Risk/Reward Vol. 346
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Mr. Market expressed displeasure at President Trump's inability to get health care reform passed. Both the major indices dropped 1.5% for the week. The most negative day was Tuesday when the White House hinted that if health care reform were not passed, tax reform was at risk. The S&P 500 tumbled 1.2% breaking a string of 109 trading days without a drop of 1% or more. A short lived flight to safety ensued with the yield on the US Ten Treasury Bond ("10Year") dropping below 2.4% for part of Wednesday. Despite this dip (which usually has a positive impact on interest rate sensitive securities), many of my favorites also sold off. I took the opportunity to purchase several more positions. By week's end, the yield on the 10Year stabilized around 2.4%. And the prices of my favorites (preferred stock closed end funds) re-correlated and rebounded. This was predictable, but pleasing nevertheless.
Although the vast majority of my investments/trades are in interest rate sensitive securities (preferred stock, leveraged closed end funds, REIT's, etc.), I remain fascinated by the oil patch. Less so from an investment perspective and more so as a study in what Bismarck termed "realpolitik". Petro-politics have dominated the world ever since "Peak Oil" was first predicted in the 1970's. Remember the oil shortages of 1973? How about 55 mph on all interstate highways to reduce gasoline consumption? Or that the first Iraqi war was precipitated by Saddam's move to capture Kuwait's oil fields. Does anyone believe that we would feign friendship with Saudi Arabia or be so heavily involved in the Middle East were it not for oil? We need to become energy independent. That is why innovation such as fracking is so important. Saudi Arabia recognized the threat and started a price war in 2015. US production fell 5.6%, but the price war also forced US drillers to become more efficient. So when Saudi Arabia and other OPEC nations recently agreed to limit production in a desperate attempt to raise prices again, US drillers ramped up. We will be producing more than 9million bbls/day by year end which is more than half our need. We are even exporting 1million bbls/day something that was prohibited for more than 40 years preceding the lifting of the ban in 2015. Add to that over 4million bbl/day imported from Canada and Mexico (and still rising) and we are very near to North American energy independence. Once that is reached you will see a decidedly different approach to the Middle East.
My favorite plays in the oil patch remain pipelines. I like two funds in that space KYN and JMF. I made significant profits on these between December 2016 and March, 2017 and they are looking tempting again. Another tempting stock is Hi Crush (HCLP). This is the fracking sand miner that I bought and sold several times a few years ago. When the Saudi price war began, sand miners were hit very hard, Indeed, HCLP (which at one time paid a double digit dividend) was forced to suspend all distributions. Understandably, the stock plummeted. With the resurgence of domestic production and the development of new fracking techniques that use more sand per well, HCLP is set to resume distributions. Recently the stock price again tumbled due to an unexpected secondary stock offering. At the current low price, the temptation to buy proved irresistible. I am starting small and slow, but I am starting.
Sunday, March 26, 2017
March 19, 2017 Repurchase
Risk/Reward Vol. 345
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
It came as no surprise to market watchers when the Federal Reserve raised short term rates on Wednesday. As noted in last week's short missive, I was focused on the "dot plot" (the Fed members' composite prognostication of future rate increases) and any indication that the Fed would reduce its $4.5 trillion balance sheet. In the press release and conference following the meeting, the Fed signaled three not four increases in 2017 and specifically eschewed the idea of reducing the balance sheet any time soon. This moderate stance caused the bond market to quicken and in turn the yield on the all important US Ten Year Treasury Bond ("10Year") fell from 2.6 to 2.5%. I expect that yield to trade in a tight range between 2.475 and 2.6% for the foreseeable future given the path described by the Fed.
On Thursday, I began repurchasing my favorites (mostly preferred stocks and preferred stock closed end funds) as the correlation in yields which I discussed at length in Vol. 343 (www.riskrewardblog.blogspot.com ) began to take shape. Due to the lack of volatility (discussed in the next paragraph), I do not expect much capital appreciation during this next holding period. But, if the quietude in rates lasts another 6 months, I can anticipate accruing an additional 3-4% in profits from the dividends alone.
Did you notice that in contrast to the panic experienced by Mr. Market lo these past 10 years anytime a rate increase was discussed let alone implemented (e.g. the Taper Tantrum of 2013 and the December, 2015 rate increase), the response to this week's move by the Fed was muted ? This fact certainly caught the eye of commentators. Many view this as the beginning of a return to normalcy; where markets are driven by fundamentals and economic policy, not by monetary policy formulated from on high by central bankers. Indeed, I predict when the economic history of the past decade is written it will be entitled "Benanke-Yellen's Folly." Artificially low rates set by the Fed have produced 10 years of sub-3% economic growth while at the same time the stock market has tripled in value. In other words, cheap debt resulted in stock price inflating buy backs with very little trickling down to Main Street.
And what about the poor American saver? You know, those who do not want to bet the farm on stocks, but merely want a safe return on guaranteed deposits and cd's. Good luck. Bank of America just reported that in 2016 it paid, on average, a whopping 0.04% in interest on all of the money it holds on deposit. And don't look for this to improve. In fact, money center banks which, post-Dodd Frank, now control most domestic banking have more money than they need. They have 65% more cash on deposit than they had 10 years ago and their loan to deposit ratio is down to 75% from 92% in 2007. There simply is no need to pay depositors when banks don't need (or want) their money.
I look for a quiet week ahead as Mr. Market awaits The Donald's promised reforms.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
It came as no surprise to market watchers when the Federal Reserve raised short term rates on Wednesday. As noted in last week's short missive, I was focused on the "dot plot" (the Fed members' composite prognostication of future rate increases) and any indication that the Fed would reduce its $4.5 trillion balance sheet. In the press release and conference following the meeting, the Fed signaled three not four increases in 2017 and specifically eschewed the idea of reducing the balance sheet any time soon. This moderate stance caused the bond market to quicken and in turn the yield on the all important US Ten Year Treasury Bond ("10Year") fell from 2.6 to 2.5%. I expect that yield to trade in a tight range between 2.475 and 2.6% for the foreseeable future given the path described by the Fed.
On Thursday, I began repurchasing my favorites (mostly preferred stocks and preferred stock closed end funds) as the correlation in yields which I discussed at length in Vol. 343 (www.riskrewardblog.blogspot.com ) began to take shape. Due to the lack of volatility (discussed in the next paragraph), I do not expect much capital appreciation during this next holding period. But, if the quietude in rates lasts another 6 months, I can anticipate accruing an additional 3-4% in profits from the dividends alone.
Did you notice that in contrast to the panic experienced by Mr. Market lo these past 10 years anytime a rate increase was discussed let alone implemented (e.g. the Taper Tantrum of 2013 and the December, 2015 rate increase), the response to this week's move by the Fed was muted ? This fact certainly caught the eye of commentators. Many view this as the beginning of a return to normalcy; where markets are driven by fundamentals and economic policy, not by monetary policy formulated from on high by central bankers. Indeed, I predict when the economic history of the past decade is written it will be entitled "Benanke-Yellen's Folly." Artificially low rates set by the Fed have produced 10 years of sub-3% economic growth while at the same time the stock market has tripled in value. In other words, cheap debt resulted in stock price inflating buy backs with very little trickling down to Main Street.
And what about the poor American saver? You know, those who do not want to bet the farm on stocks, but merely want a safe return on guaranteed deposits and cd's. Good luck. Bank of America just reported that in 2016 it paid, on average, a whopping 0.04% in interest on all of the money it holds on deposit. And don't look for this to improve. In fact, money center banks which, post-Dodd Frank, now control most domestic banking have more money than they need. They have 65% more cash on deposit than they had 10 years ago and their loan to deposit ratio is down to 75% from 92% in 2007. There simply is no need to pay depositors when banks don't need (or want) their money.
I look for a quiet week ahead as Mr. Market awaits The Donald's promised reforms.
Sunday, March 12, 2017
March 12, 2017 2.6%
Risk/Reward Vol. 344
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Having just returned from a week of skiing, this will be short.
. Both major indices took a slight breather last week, despite the economy showing continuing signs of improvement.
. I don't see any retrenchment in the equities market, but any significant increase from this point may be dependent upon progress by Congress on legislative initiatives such as tax reform and repealing and replacing Obamacare.
. Big news this week may come from the Federal Reserve. A rate increase is almost certain. However look for signs in the "dot plot" as to how many increases one can expect this year---3 or 4. Also look for any sign that the Fed will begin reducing the size of its massive balance sheet.
. Keep an eye on the Fed's impact on the US Ten Year Bond. Its yield spiked to over 2.6% on Thursday but fell below that barrier by week's end. A sustained rate in excess of 2.6% may signal the end of the decades long bond rally at least according to the erstwhile Bond King, Bill Gross. This is of great importance to me.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
Having just returned from a week of skiing, this will be short.
. Both major indices took a slight breather last week, despite the economy showing continuing signs of improvement.
. I don't see any retrenchment in the equities market, but any significant increase from this point may be dependent upon progress by Congress on legislative initiatives such as tax reform and repealing and replacing Obamacare.
. Big news this week may come from the Federal Reserve. A rate increase is almost certain. However look for signs in the "dot plot" as to how many increases one can expect this year---3 or 4. Also look for any sign that the Fed will begin reducing the size of its massive balance sheet.
. Keep an eye on the Fed's impact on the US Ten Year Bond. Its yield spiked to over 2.6% on Thursday but fell below that barrier by week's end. A sustained rate in excess of 2.6% may signal the end of the decades long bond rally at least according to the erstwhile Bond King, Bill Gross. This is of great importance to me.
Monday, March 6, 2017
March 5, 2017 Approach Explained
Risk/Reward Vol. 343
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
I am publishing tonight because I am catching a morning flight to Colorado for a combination subscriber conference/ski trip.
Say what you will about The Donald, Mr. Market loves him. Rarely have we seen a day like the one following the State of the Union address. And no one has seen as rapid a 2000 point rise in the Dow Jones Industrial Average . The Dow hit 19,000 for the first time on November 22, 2016 and hit 21,000 on March1st.
To be fair, it may not all be attributable to President Trump. Also on Wednesday, several Federal Reserve governors reacted to the latest inflation numbers and proclaimed that it is time for a rate increase. Indeed, the likelihood of a March hike rose from 30% (as reported last week) to over 80%. Investors sold 2Year Treasury Bonds like they were going out of style. As a result, the yield on the 2Year reached 1.3% for the first time since 2009. And most of that money was plowed into equities. The yield on the all important US Ten Year Treasury Bond ("10Year") was slower to react but still rose to over 2.5% immediately following Fed Chair Yellen's hawkish speech on Friday.
The developments in the bond market midweek provided the impetus to sell the majority of my holdings. Most were interest rate sensitive such as preferred stocks and preferred stock closed end funds. I will await the conclusion of the Fed's March meeting before deciding if and when to re-enter. If a rate reset occurs and/or clarity as to future increases is provided I will buy.
So why sell when Mr. Market is going through the roof? Why, because I do not invest based upon stock prices. I am wholly guided by movement in the 10Year. Allow me to explain.
Over the years I have struggled with investments. I have hired and fired advisors. For a while, I adhered to Bill O'Neill's CANSLIM strategy. I even day traded for a while. Despite several missteps, including riding the dotcom roller coaster all the way to the bottom, I arrived in 2010 with enough accumulated capital that I could contemplate retirement. My goal was to do so without invading principal which was achievable if I earned an annual pretax return of 6% on the portion of our funds which I manage. More important than any return however was our mutual desire to minimize risk.
As I explained in June, 2010 (Volume 1 www.riskrewardblog.blogspot.com ), achieving a nearly risk free 6% return would have been a layup during most of my life. From 1969 through 1997, the yield on the 10Year (considered by investors world wide as the closest to a risk free investment) rarely fell below 6%. From 1980 through 1985, the yield did not fall below 10%. But since the 2008 financial crisis, the yield has rarely exceeded 3%, has often been below 2% and currently sits at 2.5%.
So how does one achieve a 6% pre tax return with the least amount of risk?
Why not buy and hold an S&P 500 index fund like SPY? After all, SPY is up 6.4% year to date and up over 19%% over the past 12 months. That's true, but if one looks further back into history one discovers that its recent performance notwithstanding, SPY has averaged a compound annual return of only a little over 7% these past 10 years. And lest we forget, SPY dropped over 35% in 2008. It has achieved that nice 10 year average only because of some healthy double digit years. In short, SPY is hardly risk free and certainly is volatile.
So, again, how can one achieve a 6% pre tax return with the least amount of risk?
I have come to believe that one can construct a non-diverse portfolio correlated to a market singularity (the 10 Year) with movement by that singularity providing clarity on when to buy, hold or sell. I submit that by maintaining daily vigilance, adhering to strict principles and fearing not, the buying and/or selling, in short order, of some or all of one’s portfolio, one can achieve a 6% return with minimal risk. I do not buy the 10Year. Instead, I buy higher yielding securities that are very closely correlated to the 10Year. For example, through study and observation, I know that highly regarded preferred stocks maintain a roughly 320 basis point (3.2%) spread to the yield on the 10Year. Thus if the yield on the 10 Year remains stable at 2.5% one can achieve a 5.7% return by merely holding a basket of highly rated preferred stocks (such as found in the exchange traded fund PGX) and collecting dividends. If the yield on the 10 Year declines, in time, the yield on these preferred stocks will also decline ultimately reaching equilibrium at the aforementioned 320 bp spread. As a result, an investor will enjoy a capital gain. (Remember the price of an interest rate sensitive security increases as the yield declines.) If the yield on the 10Year increases or one reasonably can anticipate such an increase, one sells thereby retaining any accrued dividends and reaping the aforementioned capital gain. One then waits on the sidelines, safe and sound in cash, until stability returns to the 10Year and hopefully ahead of preferred stock equilibrium.
Here is a real life example. Anticipating a rate increase by the Federal Reserve back in December, I was on the sidelines in cash. When the increase was announced, the market overreacted as it invariably does. The yield on the benchmark 10 Year spiked to over 2.6% as its price tanked. (Remember the higher the yield on a bond the lower the price.) The price of correlated securities such as preferred stocks also tanked. I swept in and purchased them en masse at bargain prices. The rate on the 10Year ultimately stabilized below 2.5% and the above discussed equilibrium ensued thereby providing me a capital gain. I held tight until this past Wednesday when I sold in anticipation of an upcoming rate increase. Between principal appreciation and dividends I am up 5% on my invested capital in just over 2 months. Achieving another 1-2% this year should be a cake walk once stability returns to the bond market since the portfolio I will repurchase pays healthy dividends, many on a monthly basis.
I also invest in other interest rate sensitive securities such as exchange traded debt and certain leveraged closed end funds which are also correlated to the 10Year. The oil stocks I buy are correlated to the price of oil more than to the rate on the 10Year. I did not sell my oil stocks.
This approach reads more complicated than it is. In any event, it helps me sleep peacefully each and every night.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
I am publishing tonight because I am catching a morning flight to Colorado for a combination subscriber conference/ski trip.
Say what you will about The Donald, Mr. Market loves him. Rarely have we seen a day like the one following the State of the Union address. And no one has seen as rapid a 2000 point rise in the Dow Jones Industrial Average . The Dow hit 19,000 for the first time on November 22, 2016 and hit 21,000 on March1st.
To be fair, it may not all be attributable to President Trump. Also on Wednesday, several Federal Reserve governors reacted to the latest inflation numbers and proclaimed that it is time for a rate increase. Indeed, the likelihood of a March hike rose from 30% (as reported last week) to over 80%. Investors sold 2Year Treasury Bonds like they were going out of style. As a result, the yield on the 2Year reached 1.3% for the first time since 2009. And most of that money was plowed into equities. The yield on the all important US Ten Year Treasury Bond ("10Year") was slower to react but still rose to over 2.5% immediately following Fed Chair Yellen's hawkish speech on Friday.
The developments in the bond market midweek provided the impetus to sell the majority of my holdings. Most were interest rate sensitive such as preferred stocks and preferred stock closed end funds. I will await the conclusion of the Fed's March meeting before deciding if and when to re-enter. If a rate reset occurs and/or clarity as to future increases is provided I will buy.
So why sell when Mr. Market is going through the roof? Why, because I do not invest based upon stock prices. I am wholly guided by movement in the 10Year. Allow me to explain.
Over the years I have struggled with investments. I have hired and fired advisors. For a while, I adhered to Bill O'Neill's CANSLIM strategy. I even day traded for a while. Despite several missteps, including riding the dotcom roller coaster all the way to the bottom, I arrived in 2010 with enough accumulated capital that I could contemplate retirement. My goal was to do so without invading principal which was achievable if I earned an annual pretax return of 6% on the portion of our funds which I manage. More important than any return however was our mutual desire to minimize risk.
As I explained in June, 2010 (Volume 1 www.riskrewardblog.blogspot.com ), achieving a nearly risk free 6% return would have been a layup during most of my life. From 1969 through 1997, the yield on the 10Year (considered by investors world wide as the closest to a risk free investment) rarely fell below 6%. From 1980 through 1985, the yield did not fall below 10%. But since the 2008 financial crisis, the yield has rarely exceeded 3%, has often been below 2% and currently sits at 2.5%.
So how does one achieve a 6% pre tax return with the least amount of risk?
Why not buy and hold an S&P 500 index fund like SPY? After all, SPY is up 6.4% year to date and up over 19%% over the past 12 months. That's true, but if one looks further back into history one discovers that its recent performance notwithstanding, SPY has averaged a compound annual return of only a little over 7% these past 10 years. And lest we forget, SPY dropped over 35% in 2008. It has achieved that nice 10 year average only because of some healthy double digit years. In short, SPY is hardly risk free and certainly is volatile.
So, again, how can one achieve a 6% pre tax return with the least amount of risk?
I have come to believe that one can construct a non-diverse portfolio correlated to a market singularity (the 10 Year) with movement by that singularity providing clarity on when to buy, hold or sell. I submit that by maintaining daily vigilance, adhering to strict principles and fearing not, the buying and/or selling, in short order, of some or all of one’s portfolio, one can achieve a 6% return with minimal risk. I do not buy the 10Year. Instead, I buy higher yielding securities that are very closely correlated to the 10Year. For example, through study and observation, I know that highly regarded preferred stocks maintain a roughly 320 basis point (3.2%) spread to the yield on the 10Year. Thus if the yield on the 10 Year remains stable at 2.5% one can achieve a 5.7% return by merely holding a basket of highly rated preferred stocks (such as found in the exchange traded fund PGX) and collecting dividends. If the yield on the 10 Year declines, in time, the yield on these preferred stocks will also decline ultimately reaching equilibrium at the aforementioned 320 bp spread. As a result, an investor will enjoy a capital gain. (Remember the price of an interest rate sensitive security increases as the yield declines.) If the yield on the 10Year increases or one reasonably can anticipate such an increase, one sells thereby retaining any accrued dividends and reaping the aforementioned capital gain. One then waits on the sidelines, safe and sound in cash, until stability returns to the 10Year and hopefully ahead of preferred stock equilibrium.
Here is a real life example. Anticipating a rate increase by the Federal Reserve back in December, I was on the sidelines in cash. When the increase was announced, the market overreacted as it invariably does. The yield on the benchmark 10 Year spiked to over 2.6% as its price tanked. (Remember the higher the yield on a bond the lower the price.) The price of correlated securities such as preferred stocks also tanked. I swept in and purchased them en masse at bargain prices. The rate on the 10Year ultimately stabilized below 2.5% and the above discussed equilibrium ensued thereby providing me a capital gain. I held tight until this past Wednesday when I sold in anticipation of an upcoming rate increase. Between principal appreciation and dividends I am up 5% on my invested capital in just over 2 months. Achieving another 1-2% this year should be a cake walk once stability returns to the bond market since the portfolio I will repurchase pays healthy dividends, many on a monthly basis.
I also invest in other interest rate sensitive securities such as exchange traded debt and certain leveraged closed end funds which are also correlated to the 10Year. The oil stocks I buy are correlated to the price of oil more than to the rate on the 10Year. I did not sell my oil stocks.
This approach reads more complicated than it is. In any event, it helps me sleep peacefully each and every night.
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