February 28, 2016 Crystal Ball

Risk/Reward Vol. 297

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

“You babe, steppin' out
Into the night
Into the light”---lyrics from “Steppin’ Out” sung by Joe Jackson

“Oh I've felt that fire and I've been burned
But I wouldn't trade the pain for what I've learned
Of the cracks in the crystal, the cracks in the crystal ball”---lyrics from “Crystal Ball” sung by Pink

“I've been saving all my money just to take you there
I smell the garden in your hair”---lyrics from “Marrakesh Express” sung by Crosby, Stills and Nash

Once again this week, the price of oil and the two major stock indices were lock “steppin” up and down; “into the night/then into the light.” If you doubt this correlation, take a look at Wednesday’s action. In the morning, the price of oil sank below $30/bbl. on news from the Saudi minister of oil that OPEC would not cut production. The drop in the price of oil caused the Dow Jones Industrial Average (DJIA) to sink 267 points. That afternoon, the Energy Information Agency announced that gasoline inventories had fallen for the week. The price of oil jumped $2/bbl., and the DJIA rebounded 320 points to close the day up 53. Is this correlation logical? How long will it last? Logical or not, it exists. And it will continue to exist until it doesn’t. This is the current state of the market, and this is why I remain mostly in cash.

As loyal readers know, I study the factors that affect the yield on the benchmark 10 Year US Treasury Bond; the yield to which my favorite securities (preferred stock, REIT’s, BDC’s, etc.) are correlated; the yield that is my “crystal ball.” Every time that I misread the signals impacting the 10Year, I “feel the fire and I get burned.” That said, “I wouldn’t trade the pain for what I’ve learned.” So what do I see? Before Friday, all inputs signaled that the yield on the 10Year would remain indefinitely below 2%, where it has resided since the end of January. Forward interest rate indicators (e.g. the 5 Year TIPS breakeven and the 5 Year/5Year Forward) were both well below 2%. But on Friday, the Commerce Department released personal consumer expenditure (PCE) numbers (the Federal Reserve Open Market Committee’s (FOMC) favorite inflation index) which showed that year over year core inflation (that which excludes food and fuel) was at 1.7% in January; not that far from the Fed’s target of 2%. These numbers do not change my opinion that no rate hike will occur in March, but they do increase the odds of a June rate hike from 25 to 34%, at least according to the futures market. I continue to like interest rate sensitive stocks, but if other indications of inflation appear, I may exit some positions.

Speaking of interest rates, it was refreshing to hear FOMC member, James Bullard, admit on Thursday’s Squawk Box telecast that the past several years of low interest rates have deprived an entire generation of a decent return on savings. Since 2008, an investor has had no chance of visiting Marrakesh or any other locale where one “can smell the garden in one’s hair” if he has merely “saved all his money just to take you there.” Reward has come only with risks that previous generations of savers have not had to face; risks inherent in equities and lower rated bonds. But, alas, fellow savers, do not look for rates to normalize. News from yesterday’s G-20 meeting confirms that the world’s central bankers will not change their easy money, low interest rate policies any time soon.

Another week has passed, and “Déjà Vu”, the correlation between the price of oil and the stock indices “Carries On.” Directionally, that has been upward these past two weeks. Reports on Friday indicate that the number of domestic oil rigs in operation has dropped to 400 from a high of 1600 in October, 2014. Is this enough information for me to significantly increase my exposure to stock? No, not until I see more stability in the price of oil. I stated so several weeks ago, and I stand by that statement. After all, in the words of CSN, “one must have a code that you can live by.”

February 21, 2016 Ahab

Risk/Reward Vol. 296

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

“Let me tell you about Ahab the Arab
The sheik of the burning sand
He had emeralds and rubies just drippin' off 'a him
And a ring on every finger of his hand”---lyrics from “Ahab the Arab” sung by Ray Stevens

“You're losing interest in me and it's showing
It is no big thing but it's growing
The pain of heartbreak I've just started knowing
Well, it is no big thing but it's growing”---lyrics from “It Ain’t No Big Thing” sung by Elvis Presley

“There's a fire starting in my heart
Reaching a fever pitch
And it's bringing me out the dark”---lyrics from “Rolling In The Deep” sung by Adele

This week, once again, the stock market was correlated to oil. This week, however, stock prices were less impacted by the hour to hour price fluctuation in the price of oil than by the release of oil related news. And the news was encouraging, a fact which caused the two major indices to enjoy their best week of the year. Early in the week, word came from a meeting in Doha that “Ahab the Arab, the sheik of the burning sand/He of emeralds and rubies and a ring on every finger of his hand“ (in the persons of the oil ministers of Saudi Arabia, Kuwait and Qatar along with Russia) was prepared to limit production to January’s level if Iran and Iraq would likewise agree. No word was forthcoming from Iraq, but the Iranian oil minister hinted that he was in favor of production limits. Next came word that savvy investor David Tepper had made a large investment in ETP, an oil and gas pipeline owner. Then came news that the oracle himself, Warren Buffett had invested in Kinder Morgan (KMI), another pipeline owner. These investments signaled to many that the smart money had determined that oil was approaching a bottom. Oil did spike above $32/bbl midweek before falling on Friday. That fall was not precipitous, however, and oil stocks retained much of Wednesday’s healthy gains.

Further contributing to Mr. Market’s good week was news gleaned from the Federal Reserve’s January meeting minutes which were released on Wednesday. In the minutes, Fed members aired their concerns that the likelihood of inflation hitting the desired 2% target was fading. The release of the minutes was followed by a statement from heretofore Fed interest rate hawk, James Bullard, that the economy was too weak to support another rate hike anytime soon. This statement pleased Mr. Market, at least in the short run. However, for those, such as yours truly, who desire rate normalization even at the cost of short term pain, the Fed minutes and Bullard's words were disappointing. When if ever will we be able to achieve a decent return on a safe investment? Maybe not for years. It is hard to fathom now, but in 2007 one could achieve a 5.4% annual return on an FDIC insured 12 month CD. That instrument pays 1.1% today. This “loss of interest” may be “no big thing” to Wall Street mavens, but it gives me and others seeking a decent safe return the "pain of heart ache.” I suggest that the inability of Mr. and Mrs. Saver to garner any return on their deposits is a major contributing factor to their obvious distrust of and displeasure with anyone associated with the Establishment.

As loyal readers know, I am a huge fan of David Tepper (see Vols. 59 and 170 riskrewardblog.blogspot.com ). His purchase of ETP “started a fire in my heart that reached such a fever pitch that it brought me out of the dark” at least in regard oil and pipelines. I opened new positions in ETP, RDS/B, and BP this week. And if James Bullard has become a rate hike dove, then I see no reason to hold back on buying heretofore oversold interest rate sensitive stocks. So I opened new positions in REIT’s VTR and OHI, preferred stock closed end fund DFP, equity play GAB, hedge fund BX and municipal bond closed end funds MQT and VGM. That said, I am not “Rolling In Too Deep." More than 2/3rds of what I manage is still in cash. But, the signposts that I watch signaled that it was time to make a move.

Like Elvis, I invest with a healthy dose of “Suspicion.” Indeed maintaining a “Suspicious Mind”, well “That’s All Right, Mama.” My purchases this week, notwithstanding I have not “Surrender”(ed) to irrational exuberance. I know Mr. Market can “Be Cruel” even to a “heart that’s true.” If the market reverses, my loss limit rules will keep me from ever spending a night in “Heartbreak Hotel.” If things get “All Shook Up”, I will enter sell orders and cash will be “Returned to Sender.”

February 14, 2015 Rubber Ball

Risk/Reward Vol. 295

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

“I'm like a rubber ball
Baby that's all that I am to you
(Bouncy, bouncy) (bouncy, bouncy)
Just a rubber ball”---lyrics from “Rubber Ball” sung by Bobby Vee

"He saw magnificent perfection,
Whereon he thought of himself in balance,
And he knew he was.”---lyrics from “The Balance” by The Moody Blues

“So don't act like it's a bad thing to fall in love with me, me
It's not a bad thing to fall in love with me, me
Not such a bad thing to fall in love with me”---lyrics from “Not Such a Bad Thing” sung by Justin Timberlake

Was Friday’s 2% gain in the major indices a sign that “like a rubber ball/Bouncy, bouncy/Bouncy, bouncy/" Mr. Market is poised to bounce back into positive territory for the year? Is Friday’s remarkable 12% rise in oil prices (to which Mr. Market is now so closely correlated---see last week’s edition www.riskrewardblog.blogspot.com ) sustainable? I suspect not given that the impetus for the upward movement in both the price of oil and the stock indices was a statement from the United Arab Emirates’ oil minister that OPEC members will not pump more oil to compensate for lower US production. Not increasing production is a long way from cutting production. And with a world already awash in petroleum and new supplies entering the market from Iran, a cut by OPEC is what is needed.

Moreover, despite the remarkable gain experienced on Friday, both major indices closed down for the week. Why? There is no one answer, but clearly a major factor is Mr. Market’s sense that the world’s central banks are no longer effective in spurring economic growth, if they ever were. With the ECB, the Bank of Japan and several other regulators now charging banks for holding funds held in reserve and with interest rates already at historic lows, borrowing remains sluggish as do corporate capital expenditures and consumer consumption. The economists that run central banks are mystified and confused. Wasn't it in December that Janet Yellen and her cohorts raised short term interest rates confident that the economy was on the mend? Can it be that a short 45 days later she is contemplating reversing course? This bespeaks self doubt among the economists who run the Federal Reserve, which is rare given that they are schooled to believe that their levers can be used to “Balance” supply and demand. For them it is an article of faith that, with their help and guidance, resources can be reallocated to dampened or spur demand as desired. At their core, they believe that markets always seek equilibrium; that state where supply meets demand in “magnificent perfection.” What we are witnessing may prove them wrong; and may prove right George Soros’ theory of reflexivity; that is, that markets, like humans, are imperfect. They are not always rational. Like the humans who created them, markets experience fear and panic which by themselves can lessen demand and cause economies to spiral downward toward recession and its evil twin deflation even in the face of lower prices and other inducements to spend.

The fact that the indices are struggling does not mean that money cannot be made. In times of fear, investors love safety, causing the price of safe havens to rise. “It’s not such a bad thing to fall in love with safe havens/Not such a bad thing.” Two classic refuges are gold and government bonds. And at least one of our fellow subscribers loaded up on both at the beginning of the year. His vehicles of choice were TLT, an exchange traded fund holding long dated Treasury bonds which is up 9% year to date and GLD, the gold exchanged traded fund, which is up 17% year to date. Good job, Mr. X! Also doing well are certain real estate investment trusts, notably, O which is up 17% year to date and which in addition pays a nice dividend.

No doubt, these are trying times for investors. But as in all of life’s endeavors, one has choices. One can be the whiny Justin Timberlake who can only “Cry Me a River.” Being that Justin Timberlake certainly is N'Sync with current market sentiment and “Not a Bad Thing.” Or one can be the Justin Timberlake who seeks opportunity when markets are down. That Justin Timberlake knows that “What Goes Around/Comes Around." That Justin Timberlake is dedicated to bringing “Sexy Back." Through continuous study that Justin Timberlake prepares for when it’s time to “Buy, Buy Buy.”

February 7, 2016 Strange Relationship

Risk/Reward Vol. 294

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

“Do U know?
I think U and I got a strange relationship
What's this strange relationship?”---lyrics from “Strange Relationship” sung by Prince

“If you're down and confused
And you don't remember who you're talking to
Concentration slips away”---lyrics from “Love the One You’re With” sung by Crosby Stills and Nash

“Tell me, tell me, tell me lies
Tell me lies
Tell me sweet little lies”---lyrics from “Little Lies” sung by Fleetwood Mac

“Do you know/I think oil and the S&P 500 got a strange relationship/What’s this strange relationship?” Lately, as the price of oil goes, so goes the S&P. At the close on Friday, that correlation is 97% year to date. Huh? OK, maybe there is some relationship between the price of oil and the stock market. Lower oil prices reflect less demand, and lower oil prices mean fewer oil patch jobs. But, logically, any such relationship should be more than offset by the positive impact that cheap fuel has on consumer pocketbooks. Shouldn’t it? Apparently not today. Now add to the mix the relationship between the relative value of the dollar and the price of oil. Look what happened on Wednesday. Influential Fed member Bill Dudley cast shade on the likelihood of a rate hike at next month’s FOMC meeting. On that comment, the dollar fell in relation to other currencies causing the price of oil to rise 8% almost immediately. That news, in turn, caused the Dow Jones Industrial Average to go from a negative 193 points to a positive 183 points in a matter of minutes. YIKES!

Recognizing that a correlation exists explains directionality, but does not address the rapidity of the reaction. Since early January, oil and stocks have traded in lockstep, minute to minute. How can so many market participants react so quickly and so uniformly? On this point, John Boy, aren’t you “down and confused?” Not really, Dear Readers. “Don’t you remember who you’re talking to?” The answer is found in the “concentration” which exists in all markets today. The total market value of the S&P 500 is $18trillion. The total market value of the US bond market is $37trillion. Combined their market value is $55trillion. According to benefits consultant Towers Watson, the top five US fund managers have $14.4 trillion under management (for illustration purposes 14.4trillion/55trillion= 25%). The top dog, BlackRock, manages $4.7trillion alone. In other words, if just a few people atop a few firms sense (create?) a correlation, they can move the needle so as to make any such prophecy self-fulfilling. I don’t believe that a grand conspiracy exists, but the above statistics go a long way in explaining the minute to minute, lockstep correlation that exists today.

Although the previous week’s gains in the indices evaporated , my portfolio (85% in cash plus a few REIT's and a few preferred stock funds) continued to gain ground, albeit modestly. That is because the yield to which REIT's and preferred stocks are correlated (that on the US 10 Year Treasury Bond) continued to move downward, and downward yields equate to increased prices. I added GM and Ford midweek after both dropped dramatically despite record earnings and upbeat guidance. Their 5+% dividends should keep their prices from falling further. I did not buy any oil as that entire sector continues to take a beating. Perhaps deservedly so. Take Conoco. In December, Conoco’s CEO reiterated that the company’s number one priority was maintaining its dividend even at the expense of capital expenditures. So you can imagine the market’s surprise when that same CEO announced this week that Conoco was cutting its dividend by 66%! “Tell me, tell me, tell me lies/Tell me lies/Tell me sweet little lies”---indeed. This is not the first time that a CEO hath protested too much when asked about the sanctity of a dividend, and sadly it won’t be the last.

This market is like a Prince best hits album. If you follow the markets minute by minute, you will go “Delirious.” So “Let’s (not) Go Crazy.” This is not “1999” with its infamous internet bubble. And it’s not 2009 either. That said, no one is profiting enough to buy a “Little Red Corvette.” Just remain calm, don your “Raspberry Beret” and stay out of the “Purple Rain.” Next week, pay attention to Janet Yellen’s Congressional testimony. If she infers that no rate hike will be forthcoming in March, the dollar will drop in value, the price of oil will increase and, as if in lockstep, stocks will rise. If she hawkishly indicates that a rate increase could occur in March, you will "hear what it sounds like when (interest rate) doves cry," and the opposite will occur.