THIS IS NOT TAX OR INVESTMENT ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Our objective is to hit low and stable inflation in the medium term."--- Ben Bernanke, March, 2011
"The Emperor has no clothes"--- Hans Christian Andersen
"Jack be nimble."---Nursery Rhyme
One cause of inflation is an oversupply of money. The purpose of quantitative easing is to increase the money supply and to induce inflation. As the Federal Reserve (Chairman Bernanke) buys newly issued Treasury debt at artificially high prices (high prices means low yield/interest) and makes money available to banks at 0.75% interest (discount rate), we are awash in cheap credit and dollars. Everything that is not in a state of oversupply (note: housing and labor are IN oversupply) such as food and gasoline is inflating in price. There are too many dollars chasing a limited supply
---other than houses and jobs, the two items the market for which Bernanke so desperately wants to jump start.
Inflation has international implications as well. The dollar is being crushed versus the pound, Euro and yen. This helps exporters, but hurts consumers who have come to rely on imported products.
Europe, too, has experienced inflation and this week the European Central Bank (the Euro's equivalent to the Federal Reserve) raised its discount rate to 1.25% in order to gently contract the supply of money.
Whether Bernanke is correct in holding the course or the ECB is right in raising rates is beyond the expertise of this writer. I do know that the current quantitative easing (QE2) is scheduled to end in June. Without the Federal Reserve overpaying for Treasury debt and with the Japanese (third largest purchaser of Treasury debt) needing to invest in rebuilding its homeland, market forces will likely result in the price of Treasury debt falling and as a result interest rates paid thereon increasing. This will have a ripple effect throughout the entire credit market since virtually all lending is keyed as a spread to Treasury rates (e.g. CD's, money markets, home loans, commercial paper).
What does this mean to a nimble individual investor?
To me it signaled an exit of several positions I had with Annaly (NLY), Chimera (CIM) and Agency Mortgage (AGNC) which are mortgage investment trusts that make money by buying long term mortgages with short term borrowing. If the cost of short term borrowing increases after QE2 ends (which it will), the profits of these companies will suffer and their ability to pay double digit dividends will come into question. I decided to exit after this quarter's dividend (March 31) even though I do not believe their profits will suffer for at least one more quarter. To quote one of my favorite investors, Bernard Baruch, "I made all my money by selling too soon."
Ironically, I invested some of the proceeds into what others may view as more speculative ventures---but remember I am replacing dividends paying as high as 14%! I re-entered a position in the preferred shares of NatWest, a subsidiary of the Royal Bank of Scotland (NWpC). Readers may recall that I exited NWpC with the Irish debt crisis, but subsequent events have led me to believe that the risk of owning NWpC
is overcome by the 8% dividend. The UK owns over 80% of RBS and the terms of the NWpC issuance as described in the prospectus would require RBS to conclude that its solvency is in question before it stops paying dividends--something I do not see the UK government allowing.
Indeed, a closer look at how intertwined European governments are with their leading banks led me to another interesting decision. If you recall back in 2008, the US through the TARP Program lent billions of dollars to virtually every major bank in the US in order to boost their balance sheets so that they could continue to lend money. European governments did the same thing to save their major banks. For the most part, each of the major banks in the US has repaid all of the TARP loans (notable exception is Ally Bank about which I wrote last week). This is not the case in Europe. For example, Deutsche Bank (DB) still owes the German government virtually all of the billions of Euros it borrowed. DB in turn is one of the largest creditors of
the government of Greece. The National Bank of Greece (NBG) is a well run institution (according to Morningstar and S&P), but unfortunately has much of its capital also invested in the government of Greece. The preferred stock of DB pays 7% while that of NBG pays 11.5%. I figure that Germany will not let Greece default until DB has extricated itself from Greek debt. Until that happens, the preferred stock of NBG (NBGpA) looks like its worth the risk. I bought some.
On another front, Kayne Anderson MLP (KYN), a closed end fund that invests in master limited partnerships (MLP's) in the business of storing and transporting natural gas (such as Kinder Morgan, Plains America, ETP, etc.) announced this week that it was issuing more stock. As is usual with such companies, the price of this "secondary offering" was below the then market price. This caused the market to drop and presented an opportunity to purchase at around $30.50 which will result in a dividend of 6.3% and an opportunity for significant appreciation especially in light of President Obama's support, albeit lukewarm, for natural gas
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