April 21, 2012 Don't Cry for Me

Risk/Reward Vol 115

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

"I may take a holiday in Spain/Leave my wings behind me
Flush my worries down the drain/And fly away to somewhere new."---lyrics from "Holiday in Spain" by the Counting Crows

"You won't believe me/All you will see is a girl you once knew
Although she's dressed to the nines/At sixes and sevens with you
Don't cry for me Argentina"---lyrics from "Evita" by Andrew Lloyd Webber

"Opportunity, opportunity/This is your big opportunity
They shop around/Follow you without a sound"---lyrics from "Opportunity" by Elvis Costello

The Dow finished higher this week on the strength of good corporate earnings reports here in the U.S. and despite headwinds from Europe---particularly Spain. You won't "flush your worries down the drain" there these days! Indeed, a renewed concern over Spanish sovereign debt, the same kind of concern that plagued the stock market last fall (see Vol. 96 www.riskrewardblog.blogspot.com ) promises more choppiness in the coming weeks, and in my humble opinion portends more negative than positive action. We may be "leaving the wings" of this very good market behind. Here's why.

Last fall's roller coaster trading range was broken (and the stock market allowed to rise on good U.S. earnings reports) only when the European Central Bank (ECB) initiated the Long Term Refinancing Operation ( the "LTRO" as discussed at Vols. 98 and 107), in effect lending 1trillion Euros to European banks at 1% which in turn the banks used to purchase the sovereign debt of struggling countries such as Spain and Italy. Unfortunately, the Spanish banks already have exhausted the LTRO proceeds and without their participation in the auction of Spanish government bonds, the prices will plummet, and the yields will rise (sounds like the Picasso auction, doesn't it) such that the Spanish government will run out of money. Massive austerity measures and/or default loom ahead absent further European intervention. And default of the sovereign debt of a country the size of Spain would send the financial markets worldwide into a tailspin. The ECB has stated that due to inflation concerns, it likely will not embark on a third round of LTRO. To add more madness to the mix, France holds round one of its presidential elections this weekend with M. Sarkozy trailing his socialist opponent M. Hollande. Should M. Hollande ultimately prevail, the Merkel-Sarkozy partnership that has steered Europe recently will end---inaugarating a very uncertain future. And stock markets abhor uncertainty.

In short, unless and until there is a commitment for pan-European intervention on Spanish (and perhaps Italian) sovereign debt, I see the market being dominated by a "risk off " bias. As a consequence, I am avoiding cyclical stocks (those dependent on a growing economy such as steel, copper and manufacturing) and hunkering down with my preferred stocks and exchange traded debt---both of which pay great dividends but trade flat (at or near $25) absent exogenous events. I still have exposure to the preferred stocks of some European financials (DUA, IDG, NWpC, RBSpT, AEK, AEF, BCSpD, etc.) which pay handsome yields, but for which, my tolerance for loss is nearly zero. They will fall like rocks if a Spanish default approaches.


Oh, and speaking of market negatives, how about the decision by Argentine President Cristina Fernandez Kirchner this week to nationalize Argentina's largest oil company, YPF. The effect is to render worthless the common stock of that company, a large percentage of which is owned by Spanish oil giant Repsol. Such dictatorial conduct is remindful of "a girl we once knew"---Evita herself. However, when a populist leader (e.g. Hugo Chavez, Evo Morales, etc.) nationalizes a business (read, taking it over without paying a dime), it makes investment in emerging markets, in general, and in South America, in particular, significantly riskier. Investments that once were "nines" now look like "sixes and sevens". I cry for you, Argentina.


The above negative news notwithstanding, "big opportunities are around"---some currently available, some just around the corner. As to current opportunities, many more preferred stock and exchange traded debt offerings were made available this week to yield hungry investors like yours truly. I bought newly issued MFO (REIT exchange traded debt) and AHLpB (insurance preferred), paying 8 and 7.25% respectively. As to future opportunities, did you notice that the EPA published fracking regulations that don't go into effect until 2015 and even then, are no more restrictive than what responsible companies are already doing? According to the Wall Street Journal, this development was as surprising as would be George W. Bush receiving the Nobel Peace Prize. Perhaps President Obama now recognizes that cheap fossil fuels are a political asset. No matter, it moves the U.S. ever closer to a future of energy independence.


In closing, I remain cautious; 45% in cash. Any confirmed downward movement in a stock that I hold results in a sale. This week, my favorite, TNH, headed downward, and I sold it to lock in a 45% gain (down from 60%). With apologies to Andrew Lloyd Webber, the first quarter was an amazing, technicolor dreamcoat. I don't want to wake up one day like Joseph, at the bottom of some stock-drop gully, stripped of my profits.