Risk/Reward Vol. 113
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
"Picasso moon, shining bright/The universe is working fine tonight
Picasso moon, illuninate me"---lyrics "Picasso Moon" by the Grateful Dead
"We gettin' money, man/I'll show you how to turn profit
In the hood, they call me "Joey the Profit"
First you cop it, then you cook it, then you chop it"---lyrics "The Profit" by Fat Joe
"Buy! Buy!/ Says the sign in the shop
Why? Why? Says the junk in the yard"---lyrics "Junk" by Paul McCartney
"We're movin' on up/To the east side
To a deluxe apartment in the sky
We're movin on up/To the east side
We finally got a piece of the pie"---lyrics "Movin' On Up" (theme song from "The Jeffersons")
As highlighted last week, any signal on future "quantitative easing" from the Federal Reserve moves the stock market---big time. On Tuesday, the Fed released minutes of its March meeting which cast doubt on its desire to continue any "easing" past the June termination of "Operation Twist" (the buying of long term Treasuries). That news, in conjunction with concerns about Europe and a disappointing Spanish bond auction, sent the Dow into a triple digit tailspin on Wednesday and contributed to the worst week of 2012--and Friday's job report portends a lower open next Monday.
Although I touched on it last week, all investors need to understand why "quantitative easing" and other "easy money" Federal Reserve policies have such a huge impact on the stock market. Large institutional investors are no different than you and me---they need a decent return. Currently, they cannot get it from Treasuries even though that "safe haven" is where all of us would love to park a large chunk of our money. So, why are Treasury yields so low?
Perhaps the following analogy will "illuminate" you. Suppose Picasso were still alive and selling his art in monthly auctions. Due to his reputation, the auctions attract numerous buyers, but Picasso is unsatisfied by the prices he is receiving. He devises the "bright" idea of controlling his "universe" by planting a shill in the audience to bid up prices. Over the course of a year or so, the prices at auction go to "the moon", but the shill ends up with 61% of the art. The "sale" to the shill is illusory, of course, because no money changes hands. But the prices paid by other buyers are high. Now, what happens if and when Picasso pulls the shill out of the auction? The prices drop, of course, and perhaps precipitously.
This is exactly what is happening in the Treasury bond market. As reported last week in the Wall Street Journal (Google "Lawrence Goodman and Federal Reserve"), the Federal Reserve via "quantitative easing" (QE) purchased, through bid, a stunning 61% of all of the new debt issued by the Treasury in 2011, and similarly large percentages in other recent years. It did so by expanding its balance sheet (read; printing money) which has gone from $900billion to $2.9trillion in 3 1/2 years. QE's stated purposes have been to keep Treasury bond prices high (and yields low), concomitantly to drive investors out of Treasuries and into the stock market (and thereby attempting to spur economic growth and job creation) and to flood banks with liquidity. And, it has worked, at least in part. Look at the stock market's recovery since 2009 and the bloated, excess reserves held by money center banks ($1.5 trillion---which is $400billion more than all of the US currency currently in circulation!). But, just like the shill's purchases of Picasso's art, it has created a false market. When QE ends (and it will end sometime or the excess reserves held by banks will be invested into the real economy with a hugely inflationary impact) and the Fed stops bidding up Treasury bond prices, those prices will fall unless some exogenous event (Eurozone failure, tsunami or an Iranian war) causes a massive "flight to safety" by purchasers other than the Fed.
So, it makes sense, does it not, that when the Fed hints that it may exit Treasury auctions, the prospect of lower prices (and higher yields) in the Treasury bond market begins to look like a real, and very attractive possiblity to me---and to institutional investors. And conversely, the stock market, which has risen because no one can get a decent yield on Treasury bonds, begins to look inflated. Investors (yours truly included) want to get out ahead of a stock market "correction". Thus, like Fat Joe, having "copped" and "cooked" some nice gains, they begin to take profits in some positions (sold all my AEG this week for a 20% profit) and to "chop" even small loss positions (sold POM at a slight loss) thereby raising cash in anticipation of a drop in Treasury prices, a rise in Treasury yields and a drop in stock prices. Unless and until the Fed hints it may continue some accommodation, I plan to continue to take some profits and to raise cash, pruning my holdings down to good yielders (and probably keeping AAPL). That said, I have not yet invested in the VIX or repurchased a Treasury short position which I discussed last week.
Speaking of yields, have you noticed the 1/4 page ads run by BlackRock in the WSJournal and the Financial Times hyping investment in HYG, its flagship junk (excuse me, high yield) bond exchange traded fund? As discussed last week, the market is flooded with new junk bond issues as companies seek to take advantage of the prevailing low interest rates which in turn are priced off of the low yields on Treasury bonds (called the "yield spread"). Check out www.quantumonline.com , a convenient place to "shop" for junk . I bought MHNB and KFI which yield 8% and 7.5% respectively, 50 basis points lower than earlier issues (MHNA and KFH) but still worthy of investment. I don't see putting these babies out in the "yard" anytime soon.
One reader this week asked me what I think of real estate. After several years of depression, it clearly is beginning to turn around. In fact, it is "movin' on up" as a percentage of my holdings. You don't have to be George and Weezy Jefferson to "get a piece of the pie" these days. As noted last week , I like the preferred shares of real estate investment trusts, particularly those that also carry a hefty common dividend. Currently, I own RASpC, CLNYpA, AHTpD, DFTpB, GRTpG, HPTpD, LXPpD, PEBpB, SFI pE and I as well as AGNC, NLY, HCN, SLA and the closed end fund RQI---each of which has appreciated in principal and pays over 7% annually in dividends and all of which on average pay in excess of 8 %
In closing, I wish all of you a joyous holiday weekend. On a personal note, Barb and I received one of the greatest dividends of all this week--- the birth of our fourth grandchild, Arthur Lucien Jaworksi---a dividend made possible by our all-time smartest investment---The Busch Girls
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