May 11, 2013 Sign, Sign

Risk/Reward Vol 169

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

"Sign, sign everywhere a sign
Blockin' out the scenery/Breakin' my mind
Do this/Don't do that
Can't you read the sign?"---lyrics from "Signs" sung by The Five Man Electrical Band

"My heart is telling me to be different/It's about time for me to move on
Swallow everything that I've heard/I'm at a point of no return."---lyrics from "No Return" by Eminem

"It's a narrow margin/Just room enough for regret
In the inch and a half between 'Hey, how ya been?'
And 'Can I kiss you yet?' "---lyrics from "Providence" by Ani Difranco

As the Dow Jones Industrial Average (DJIA) and the S&P500 (S&P) reached new highs again this week, I continued my search for a "sign, sign" that the bubble is about to burst. Market mavens are advising "do this/don't do that." Nevertheless, their noise is not "blockin' out the scenery" nor is it "breakin' my mind". If one cares to look, "everywhere there's a sign" that the market may be topping. "Can't you read the signs?"

What signs you ask? Consider the following:

1) Hedge funds, run by very savvy people who fixate, first and foremost, on managing risk, averaged a 4.6% year to date return through April 30, 2013. For the same time period, the DJIA and the S&P returned nearly 14%. Does this mean that I should "swallow everthing that I've learned" about the sagacity of hedge fund managers? No, to the contrary, "my heart is telling me different." It's telling me that the markets are very risky at present, and that although we are "not at a point of no return", perhaps "it's about time to move on."

2) On Monday, in a master stroke of British understatement, the Financial Times reported: "Demand for yield has become the main driver of investor behavior." In this regard, note that junk bonds rated CCC ("extremely speculative") now yield a record low 6.77%. Last year at this time, they yielded 10.13% In fact, the average yield across the entire junk bond spectrum (bonds rated BB+ through D) fell below 5% this week---a record low. Talk about a "narrow(ing) margin!" In addition, the yield on the sovereign debt of emerging market countries is near a record low: 5.5% Remember, lower yields mean higher bond prices. These record low yields are signs that risk is out pacing reward.

3) The New York Stock Exchange reported on Thursday that margin debt (the amount of money borrowed with brokerage accounts as collateral) is within an "inch and a half" of its all time high which was reached just weeks before the markets started to reverse in 2007. This is significant because it indicates exuberance in the market--perhaps even over confidence. Understand, that if the markets reverse, even temporarily, brokerage houses that have lent money on margin will demand more collateral and/or a repayment of loans---a situation that in the past has compounded losses and accelerated declines. Does this mean that there is "just enough room" to exit "before regret?" or can I continue to "kiss the market?"

4) A story ran in this morning's (Saturday's) Wall Street Journal reporting that the Federal Reserve has mapped an exit from its quantitative easing program (QE3). Rumors of this story caused a large intraday drop on Thursday. If the stock market's recent spectacular performance is truly just a QE3 induced bubble, this story could have a substantial negative impact come Monday. Keep a watchful eye open.

Hold or sell---this is a tough question for which there is no certain answer. For now, I remain invested. But, I will exit if I perceive that the market is turning. I am not "Just gonna stand there, and watch (my profits) burn/That's not alright/ Because I don't like the way it hurts."

P.S. This week, an unfavorable report from Barron's and an attack by short sellers caused me to exit LINE and LNCO. In the long run, I believe this family of oil producing companies will do well, but I don't need to fight the market---particularly when there are suitable alternatives available such as VNR.

P.S.S. With the exchange rate falling below 100 Yen/$1, I upped my exposure to the Japanese stock market via the dollar hedged exchange traded fund, DXJ ( see discussion at www.riskrewardblog.blogspot.com Vol. 152). DXJ has gained 33%
since I first bought it on January 9, 2013.