May 22, 2017 Get On Up

Risk/Reward Vol. 308

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

“So get on up
On the floor
Get on up, now
And dance some more”---lyrics from “Get On Up” sung by The Esquires

“Sky high
Hey, let's fly
Sky high”---lyrics from “Sky High” sung by The Atlantic Rhythm Section

“Spark and it's like gasoline
I start pumping like a machine,
My heart only runs on supreme”---lyrics from “Gasoline” sung by Britney Spears

Two weeks ago (Vol. 306 www.riskrewardblog.blogspot.com ), I discussed a core tenet of modern investing: markets are driven more by monetary policies set by central bankers than by traditional metrics such as earnings and profits. This week put to rest any dissenting view. On Tuesday, two members of the Federal Reserve indicated that the Mr. Market had underestimated the likelihood of a rate increase this summer. On Wednesday, the Fed released the minutes from its April meeting which read much more hawkish on interest rates than the press release following that meeting. In the wake of these events, the futures market “got on up/Off the floor” as the likelihood of a June increase shot up from 4% at of the beginning of the week to 34% on Thursday. Over the past eight years, the threat of higher rates has caused Mr. Market to sell off and this time was no different as both the Dow Jones Industrial Average and the S&P 500 gave back gains achieved earlier in the week.

So why are Fed members so concerned about Mr. Market’s misreading of their intentions? The answer is succinctly addressed in an opinion piece that appeared in Wednesday’s Wall Street Journal written by Martin Feldstein, President Reagan’s chief economic advisor. Therein, Feldstein described the disruptions that have resulted from eight years of zero bound interest rates. Among those are a stock market that trades at a historically high price/earnings ratio and a commercial real estate bubble that will undoubtedly burst in the near future. If you doubt this latter point, drive around your city or any city and take stock of the building boom---apartments and office buildings are springing up everywhere. Cranes are “sky high/let’s fly/sky high.” Why are they being constructed? I doubt that it is to serve tenant demand. Rather, investors are in a desperate search for a decent return and are willing to take outsized risks, and banks need to deploy capital. Thus a perfect storm is brewing. Several members of the Federal Reserve see what’s ahead and are trying to soften the blow by moderating Mr. Market's expectation of endless low rates.

Although the stock markets cooled, the price of oil rose again this week. News of increasing inventories and the adverse impact of a rising dollar were offset by continuing supply disruptions in Canada and Nigeria and a report that Americans are consuming a record amount of gasoline. This bodes well for oil prices as the ever important summer driving season begins. Early in the week Goldman Sachs raised its near term crude oil price target, and Daniel Yergin, considered by many as the most knowledgeable student of oil pricing, 1, 2017raised his September, 2016 estimate to $50/bbl. My oil stocks (listed in previous editions) continued to appreciate. “Spark and it’s gasoline/pumping like a machine/My heart (and portfolio) run on supreme.” Leading the surge once again is OKE which is up 16% since I repurchased it on April 28th and up an incredible 80% since I first purchased it on February 26th!

So what do I make of this week’s action? If I believed that the Fed would raise rates in June, I would sell on the next big up day. I don’t believe that they will act in June. The data upon which they rely is not sufficiently firm, and everyone is sweating the world wide impact should Britain vote to exit the European Union. That referendum is scheduled for June 28th, after the next Fed meeting. However, if the data continues to improve and Britain stays in the EU, July could see a rate increase. I will be out of the market in advance of that event. We all saw what happened after the last rate increase in December. Both major indices dropped by more than 10%. Who needs that? I will sell and reenter once the market experiences a confirmed rebound---like it did in late February of this year. I take heed from Britney’s first big hit. Once Janet gives “me the sign, Baby”, I won’t wait for her “to hit me one more time.”

May 15, 2016 Graham

Risk/Reward Vol. 307

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

“ I could be your payback
Hey, gonna help you get your sway back”---lyrics from “Payback’ sung by Rascal Flatts

“You are the apple of my eye,
Forever you'll stay in my heart”---lyrics from “You Are the Sunshine of My Life” sung by Stevie Wonder

“Flow river flow
Past the shaded tree
Go river, go
Go to the sea”---lyrics from “The Ballad of Easy Rider” sung by The Byrds

One result of lower first quarter earnings (discussed in last week’s edition See Vol. 306 www.riskrewardblog.blogspot.com ) is that a higher percentage of profits is being paid out as dividends. Do the math. Dividends are paid from earnings. If dividends remain the same and if earnings decrease then perforce a higher percentage of earnings must be allocated to dividend payments. Recently, the average percent of earnings paid in dividends, by those companies in the S&P 500 that pay dividends, has risen to 50%, noticeably above the 43% paid out in 2014 and the ten year average of 46%. Recently, this increase in dividend percentage prompted Larry Fink, the CEO of BlackRock, to write to the boards of directors of each of the S&P 500 companies to warn them to be more careful on how they allocate capital. Fink wants these boards to invest more in innovation and to pay out less in dividends. Fink’s missives are not dismissed lightly considering that BlackRock manages $4.5 trillion (more than 2% of ALL of the world’s financial assets!) much of which is invested in large chunks of each of the 500. But is he correct? Not according to Benjamin Graham, Warren Buffet’s mentor and the father of modern portfolio management. According to Graham, the hallmark of a healthy company is a long record of dividend payments in the magnitude of 67% of corporate earnings. Indeed, before 1970, the 30 companies comprising the Dow Jones Industrial Average paid over 60% of earnings out as dividends. Not so today. But in a world that pays no return on savings accounts, cd’s or bonds how is one to derive income if not from dividends? I look for such shareholder friendly companies and put them on a list for further study. Dividends are a way to “get your payback/ to get your sway back.” Accordingly, I am in Graham’s camp; not Fink’s.

The antithesis of Benjamin Graham was Steve Jobs---and his successor at Apple, Tim Cook, is not much better. Although Apple has started paying a dividend, it is a pittance in comparison to what it should be. For this and other reasons, Mr.Market no longer considers AAPL the “apple of his eye” which necessarily must “forever stay in his heart”---or his portfolio. Allow me to elaborate. As of the most recent quarter, AAPL holds $233billion in cash or cash equivalents on its balance sheet. To put this in perspective, with just this free cash, AAPL could purchase all but a handful of the world’s other companies. Moreover, it continues to accumulate cash, quarter after quarter, because its capital needs are met from current earnings. AAPL trades at less than 9 times earnings, well below the average for the S&P 500 which means that Mr. Market places no value at all on AAPL’s huge cash position. So, Mr. Cook, why not reward your shareholders by paying them a dividend FROM THE MONEY THEY HAVE EARNED? After all, you do recognize, do you not, that it is the shareholders’ money? Given that much of the cash hoard is oversees and upon repatriation would be taxed at the corporate level, AAPL still would have over $170million to distribute which equates to about $31/share, a one time 30% dividend given AAPL’s current price. Okay, spread the payments out over a few years, but pay it out! Won’t happen, will it.

One sector that remains dedicated to rewarding shareholders with dividends is the oil patch. Indeed, its leaders are committed to doing whatever is necessary to maintain those dividends even in the face depressed oil prices and earnings. Will they be able to do so? Time will tell, but their task has become easier given that the price of oil has now climbed above $45/bbl. As discussed last week, contributing to the recent price increase are geopolitical issues that raise questions on whether “the river of oil “ in some hot spots will continue to “flow/Past the shaded tree/and Go to the sea.” The hot spot this week was Nigeria where insurgents have disabled pipelines and taken nearly 1million barrels off the market. This portends well for those invested in this sector as the summer driving season approaches.

Ever so cautiously, I continued to add to positions this week hoping to prosper in this bunny hop market (Dow up 200 points one day; down 200 points the next). In the words of The Byrds:

“To everything - turn, turn, turn
There is a season - turn, turn, turn”

Hopefully, in the near future, it will be “time to 5, 20reap”--- profits that is.

May 8, 2016 0% Interest

Risk/Reward Vol. 306

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

"Candy's got some space to fill in her daydream
Living high on yesterday's lies
Talking to me about some 0% interest and,
How she got a better deal than the next guy”---lyrics from “0% Interest” sung by Jason Mraz

‘Born under a bad sign.
I've been down since I began to crawl.
If it wasn't for bad luck,
I wouldn't have no luck at all”---lyrics from “Born Under a Bad Sign” sung by Cream

“All I need is what I've got
My soul is free and I've got more than enough
Let it roll, roll, roll right off my back
Let it flow, flow, flow, that's where I'm at”---lyrics from “All I Need” sung by Natasha Bedingfield

With first quarter earnings season coming to a close, the results have been disappointing. Year over year, the average Q1 earnings of the 500 largest companies in the US (comprising the S&P 500 Index) are down 7.1%. Clearly, corporate America has “some space to fill in its daydream.” Indeed, with the two major stock indices still positive year to date (albeit barely) one could argue that Mr. Market is “living high on yesterday’s lies.” That is, of course, if the stock markets were driven by fundamentals like earnings and profits. Clearly, they are not. They are driven by central bankers who for the past several years have kept traditional savings instruments worldwide at “0% Interest” or 0%lower thereby driving everyone into stocks. In other words, stocks are the only game in town and will remain so as long as the Federal Reserve does not raise interest rates. That is why stocks rallied on Friday on the heels of a disappointing job growth report. A bad jobs number means that it is unlikely that the Fed will raise rates in June. Indeed, the futures markets now indicate only a 4% chance that the Fed will act then. With no money to be made in savings accounts, cd’s or bonds, investors have no choice but to bid up stocks. Look for the sugar high that that stocks currently enjoy (the description used this week by noted investor Stanley Druckenmiller) to continue for a while longer and for a postponement of the day of reckoning mentioned by Carl Icahn last week.

So do all of these economic “bad signs” mean that investors will have “bad luck or no luck at all?” Of course not. I, for one, intend to profit from interest rate sensitive securities that are currently mispriced in anticipation of a rate increase in June, an increase that I now do not believe will occur. And I am not alone in this pursuit. At this past week’s Sohn Investment Conference (the annual gathering of billionaire money managers), the Bond King himself, Jeffery Gundlach (cited in Vols. 220, 235, 263, 266 and 269 www.riskrewardblog.blogspot.com ) informed the group assembled that the most underpriced interest rate sensitive securities were shares in mortgage real estate investment trusts (“mREIT’s). This has always been one of my favorite sectors. Indeed, I bought CIM when I re-entered the market several days ago. Gundlach invests in REM, an mREIT exchange traded fund.

I also believe that money can be made in the oil/natural gas sector by buying on dips, collecting an occasional dividend and selling into rallies; in effect trading “bunny hop” style as discussed2016 in the three immediately preceding editions. Until this week, much of the news in this sector has been about how everyone has “more than enough”, how production just “rolls, rolls, rolls” and how crude just “flows, flows, flows.” The horrendous fire in Alberta, Canada this week, however, has had an effect. The US imports 2 million bbls/day from Canada. The fire has taken nearly 1 million bbls/day off line and more importantly has re-inserted production risk into the price of oil I say “re-inserted” because until the past year or so, the price of oil carried a significant production risk premium arising from the possibility of natural disasters (e.g. fires, pipeline breaks, etc.) and/or the politics of the locales responsible for the vast majority of the world’s production (e.g. the Mid-east, Venezuela, Africa and Russia). Recent production and, as a consequence, pricing have been set by the Saudi’s at a level designed to drive non-conventional producers (frackers) out of business. In addition, much has been made of a lack of storage for this excess production. But remember, the total US non-strategic storage capacity is only 500million barrels which is barely one month’s supply. I see oil staying above $40 given the current state of affairs which is the level I need to justify investing. In the past two weeks, in this sector, I have bought BP, RDS/B, ETP, KYN, JMF, FEI, DPM, OKE and PAA on dips. Time will tell if I have gauged this correctly.

As loyal readers know, I believe that the markets are now positioned for me to make money (see. Vols. 302 and 303): oil above $40/bbl. and the rate on the US Ten Year 016reasonably stable and comfortably below 2%. I am about 20% invested and will continue to add positions as opportunities present. I am never comfortable in the markets, but participation is a necessary evil. So please, Mr. Market, take note of Cream's famous lyric and do not disappoint:

"I've been waiting so long
To be....
In the sunshine of your love."

May 1, 2016 Breaking Up

Risk/Reward Vol. 305

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

"Runnin' Bear loved Little White Dove
With a love big as the sky
Runnin' Bear loved Little White Dove
With a love that couldn't die”---lyrics from “Running Bear” sung by Johnny Preston

"I beg of you don't say goodbye
Can't we give our love another try?
Come on, baby, let's start anew
Cause breaking up is hard to do”---lyrics from “Breaking Up Is Hard To Do” sung by Neal Sedaka

“One pill makes you larger
And one pill makes you small…
And if you go chasing rabbits
And you know you're going to fall”---lyrics from “White Rabbit” sung by Jefferson Airplane

As I reminded you last week, Dear Reader, I exited the market in early April in anticipation of two events: 1) the oil ministers’ meeting in Doha on April 17 and 2) the Federal Reserve’s meeting held this past week. Both have occurred, and neither has had the effect that I anticipated. Despite the failure of the Doha participants to reach an agreement limiting oil production, the price of oil has risen 20% in April and now is 70% higher than it was in January. Why? In large part due to production cuts in the US and supply disruptions elsewhere. As for the Fed, as anticipated, it did not raise rates at its April meeting. But instead of clearly signaling a rate increase in June, it published some dovish comments which diminished the likelihood of that occurring. Usually such dovish statements bring out the bulls. This time however, it was "Runnin’ Bear who loved Little White Dove/With a love big as the sky.” Both major indices fell this week relinquishing much of their year to date gains. Why so bearish? I surmise it was a combination of factors: 1) a disappointing economic growth report for Q1; 2) market darling Apple reporting a quarterly reduction in sales for the first time since 2003; and 3) noted investor Carl Icahn’s statement that the persistence of low interest rates has created a stock market bubble.

One trend that continued this past week was the “breaking up” of the correlation between the price of oil and the direction of the indices. As highlighted above, this week oil rose while the markets in general fell. Will the two “say goodbye” or will they give it “another try” and “start anew.” After all, once a correlation is established “breaking up is hard to do.” I believe that the break-up will continue since it has always seemed counterintuitive to me. Shouldn’t lower oil prices be good for the consumer and thus good for our consumer based economy? Besides, the price of oil is more naturally correlated to the dollar which closed Friday at a year to date low when compared to a basket of other major currencies (known as the "dollar index"). This was primarily the result of the Bank of Japan declining to lower interest rates thereby allowing the yen to appreciate versus the dollar. As discussed in previous editions (see e.g. Vol 300 www.riskrewardblog.blogspot.com ), a weaker dollar results in higher oil prices.

And so the bunny hop market continues (See Vols. 302 and 303 www.riskrewardblog.blogspot.com). "One pill makes the market larger/And one pill makes it small.” So is it true that if you “go chasing rabbits/ you’re going to fall?” Well, I suppose you could go ask Alice, but in my opinion, not necessarily. I spotted some opportunities as the market swooned on Thursday 1, 2016, and thus began my re-entry. I am treading lightly, but if oil prices hold and the Fed doesn’t raise rates in June, I should make some money by carefully picking, choosing, buying and selling. Not easy, but you gotta do what you gotta do in a bunny hop market.

It is a crazy market indeed; very tough to read. But as we all know if playing the market were easy we would all be rich. Just keep studying and learning. To quote Jefferson Airplane:1, 2016

"When logic and proportion
Have fallen sloppy dead
And the White Knight is talking backwards
And the Red Queen's off with her head
Remember what the dormouse said
Feed your head"