home sales missed expectations, jobless claims increased and most significantly, the consumer price index (CPI) fell 0.7% between December and January and fell 0.1% over the past 12 months. Stripping food and energy from the equation (leaving the so-called "core inflation") results in the CPI increasing at an annual rate of only 1.6%, still quite far from 2%. And don't look for any inflationary trend elsewhere in the world. Deflation has hit the Eurozone. Consumer prices there have dropped 0.6% over the past year. Germany just issued 5 year bonds at a negative interest rate---that's right, those purchasers willingly bid upon and received the right to receive LESS in five years than what they paid this week! What? In short, incoming data indicates that every major economy in the world is deflating, not inflating It's no wonder the US bond market, including the bellwether 10Year, traded as if a rate increase were in the distant future. As an income investor, "I am/I am/ I am like a (New England) Patriot." I win with deflation---at least in the near term.
One sector in which prices appear to have bottomed is oil. A spate of production cuts has "pumped it up" with the price stabilizing just below $50/bbl. This has emboldened me to tiptoe back into the arena. As discussed last week, I have initiated several positions in the preferred stock of Magnum Hunter (MHRpC and MHRpD) which is really a natural gas play. These positions continue to "show me love.". This week I bought the preferred stock of Vanguard Natural Resources (VNRBP) after reading the transcript of a February 17, 2015 guidance call (available at www.vnrllc.com ). Therein, VNR's CEO "let me see what he was was workin' wit'. " He stated that VNR had reduced substantially its common share distribution, had strengthened its balance sheet and had solidified its hedges, all of which added to the credit worthiness of VNR's preferred. I am not alone in recognizing VNRBP as a bargain. It has appreciated 6.5% since I bought it on Monday. To reiterate, I believe that the recent stabilization of oil prices provides clarity as to which of the small oil and gas producers will survive and prosper. And I am betting on MHR and VNR.
For the second week, the major stock indices have remained remarkably stable. Given the negative incoming economic data, this performance is as good as one can expect. Through it all, I remain a student of that which impacts the yield on the 10Year. (See Vol. 221 www.riskrewardblog.blogspot.com ) To quote Jackson Browne:
"Doctor my eyes have seen the years
And the slow parade of fears without crying
Now I want to understand."
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