April 24, 2016 Doves Cry

Risk/Reward Vo. 304

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

“I said let's go crazy (Go crazy)
Let's go, let's go
Let's go”---lyrics from “Let’s Go Crazy” sung by Prince

Touch if you will my stomach
Feel how it trembles inside
You've got the butterflies all tied up
Don't make me chase you
Even doves have pride”---lyrics from “When Doves Cry” sung by Prince

“Little Red Corvette
Honey, you got to slow down
(Got to slow down)
Little Red Corvette”---lyrics from “Little Red Corvette” sung by Prince

Two weeks ago, when last I corresponded, I reported that I had sold my holdings thereby capturing an acceptable level of profit. I was awaiting the results of the oil ministers’ meeting in Doha (April 17th) and the Federal Reserve’s meeting scheduled for April 26-27th before deciding whether to re-enter the market. The meeting in Doha ended without Saudi Arabia or any other major oil exporting country (e.g. Iran or Russia) agreeing to limit production. But instead of this news causing oil prices to decline, they have risen---and risen quite sharply---8% this week alone. What? Has the oil world “Gone crazy”? Given what has also happened, probably not. Domestic production continues to fall with US daily output now below 9million bbls/day. In addition, oil workers are on strike in Kuwait and flows from Iraq and Nigeria have also been disrupted. These latter events have reduced the daily worldwide supply by 3%. Will these disruptions continue? Who knows, but those who remained in the oil patch these past two weeks have been richly rewarded.

And boy don’t I know it. Had I remained in the oil stocks that I sold two weeks ago I would have doubled my profits in that sector. Yes doubled! And with the rest of the market continuing to trade in correlation to the price of oil, the other stocks that I sold did well also. “Touch if you will my stomach/Feel how it trembles inside/Losing those profits has got the butterflies all tied up/Even doves have pride.” But I am not kicking myself. I have rethought my decision to sell several times these past few days, and I believe that my judgment was sound. You can’t always get it right. I find solace in two quotes from the legendary investor Bernard Baruch: 1) “Being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong “ ; and 2) “I made my money by selling too soon.”

One difference between now and a few years ago is my ability to resist chasing profits. In times past, when a sector sky rocketed like oil did this past week, I would have been back in as fast as “a Red Corvette.” And invariably, I would have bought just in time to see the rocket fall back from space. Nowadays, “honey, I just slow down.” Another opportunity to profit will come along. One need only be patient. Indeed, my eyes are now on the Federal Reserve meeting scheduled for next week. No one expects a rate increase this time around, but look closely at the press release following the meeting. Given the steady increase in job numbers and continued positive domestic economic news, the Fed may signal a rate increase in June. Such a “hawkish” signal would widen the divergence between the Fed and both the Bank of Japan and the European Central Bank. Each has signaled a willingness to lower rates even further into the negative and to otherwise be more “dovish.” In times past, any widening of this divergence has resulted in a stronger dollar which in turn has lowered oil prices and by correlation, the US stock market in general. A similar result next week could present a buying opportunity.

And so my education continues. I missed out on some great profits these past two weeks, but I am not second guessing myself. If investing were easy, everyone would be rich. The nice thing about Mr. Market is that he presents us with money making (and money losing) opportunities time and again. Unlike Prince, we “are not out of time.” There is no reason to party (or to invest) like its “1999”.

April 10, 2016 Bunny Market 2

Risk/Reward Vol. 303

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

“All join in the fun
Father, mother, son
Do the Bunny Hop
Hop, hop, hop”---lyrics from “The Bunny Hop” sung by Ray Anthony

“You know the good ole days weren't always good
And tomorrow ain't as bad as it seems
I’m keepin’ the faith.”--- lyrics from “Keeping the Faith” sung by Billy Joel

“Get down, get down, get down
Get down, get down tonight baby”---lyrics from “Get Down Tonight” sung by KC and the Sunshine Band

As I noted in last week’s edition, we are in a “bunny” hop market. This week, both the Dow Jones Industrial Average and the S&P 500 were up two days and down three, finishing the week off 1.2% and basically flat for the year. “Father, mother, son” have all been forced to “join in the fun.” There is no escape---unless of course one sells which is what I did this past week. I picked my spots and captured some excellent first quarter profits. I intend to stay mostly in cash until after the OPEC meeting in Doha, Qatar and the Federal Reserve meeting (about which I wrote last week www.riskrewardblog.blogspot.com ) each of which is to be held later this month.

The stock indices would have performed much worse but for oil stocks which were buoyed by an 8% increase in the price of oil. Oil now hovers near $40/bbl. Why you ask? Here are a few reasons: 1) midweek the Kuwaiti oil minister predicted that the major oil producers would limit production at the Doha meeting even if Iran balked; 2) supplies from Canada were interrupted by a leak and subsequent shut down of the Keystone pipeline (not to be confused with the ill-fated and disapproved Keystone XL pipeline); and 3) the number of oil rigs operating domestically dropped to 354, one half the number pumping just one year ago. Lost in this wave of good news for oil stocks was a report that at current production levels the world is oversupplied by 1million bbls. of oil per day (about 1.2% of daily consumption). Apparently, Mr. Market is “keeping the faith” when it comes to oil, believing that the “good ole times weren’t always good and tomorrow ain’t as bad as it seems.” I am not so sanguine. That is why I am completely out of oil until after the meetings in Doha.

Okay, that explains why I am out of oil, but why did I sell interest rate sensitive stocks when the yield on the 10Year has plummeted to 1.7%? (Remember the value of interest rate sensitive securities goes up when interest rates go down.) The simple answer is to capture profits. The nuanced answer lies in my belief that the world’s central bankers are now engaged in an all-out currency war in which each is deploying tools that heretofore have never been used such as negative interest rates. Stymied by an inability to cheapen each’s currency and thus to spur inflation (the perceived wisdom today being that inflation is a good thing), God only knows what tools each will employ next; all in a desperate effort to have the yen, Euro or dollar “get down, get down, get down” in comparison to other currencies. Worse off than most is Japan where the yen keeps appreciating and deflation keeps mounting despite drastic measures having been taken to cause the opposite. It is my belief that the Bank of Japan will take another, as yet unknown step toward debasing the yen in advance of or in response to the Fed’s meeting in late April. Hamstrung by its commitment to raise rates at least twice in 2016, at that meeting the Fed likely will signal a rate increase for June. This will exacerbate the divergence in worldwide monetary policy, the impact of which on interest rates and those securities that trade in correlation thereto is unknown---and unknowable given the lack of precedent. I find this discomforting. So why not take some time off?

In sum, I sense that in the next few weeks events may unfold that will “Shake shake shake, shake shake shake/Shake Mr. Market’s booty, shake his booty.” As set forth above, I have good reason to so believe. In times past I have not acted on such beliefs, much to my regret. So, I will let events unfold and once the dust settles (assuming there is a dust up in the market), I will re-enter. Because like KC, “That's the way, uh-huh, uh-huh/I like it, uh-huh, uh-huh”

April 3, 2016 Bunny Market

Risk/Reward Vol. 302

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

Due to travel and family commitments, this edition will not follow the usual pattern. However, important developments occurred this week which require recording and reporting.

. Both the Dow Jones Industrial Average and the S&P 500 gained each day and now reside in the green: the DJIA up over 2% and the S&P up over 1.5% year to date.

. No one can doubt the sway that the Fed holds over Mr. Market. Much of the gains experienced this week came after Janet Yellens’ speech on Tuesday. Before she spoke the DJIA was down nearly 100 points. After she spoke it spiked 200 points (1.2%), and never looked back.

. In her speech, she noted that despite several indicators pointing to a strengthening economy, inflation as measured by the Fed’s favorite yardstick (the PCE Index) remained at 1.7% year over year; stubbornly below the Fed’s desired 2%. She emphasized the “asymmetry” that now exists in the Fed’s tool box. That is, the Fed’s tools to spur inflation are nearly exhausted (zero bound interest rates and prolonged quantitative easing) while those that exist to curb inflation remain unused (higher rates and increased reserve requirements). This observation was interpreted by some to suggest that the Fed may wait until the PCE Index attains or exceeds 2% before raising rates.

. Yellen’s speech lessened the likelihood of a rate increase in April to nearly zero. The spotlight now is squarely on the June meeting. If the Fed is to maintain any credibility in regard its prognostications , one should expect the minutes following the April meeting to signal a move in June.

. Oil prices hovered just below $40 until Friday when the Saudi oil minister reversed position and said that Saudi Arabia would not support limits at this month’s OPEC meeting in Doha unless Iran and other large producers likewise agreed. This statement caused a significant drop in oil prices. Adding to the woes in the energy sector was news on Friday that natural gas reserves were at an all time high (52% higher than the five year average) just as the heating season ends. This was not good news to nat gas iproducers or to pipeline companies.

. Friday’s energy sector news notwithstanding the DJIA rose 100 points on Friday following an encouraging, but not too rosy employment report. Perhaps the correlation between oil and the indices about which I have written over the past several weeks may be coming to an end.

. Does this week's action portend that the indices will continue to rise as they have since hitting the year’s low in February? I suspect not. And I am not alone. Take a look at the most recent newsletter from James Paulsen, Chief Investment Strategist at Wells Fargo Capital Management and a frequent contributor to CNBC’s Squawk Box. http://www.wellscap.com/docs/emp/20160321.pdf . Paulsen terms the current situation a “bunny market”; one that hops up and down but does not go anywhere. Unlike most of his peers, Paulsen recommends that investors attempt to time the market, a strategy that is heresy to most money managers.

. So what does this all mean to me? As loyal readers know, I study correlations; primarily those tied to the yield on the 10 Year US treasury. That yield impacts domestic interest rate sensitive stocks (my favorite sectors) and the value of the dollar/oil internationally. As the rate on the 10 Year rises, the value of the dollar increases and the price of oil falls. Since my portfolio is premised upon 1) the rate of the 10 Year not spiking above 2% and 2) the price of oil remaining near $40/bbl. , I have done quite well so far this year as the 10 Year rate has fallen consistently and the price of oil has appreciated nearly 50% since my mid February re-entry. That said, I see little upside in remaining as fully invested as I am as mid-April approaches--- when both the Doha (OPEC) and the Fed meetings are scheduled. I see great risks to my two investment premises coming from these two events. Accordingly, I will harvest some profits soon. Hopefully, I will catch a bunny hop that will vault me to year to date highs (as experienced Thursday past), but even if I don’t I will raise cash. I intend to watch the Fed and Doha mostly from the sidelines.

March 27, 2016 Just Like Me

Risk/Reward Vol. 301

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

“Oh baby, come on, let me take you where the action is
Oh baby, come on, let me take you where the action is
It's so neat to meet you, baby, where the action is”---lyrics from “Action” sung by Paul Revere and the Raiders

“And don't it seem like
Kicks just keep gettin' harder to find
And all your kicks ain't bringin' you peace of mind”---lyrics from “Kicks” sung by Paul Revere and the Raiders

“It's just like me, it's just like me
It's just like you my baby, it's just like you”---lyrics from “Just Like Me” sung by Paul Revere and the Raiders.

One would have thought that the terrorism in Brussels would have dominated the markets this past week. Surprisingly, it did not. Indeed, by the close of business on Tuesday, all of the major market indices in Europe (CAC 40, FTSE and DAX) showed gains. In the US, the major indices gave some ground, but there was no flight to safety, with the favorite refuge of those in flight, the US 10 Year Treasury Bond, having more sellers than buyers that day. So, dear Readers, “let me take you where the action is” (or at least was this past week.)

And that was with our old friends, the Federal Reserve and the price of oil. Despite a clear signal ten days ago from the Federal Reserve’s Open Market Committee (FOMC) that no more than two rate increases should be expected this year and none before June (see Vol 300 www.riskrewardblog.blogspot.com ), Mr. Market was taken aback on Thursday by an interview given by influential FOMC member James Bullard. He indicated that the first of those rate increases “may not be far off.”’ In response, the futures market handicapped the likelihood of an April rate increase at 12%, considerably higher than the 2% odds that prevailed at the end of last week. In turn, the dollar strengthened in comparison to other currencies which (as discussed last week) caused the price of oil to fall below $40/bbl. The correlation between the price of oil and the stock indices held, so both the Dow Jones Industrial Average and the S&P 500 ended lower for the first time in five weeks. Commentators speculated that Ms. Yellen may be facing an insurrection on the FOMC. This is not good news. Given the Fed’s outsized influence on markets here and abroad, even the hint of dissension “ain’t bringin’ you, me or Mr. Market any peace of mind” and most certainly will make stock price increases “harder to find.”

So what does this mean to investor/traders “just like me” or to those “just like you”? I can’t speak to those like you, but for those like me, a sooner-than-later rate increase may cause me to exit en masse. As I discussed in last week’s edition and as I alluded to above, an unexpected rate increase would cause the dollar to appreciate versus other currencies which in turn would cause the price of oil to plummet. My portfolio is built on two assumptions: 1) the rate on the US Treasury 10 Year Bond not spiking above 2% (emphasis on spike) and 2) the price of oil remaining at $40/bbl. Mr. Bullard’s comments last week cast shade on both of these assumptions and put a corresponding dent in my year to date profits. My tolerance for losing any more is wearing thin.

One good (no great) benefit of writing Risk/Reward is the connection it maintains between my Readers (many of whom are longtime friends) and me. This week one Reader/ friend requested lyrics from Paul Revere and the Raiders. Who am I to refuse? Because in the end, it is personal relationships and not profits that are the source of life’s great joys. As Paul Revere reminds us,

“When your world don't seem just right
And life's gettin' you uptight
You can change that wrong to right
Cause I was there myself last night
We're gonna' have a good thing
Such a good thing baby”