September 22, 2012 Gangnam Style

Risk/Reward Vol. 137

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

"We shall survive, let us take ourselves along/Where we fight our parents out in the streets
To find out who's right and who's wrong/B-B-B Benny and the Jets"---lyrics from "Benny and the Jets" by Elton John

"In New York, concrete jungle/ Where dreams are made of
There's nothing you can't do/Now you're in New York"---lyrics from "Empire State of Mind" by JayZ

"Bubbles, bubbles/I wish my name was Bubbles, Bubbles
I wish my friends were bubbles, bubbles/I go real far on bubbles, bubbles"---lyrics from "Bubbles" by Linkin Park

As I have detailed over the past few weeks, two of the three economic conditions necessary for a stable stock market appear to be developing: 1) a plan to address sovereign debt in the Eurozone and 2) a stimulus program in China. The third condition, a resolution of the impending U. S. Fiscal Cliff, likely will develop before year end, but its contours (left, right or more likely a postponed decision) will not be known until after our elections in November. My concerns now run to possible exogenous events that could disrupt the world economy---and number one on my worry list is "B-B-B Benny and his Jets". Prime Minister Benjamin Netanyahu has proclaimed that in order for Israel to "survive" it must deliver a debilitating blow to Iran's nuclear capability. Some wags are predicting a strike by Israeli "Jets" sometime before our elections, a move that would force President Obama's support so as not to alienate Jewish voters. Whether you believe such a strike is "right" or "wrong", one consequence could be a blocking of the 21 mile wide Strait of Hormuz through which passes each day 17million barrels of oil, 20% of the world's daily consumption. Disruption of that flow would wreak havoc on the world's economy and would cause stock markets to plummet. This is a real concern, but is not one that has caused me to exit--yet.

You don't have to be JayZ or Carrie Bradshaw to know "what the dreams of real New Yorkers are made of": finding a rent controlled/rent stabilized apartment in "the concrete jungle". Once located, tenants rarely leave. Consequently, underwriting mortgages on rent controlled buildings is a safe, if boring way for banks to earn interest. And the recognized leader in underwriting rent controlled building mortgages is New York Community Bank (NYB), the nation's 21st largest bank. Sixty eight percent of its loan portfolio is multifamily residential building mortgages, most of which are rent controlled. But, what makes NYB attractive to me is its 7.2% dividend. Moreover, it has appreciated 7.8% since I bought it on July 26th.

Speaking of real estate, is anyone else concerned that cheap mortgage credit is creating another real estate bubble? Oh, don't get me wrong. So far this "bubble is my friend", and I "have gone real far" toward financial independence on this "bubble". Dividends from those real estate investment trusts that prosper in a low interest rate environment have rewarded me handsomely. I especially like the preferred stock of those REITs, the dividends on which must be paid in full before the even higher yielding (and less consistent) common stock dividends can be distributed. I am so attracted to this "bubble" that I am overweight in this sector. Under traditional rules of diversification, I would be deemed foolish. I take solace in the fact that I am vigilant to a fault so that at the slightest hint that any portion of this sector is weakening I can exit. For example, I am currently watching closely the impact of the Federal Reserve' s recently announced mortgage buying program (QE3) on agency mortgage reits (AGNC, NLY, etc.) which could be adversely impacted by a plethora of refinancing. I do not recommend this overweighting for the less diligent.

Despite the negative tenor of this article, my portfolio (a list of which will be provided under cover of a separate email) just experienced a great week, performing far better than the market in general. Indeed, the stable to upward performance of the market since my re-entry in June has provided me a welcome "Psy" of relief from the turbulence that dominated the first several months of the year. At this rate (my portfolio averages 7.5+% in dividends), even in retirement I will be able to afford my "sexy lady" and to otherwise lead my life-- "Gangnam style."