March 20, 2016 Fool on The Hill

Risk/Reward Vol. 300

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

“(Turn around)
Every now and then
I get a little bit nervous
That the best of all the years have gone by”---lyrics from “Total Eclipse of the Heart” sung by Bonnie Tyler

“Baby you can drive my car
Yes I'm gonna be a star
Baby you can drive my car
And maybe I love you”---lyrics from “Drive My Car” sung by The Beatles

“Ooh, the beauty is there
But a beast is in the heart
(Oh-oh, here she comes)
Watch out boy
She'll chew you up”---lyrics from “Maneater” sung by Hall & Oates

It was a mere five weeks ago, February 11th to be exact, when the Dow Jones Industrial Average and the S&P 500 hit bottom; both down over 10% year to date. The investing public was “a little bit nervous/That best of all the years had gone by.” Since then however, both major indices have experienced a significant “Turn around” and are now positive for the year. The reason for the recovery can be found by simply charting the price of oil against these indices. As reported here, over the course of the past several weeks, with few exceptions (like Friday), up and down days even hours in the indices have been directly, almost perfectly, correlated to the price of oil.

So why has the price of oil improved from $27/bbl. on February 11th to $40/bbl. this week? One factor is a cut back in domestic production. Another is the hope that major international producers likewise will limit production, a hope that gained traction this week with the announcement that Saudi Arabia, Russia and other major oil exporters are meeting in Doha, Qatar on April 17th to discuss the price of crude. A third factor “driving that car” may not be so obvious---US monetary policy. What? Janet Yellen influences the worldwide price of oil? Most certainly. When it comes to oil prices, the Fed is “a star.” Like many commodities, the price of oil is denominated worldwide in dollars. The higher the dollar goes in comparison to other currencies, the more expensive oil becomes internationally. More expensive oil lowers demand, and lower demand means lower prices. With the news on Wednesday that the Federal Reserve was holding pat on interest rates and foresaw no more than two small increases during the remainder of 2016 (compared with 4 foreseen just last December), the value of the dollar sank in comparison to other currencies and the price of oil jumped $2/bbl.

So what does this mean to me? Well, if oil stays above $40/bbl. and if the interest rate on the benchmark 10 Year US Treasury Bond does not spike above 2%, I should do well with the non diverse, interest rate and oil sensitive portfolio that I began acquiring in mid February (see Vol. 296 http://www.riskrewardblog.blogspot.com/ ) The stocks in each of these sectors were bludgeoned earlier this year in anticipation of more aggressive interest rate increases and plummeting oil prices. With both of these factors moderating I should see continued capital appreciation and a few months of excellent dividend payments. I say a few months because even though “the beauty is there”, the “beast is in the heart.” By that I mean that the value of these positions is entirely within the control of Janet Yellen. If she decides to become more aggressive on rates, “watch out boy, she’ll chew you up.” Any such increase will depress interest rate sensitive stocks and as discussed above will cause the price of oil to fall thereby decreasing the value of oil related companies.

So why do I not diversify? In my humble opinion, diversification in this market is false prophecy. Asset prices worldwide are supported entirely by a debt bubble created and manipulated by a handful of central bankers who are experimenting with tools (i.e. negative interest rates) that heretofore have never been deployed. I am singularly focused on what these bankers do. Thus, my investments are in those securities that are most directly correlated to their actions. When the worm turns, I will sell everything. You may believe diversification will provide you a buffer to ride out the next bubble burst. Those who so believed in 2008 were bailed out by the world's central bankers (via quantitative easing and zero bound interest rates) and by China's central planners (via massive infrastructure improvements). The tools they used are no longer effective or are no longer available. So sell, I will. It’s a just a matter of time. A fool I may be; but, like The Beatles, I will be a “Fool on The Hill”; a hill of cash.

March 13, 2016 Beggar Thy Neighbor

Risk/Reward Vol. 299

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

As noted, my schedule does not permit a typical edition this week. However, the week was significant and worthy of some observations.

. In the face of warnings from the Bank for International Settlements (the central bank for central banks) that negative interest rates carry unknown risks, the ECB lowered rates further into the negative on Thursday. In addition, it expanded its bond buying spree to 80billion Euros per month and promised virtually unlimited liquidity to Europe’s banking community. Despite spiking the monetary punch bowl, the ECB forcasts growth across the Eurozone at only 1.4% for 2016 and inflation at 0.1%. Apparently, one can only consume so many champagne cocktails.

. The unstated reason for the ECB’s action is to “beggar thy neighbor”; that is to spur exports at the expense of other economies by cheapening the value of the Euro vs. the dollar and other currencies. Here is the logic. Lower interest rates cause those with excess cash to dump Euro bonds and to buy higher earning ones such as those of the US. In order to effect this sale and purchase, one sells Euro’s and buys dollars. In the process, the demand for and thus the value of Euros lessens and the demand/value of the dollar (or other currency) increases. Currency devaluation is one way of spurring exports since one’s goods are cheapened by definition. That said, the ECB’s plan backfired. Within minutes of the announcement, ECB president Mario Draghi was asked if there could be more accommodation in the future. He responded that he doubted the need. This caused currency speculators to support the Euro which actually appreciated in value by day’s end. Not very super, Mario!

. Pipeline master limited partnerships plummeted mid-week on news that a bankruptcy court in New York ruled that the contracts between mlp’s and drillers were executory; that is they could be rejected in bankruptcy. I would have been surprised had the ruling gone the other way, so I viewed the dip as a buying opportunity. I added to positions. By week’s end, the sector had recovered.

. The ECB’s move almost certainly dooms any threat that the Federal Reserve will raise rates in March and casts further doubt on a rate increase before this fall. This development plus the apparent bottoming of the oil market prompted me to be a buyer this week. I added to my OKE and STAG positions and bought LVS, PSEC and JMF which I viewed as undervalued. I also took a flyer on CIM, a mortgage REIT that I have owned (and been burned by) in the past. It would not have been my first choice in that sector but for the recent announcement that it was paying a special dividend in addition to its normal one this quarter. Within the next two weeks I will have earned $0.98 in dividends on a $13.76 stock, a 7% return. Comparing CIM’s performance against the mREIT market in general reveals that very little of the dividend is baked into the purchase price. In other words, I don’t’ think CIM’s price will fall much ex-dividend.

March 6, 2016 Signs

Risk/Reward Vol. 298

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

“Just gimme some kind of sign girl
Oh my baby
To show me that you're mine girl
Oh yeah”---lyrics from “Gimme Little Sign” sung by Brenton Wood

“Signs, Signs, Everywhere there's signs.
Blocking out the scenery. Breaking my mind.
Do this! Don't do that! Can't you read the signs?”---lyrics from “Signs” sung by The Five Man Electrical Band

“It's a sign of the times
That your love for me is getting so much stronger
It's a sign of the times
And I know that I won't have to wait much longer”---lyrics “Sign of the Times” sung by Petula Clark

As loyal readers know, I have been looking for “some kind of sign/Oh, my baby/To show me” some stability in the factors that influence Mr. Market. This week there were “Signs, signs/ Everywhere there were signs/Breaking my mind/Can’t you read the signs.”

Here is what I saw:
1) Oil prices rose for the third consecutive week. More importantly, they rose despite reports that crude oil inventories are at their highest level in 80 years. I believe they rose because of the continued reduction in the number of domestic rigs in operation and signs that Saudi Arabia and Russia are actually both committed to limiting production to January levels. Whatever the reasons, oil prices appear to be stabilizing above $30/bbl.
2) Although the performance of the stock indices remains tied to the price of oil, the correlation is not as lock stepped as it has been for the past several weeks. Indeed, on Monday the major indices dropped despite the price of oil increasing. Moreover, throughout the remainder of the week, the indices and the price of oil frequently diverged intraday. I view this uncoupling as a healthy sign.
3) Both major indices saw broad support as the Dow Jones Industrial Average closed the week above the all-important 17,000 level for the first time since January 5th, and the S&P 500 closed at 1999.99, just below the magical 2000 mark.
4) The yield on the 10 Year Treasury rose to 1.87% as investors rotated out of the fear-trade and into equities. That said, the rise was not a spike, and thus did not adversely impact my preferred stock and REIT holdings. This rotation notwithstanding I do not see the rate on the 10Year exceeding 2% any time soon. Several factors are at work to depress it. First, as reported on Friday, wages actually fell in February despite a healthy increase in the number of jobs. An increase in average hourly wages is the Fed’s number one indicator of inflation. So, with the prospect of wage growth and thus inflation low, I do not see the Fed raising rates in March and likely not in June. Moreover, in Europe, the ECB reported this week that prices in the Common Market deflated in January, and that in response one could expect short term rates to go even more negative. Also to combat deflation, Japan issued the world’s first negative rate 10 Year Bond this week. With negative rates prevalent everywhere but in the US, one can expect excess cash to flow into US bonds increasing their price and keeping their rates low.

So how did these “signs of the times” impact me? They made my current holdings “so much stronger” and gave me confidence that I won’t “have to wait much longer” to be a more aggressive buyer. Indeed, I have started already. As loyal readers know, going into February I held only a few positions and those were in preferred stock funds. During that month I cautiously added stocks that I viewed as extremely oversold (see Vol. 296 www.riskrewardblog.blogspot.com ). Here are some and how they have performed through yesterday:

BuyDate /Sec. /+ % /div
2/3 GM 10% 4.8%
2/4 Ford 17% 4.4%
2/16 Shell 6.5% 7.8%
2/16 BP 7% 7.7%
2/16 Ventas 15% 5.2%
2/16 Omega 15% 6.6%
2/16 Blackstone 13% 9.3%
2/17 ETP 1% 14%
2/18 Gabelli(GAB 7% 11%
2/23 Sunoco(SUN 7% 8.8%
2/26 Oneok 12% 9.2%

More importantly, nothing I bought in February is in the red. The above performances warranted adding to each position in recent days.

Due to my heavy cash position, the entire portfolio that I manage is up only 1.5% year to date which is better than the major indices which are still 2.6% underwater. With recent purchases, I am now 40% invested. I don’t expect the stocks listed above to continue to appreciate at their current rate. However, I am hoping to hold them for at least 6 months so that I can collect 2 quarter’s worth of dividends. I intend to buy some other stocks that I view as oversold, but likely I will not reduce my cash position much below 50%. This is my intended, low risk path to my desired 6% annual return. If the market turns however, I will sell it all---very quickly. At this stage in my life, preservation of principle is most important. As Petula knows, Barb and I want to continue living “Downtown” and will do whatever it takes so that we "Don't Sleep in the Subway, Darling.”