March 10, 2012 As Good As It Gets

Risk/Reward Vol. 109

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

"And when I get excited/My little China girl says
Oh baby, just shut your mouth/She says ...sh"---lyrics "China Girl" by David Bowie

Melvin Udall (Jack Nicholson)--"You're a disgrace to depression!"---quote from the movie "As Good As It Gets"

"My thinking is derailed/I'm tied up to the tracks
The train of consequences/There ain't no turnin' back"---lyrics "Train of Consequences" by Megadeath

"Downtown people on the corner watching the people play
And while the people watch them play/The players watch the people
On a Wall Street kind of day"---lyrics "Wall Street Kind of Day" by the Four Seasons

As loyal readers know, I believe that American stock markets, absent exogenous events (e.g. an Israeli air strike or a tsunami), are driven, up or down, by three factors: the U.S. economy (read, corporate earnings and job growth); stability in the Eurozone; and the rate of growth in China. See Vols. 70 and 74 available at www.riskrewardblog.blogspot.com . One needs no further proof than what happened on Tuesday. Having "gotten excited" by last month's excellent quarterly earnings reports and in the wake of the European Central Bank's (ECB) stabilizing Long Term Refinanciing Operation (the LTRO discussed last week), the Dow Jones Industrial Average was flirting with the 13,000 level only to experience a "mouth shutting" two hundred point drop on the news that "China Girl" was revising its forecasted growth rate down from 8.5% to 7.5% and further news that Chinese leaders saw no immediate need for any stimulus. Talk about "saying---sh!" Some decent domestic job news on Thursday and Friday caused a rebound, but the Dow closed 55 points down for the week.

So how does an individual investor react to this development? Here is what I did. Since 60% of all iron ore is consumed by China, I sold my stake in the Mesabi Iron Trust (MSB). I also deferred any further investment in China's favorite commodity supplier--Brazil. On a broader scale, with Thursday's uptick, I sold most of my losing positions (thankfully only a handful)--even those that had never approached my 8% loss limit. Unlike Melvin Udall, I'm not talking "depression" or even a recessionary dip, but absent better news from China, yours truly believes that at its current level, the stock market is about "as good as it gets". Selling my losers allows me the luxury of excess cash to be used to buy if and when drops like those last Tuesday occur. P.S. Cramer advised the same this week.

We are living in a world of unintended "consequences". The Federal Reserve has kept its discount rate (the rate it lends money to banks) at record lows, and the ECB via the LTRO has literally flooded Eurozone banks with 1trillion Euros worth of 1% loans, both with the express purpose of incenting banks here and abroad to, in turn, make low interest rate loans to their industrial customers thereby encouraging investment and more importantly spurring job growth. Unfortunately, "that thinking has been derailed" because, at the same time, bank regulators here and abroad by virtue of increased capital requirements and stricter lending standards have "tied banks to the tracks" causing them to hoard cash and to reduce, not grow, their lending activity. And, as Megadeath predicted "there ain't no turnin' back." For example, commercial banks at the insistence of regulators who deem them too risky, are selling entire portfolios of real estate loans just as the real estate market, particularly the commercial space, is beginning to turn around.

But, fear not, dear Readers, where there is a demand for capital, the ever "watchful people of Wall Street will play". Wall Street knows how to raise money, and the good "players" know how to price (measure) risk. If banks won't lend to companies, Wall Street will borrow on their behalf in the public markets via bonds and exchange traded funds or create other pools of money in the form of investment trusts or development companies which in turn can lend to industry. Activity in these areas is currently at a fever pitch precisely because banks are not lending, with new offerings literally every day. The low yields on investment grade bonds and the clumsy manner in which they trade make them unappealing to me. I prefer high yield bonds to which I gain exposure in a liquid and diversified way via exchange traded funds such as JNK or HYG. As discussed in previous editions, I also gain exposure through senior loan, closed end funds like JFR. On the business development side, I like ARCC, SLRC and the closed end fund FGB. As for real estate loan exposure, on the residential side, I like investment trusts that purchase mortgages guaranteed by the federal agencies, Fannie Mae and Freddie Mac; trusts such as NLY and AGNC (currently priced attractively due to a secondary offering). In the commercial mortgage space, look at the preferred shares of commercial mortgage real estate investment trusts like RAIT and NorthStar Realty, both of which have decent yields and are protected by hefty common dividends.

In closing, I solicit some responses--responses of any kind to my postings. Honestly folks, sometimes I feel like Wall-E, toiling away in complete solitude. When I do get responses, I find them very helpful--not only with investing ideas but with guidance on how to make future postings more relevant. Recognizing that the Four Seasons suffer from dissociative identity disorder, I request that you eschew their advice that "Silence Is Golden" and that instead you follow their admonition to "Talk like a Man"--at least to talk like this man. I look forward to your comments.