Risk/Reward Vol. 175
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"You think that I don't even mean a single word I say
It's only words/And words are all I have
To take your heart away."---lyrics from "Words" by the BeeGees
"We're caught in a trap/I can't walk out
Because I love you too much baby
Why can't you see/What you're doing to me---lyrics from "Suspicious Minds" sung by Elvis Presley
"It's your thing /Do what you wanna do
I can't tell you/Who to sock it to"---lyrics from "It's Your Thing" by the Isley Brothers
"It's only words" that Federal Reserve Chairman Ben Bernanke spoke on June 19th, but they "took the market's heart away." In what I believe to be a calculated moment of transparency, Bernanke stated that, should the economy continue to improve, the Federal Reserve's $85billion/month Treasury bond and mortgage purchase program known as QE3 would begin to taper this fall and would end as early as next June. Markets worldwide reacted immediately. Appreciating that the impact of QE3 has been to inflate prices across the risk spectrum (and in some instances such as junk bonds to create asset bubbles), frontrunners began to sell assets of all types (but most prominently U.S. Treasury Bonds) as soon as Bernanke uttered this definitive timetable. Within four trading days, Treasury bond prices plummeted as did the price of almost every financial asset around the globe. The Dow Jones Industrial Average (DJIA) dropped nearly 5%. (Recall that virtually all securities are priced in relation to the safest security in the world---the 10 Year US Treasury Bond; if it falls in price so does everything else---see vol. 172 www.riskrewardblog.blogspot.com ) This reaction was predictable unless Bernanke "didn't mean a single word he said."
Could it be that Bernanke and the Federal Reserve's Open Market Committee (FMOC), which administers QE3 and which authorized the statement, "did not see what they were doing to me (and the rest of the market)?" I think not. For the past several weeks every financial commentator has remarked that "we're caught in a (QE3) trap and can't walk out." That is, the markets "love QE3 too much, baby;" so much so that they rise on bad economic news and fall on good news because the former means that it is more likely that QE3 will continue. You think not? Then explain why the DJIA spiked 150 points on Wednesday on news that the gross domestic product grew only 1.8% instead of the previously reported 2.4%. In normal (not QE3 dominated) times the reaction to such disappointing news would be exactly the opposite. Moreover, Wednesday's rise was sandwiched between two thinly disguised attempts by the Fed to clarify Bernanke's timetable (both of which caused market gains) with two Fed governors stating on Tuesday and Thursday that the timing of any QE3 tapering should be driven by events, in particular a reduction in unemployment, and not by a calendar as suggested on June 19th by Uncle Ben. But, Friday saw the DJIA drop triple digits as Fed member Jeremy Stein muddied the waters further by stating that although any decision will be data driven, tapering could begin in September. If and how long QE3 lasts is the largest factor moving markets today---and as the above chronology demonstrates that revelation is not merely the product of my "Suspicious Mind." I believe the FOMC is purposefully sending mixed messages about QE3 tapering to wean the market from this dependence.
What should one do, trapped in a world so dominated by QE3? "It's your thing/Do what you wanna do. I can't tell you/ Who to sock it to". But I remain as uneasy as the markets themselves. One day the markets may tire of reacting to the FOMC's messaging at which time they will do "Their Own Thing." To me, the key indicator of this occurring will be the yield on the 10 Year Treasury Bond. If it stays at or below 2.5% for a sustained period it will indicate to me that the frontrunners are standing pat---at least for a while. If so, I likely will repurchase high yielding monthly dividend paying closed end funds to recapture some of the gains I lost during my short foray into "second level thinking." ( See Vol. 174 http://www.riskrewardblog.blogspot.com/ ). But even then, I will be prepared to exit should those yields rise above 2.5% (meaning the bond prices are falling). These past two weeks have given us a preview of how asset prices will deflate if and when Treasury bond prices begin to fall. I do not want to be holding stocks or bonds when they do.
Had I not been in cash, the triple digit daily volatility of the DJIA over the past two weeks would have caused me to "Twist and Shout" like an Isley Brother. And so, my profits and I remain on the sidelines, surveying the situation; all the while determined to "work it on out."
P.S. Thanks for all the warm congratulations on our 40th annivesary. I am a lucky man.
Saturday, June 29, 2013
Saturday, June 15, 2013
June 15, 2013 Patience
Risk/Reward Vol. 174
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Could use some patience/Gotta have some patience
All it takes is patience/Just a little patience."---lyrics from "Patience" by Guns N' Roses
And so its true/Pride comes before a fall
I'm telling you/So that you won't lose it all
I'm a loser/And I am not what I appear to be."---lyrics from "Loser" by The Beatles
"Now I'll be bold as well as strong
And use my head along side my heart
And I will wait/I will wait for you."---lyrics from "I Will Wait" by Mumford and Sons
I "could use some patience. Gotta have some patience. All it takes is patience. Just a little patience." Get the point. As reported last week, I was so proud of my Second Level Thinking, I bought several positions--- without considering other factors . On Tuesday and Wednesday as the bond market continued to deteriorate, bond like assets (such as those that I bought) were punished as well. Note to self: Second Level Thinking is not a substitute for patience. Clearly, I jumped too soon. I am not good at timing a market bottom, and Tuesday,Wednesday and Friday showed me that we may not be there yet. I have not and do not profit by buying at the bottom or selling at the top. I play the middle zone-- but that takes patience. Let the market for bond-like securities (e.g. those that pay predictable dividends such as REITS, preferred stock, exchange traded debt, utilities, etc.) find its equilibrium and buy on the way up---that's my game.
"And so it's true. Pride comes before a fall." As a consequence, "I'm a loser" this week. For those that hailed me as a victor for my exit in May, "I am not what I appear to be." But, I did not lose much because I was less than 20% invested and because I set my loss limit (a mental one not a stop/loss order) very close to my entry price. If positions reached that level, I sold. Had I stayed put, I would have recovered most of my losses on Thursday as the market rallied on a report by Jon Hilsenrath of the Wall Street Journal that Federal Reserve Chairman Bernanke likely will give guidance next week that QE3 will not end soon. Thursday's rise notwithstanding, my mistake was not in selling on Wednesday, but in buying in the first place. There is no dishonor in cutting losses and no second guessing in rules based selling. According to all that I have read (and I have read a lot on the subject), the number one rule for most successful investors is to cut losses and to let winners run. "I am telling you (my story)/So that you won't lose it all."
But rest assured, once there is confirmation of stablization in the market in general and in bond prices/yields in particular, I "will be bold as well as strong" in my buying. Unlike last week, however, "I will wait, I will wait" for that confirmation--- which will not come earlier than Bernanke's press conference on Wednesday. This time I will "use my head along side my heart." And I have some juicy prospects under consideration. They include some that I sold this week (just because I was premature in my buying doesn't make them bad selections). Also, take a look at the WSJ Closing Table for Preferred Stock and Exchange Traded Debt ( http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html?mod=mdc_h_usshl#C ), a sector that has been hit unmercifully since the release of the Federal Reserves minutes on May 22nd ( Vol 171 http://www.riskrewardblog.blogspot.com/ ). There you will see a wonderland of potential selections for a yield hunter like me. For those with a taste for more speculation, look at the mineral/mining sector. Rio Tinto (RIO) hasn't traded this low since 2009, a time when iron ore was selling for $60/ton not $112/ton like today---and it pays a 4% dividend while you wait for the price to recover. The same can be said for CLF and BHP. Don't buy any of these without further study, but at first blush they are either woefully underpriced, or the world is headed for a major contraction. Iron ore=steel, steel=manufacturing, manufacturing=economic growth. The opposite is true as well.
I am convinced that the current market volatility is creating excellent buying opportunities and will reward the "Patient" with a trip to:
"Paradise City/ Where the grass is green/ And the girls are pretty."
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Could use some patience/Gotta have some patience
All it takes is patience/Just a little patience."---lyrics from "Patience" by Guns N' Roses
And so its true/Pride comes before a fall
I'm telling you/So that you won't lose it all
I'm a loser/And I am not what I appear to be."---lyrics from "Loser" by The Beatles
"Now I'll be bold as well as strong
And use my head along side my heart
And I will wait/I will wait for you."---lyrics from "I Will Wait" by Mumford and Sons
I "could use some patience. Gotta have some patience. All it takes is patience. Just a little patience." Get the point. As reported last week, I was so proud of my Second Level Thinking, I bought several positions--- without considering other factors . On Tuesday and Wednesday as the bond market continued to deteriorate, bond like assets (such as those that I bought) were punished as well. Note to self: Second Level Thinking is not a substitute for patience. Clearly, I jumped too soon. I am not good at timing a market bottom, and Tuesday,Wednesday and Friday showed me that we may not be there yet. I have not and do not profit by buying at the bottom or selling at the top. I play the middle zone-- but that takes patience. Let the market for bond-like securities (e.g. those that pay predictable dividends such as REITS, preferred stock, exchange traded debt, utilities, etc.) find its equilibrium and buy on the way up---that's my game.
"And so it's true. Pride comes before a fall." As a consequence, "I'm a loser" this week. For those that hailed me as a victor for my exit in May, "I am not what I appear to be." But, I did not lose much because I was less than 20% invested and because I set my loss limit (a mental one not a stop/loss order) very close to my entry price. If positions reached that level, I sold. Had I stayed put, I would have recovered most of my losses on Thursday as the market rallied on a report by Jon Hilsenrath of the Wall Street Journal that Federal Reserve Chairman Bernanke likely will give guidance next week that QE3 will not end soon. Thursday's rise notwithstanding, my mistake was not in selling on Wednesday, but in buying in the first place. There is no dishonor in cutting losses and no second guessing in rules based selling. According to all that I have read (and I have read a lot on the subject), the number one rule for most successful investors is to cut losses and to let winners run. "I am telling you (my story)/So that you won't lose it all."
But rest assured, once there is confirmation of stablization in the market in general and in bond prices/yields in particular, I "will be bold as well as strong" in my buying. Unlike last week, however, "I will wait, I will wait" for that confirmation--- which will not come earlier than Bernanke's press conference on Wednesday. This time I will "use my head along side my heart." And I have some juicy prospects under consideration. They include some that I sold this week (just because I was premature in my buying doesn't make them bad selections). Also, take a look at the WSJ Closing Table for Preferred Stock and Exchange Traded Debt ( http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html?mod=mdc_h_usshl#C ), a sector that has been hit unmercifully since the release of the Federal Reserves minutes on May 22nd ( Vol 171 http://www.riskrewardblog.blogspot.com/ ). There you will see a wonderland of potential selections for a yield hunter like me. For those with a taste for more speculation, look at the mineral/mining sector. Rio Tinto (RIO) hasn't traded this low since 2009, a time when iron ore was selling for $60/ton not $112/ton like today---and it pays a 4% dividend while you wait for the price to recover. The same can be said for CLF and BHP. Don't buy any of these without further study, but at first blush they are either woefully underpriced, or the world is headed for a major contraction. Iron ore=steel, steel=manufacturing, manufacturing=economic growth. The opposite is true as well.
I am convinced that the current market volatility is creating excellent buying opportunities and will reward the "Patient" with a trip to:
"Paradise City/ Where the grass is green/ And the girls are pretty."
Saturday, June 8, 2013
June 8, 2013 Second Level
Risk/Reward Vol. 173
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"I heard the news today, oh boy/About a lucky man who made the grade
And though the news was rather sad/Well, I had to laugh."---lyrics from "A Day in the Life" by The Beatles
"Everybody get to putting up your lighter now
Baby girl you see me shining much brighter now
Let's go to the next level."---lyrics from "Next Level" sung by Mary J. Blige featuring Busta Rhymes
"Where are you going now my love/Where will you be tomorrow
Will you bring me happiness/Will you bring me sorrow
On the questions of a thousand dreams/What you do and what you see
Lover, can you talk to me?"---lyrics from "Carry On" by Crosby, Stills and Nash
"Oh boy." On Monday and Tuesday, as "I heard the news each day", I accurately predicted the direction of the market. And it was not because I am "a lucky man who made the grade." On Monday, I simply recognized that "though the news was rather sad" (disappointing PMI numbers), the market would rise--- because, as noted last week, bad economic news increased the likelihood that the Federal Reserve will continue quantitative easing (QE3). On Tuesday, "I had to laugh" when I accurately predicted that the morning's good news (trade deficit numbers better than expected) would result in a market decline--- because that news lessened the prospect for continuing QE3. By Wednesday, however, whether the news was good or bad did not matter. Predictability gave way, as the uncertain future of QE3 dragged the Dow Jones Industrial Average (DJIA) down triple digits. Thursday's action was a roller coaster in advance of Friday's much anticipated jobs report--- which hit the sweet spot, 175,000 new jobs---high enough to indicate moderate economic growth, but not so high as to warrant tapering, at least not in the minds of the investing public. As a consequence, the DJIA skyrocketed, to end the week up 133 points. Curiously, it did so at the same time that the price of the 10 year Treasury Bond hit a 14 month low. As discussed over the past two weeks, recently, falling bond prices have resulted in lower stock prices across the board---but not on Friday. This uncoupling of bond and stock prices promises more unpredictability next week. How quickly markets change!
Unpredictability aside, recent market volatility has revealed some massively mis-priced assets; "babies" thrown out with the bath water. This situation is discussed at length in the book I just finished entitled "The Most Important Thing" written by noted investment advisor/billionaire Howard Marks of Oaktree Management. Marks' thesis is that turbulent times such as these produce opportunities that can be exploited if one can think on the "second level." Here is how the thesis works in real life. First level thinking led to the conclusion that I drew two weeks ago: to wit, because 10 year Treasury bond prices were falling quickly, income producing assets priced in relation thereto such as mortgage real estate investment trusts, junk bonds, and high dividend stocks would likewise decline quickly and should be sold if one wished to capture year to date profits. (Note: this correlation held true even yesterday as mortgage REITS, junk bond funds and business development companies continued to lose ground and utilities (VPU) traded 9% below where they were just two weeks ago--- even as the DJIA spiked.) Since income producing assets are among my favorites, I sold most of my holdings last week. Thinking on the "next (second) level" led to the observation this week that some of those disfavored assets would be oversold and thus mis-priced. Thinking on this level caused me to search for such opportunities and on Tuesday to buy FFC, a closed end fund that was massively underpriced. It is "shining much brighter now" and even rose on Wednesday while the rest of the market tanked. I used "second level" thinking on Thursday to locate and to purchase JPI, HPS and DUC. "Everybody get to putting up your lighter now!" (Email me if you want a more detailed description of my second level thought process.)
Even with the "second level" purchases discussed above, I am still 80% in cash which is where I likely will remain until there is more clarity on interest rates and/or QE3. Mr. Bernanke, "where are you going now, my love/where will you be tomorrow?" Will QE3 continue unabated or will tapering begin? I have "questions on a thousand dreams, what you do and what you see/Lover, can you talk to me?" And I am not alone. On Tuesday, Bill Gross, the founder of PIMCO and nicknamed by those in-the-know as the "Bond King," published his monthly Investment Outlook (available on PIMCO's webpage) in which he criticized QE3 and its unprecedented suppression of yields. According to Gross, its initial stabilizing aspects notwithstanding, QE3 now is negatively impacting investor appetite to "carry" risk. Even if risk is correctly priced on a RELATIVE basis (e.g. an appropriate spread between the yields on say, Treasury bonds and junk bonds), all yields are too low on an ABSOLUTE basis. Junk below 5% simply is not worth the risk; nor is committing $1000 for one year in a Treasury note for a paltry 0.14%; nor is buying a utility stock for a 3% return---especially when each can lose 10% or more of its value within a few trading sessions if and when the yield on the benchmark 10 Year Treasury Bond spikes (and its price drops) like it did in May. To quote Gross, "... never have investors received less for the risk they are taking." On Friday, former Fed Chair Alan Greenspan joined Gross' chorus and called for QE3 tapering to begin. Otherwise, according to Greenspan, other market participants may decide to abandon Treasury Bonds-- tapering or no tapering. If that happens, the Fed could lose sway over interest rates altogether which Greenspan believes would add further uncertainty to our fragile economy and more unpredictability to markets. Friday's drop in the price of the 10 year Treasury Bond despite the market's belief that QE3 will continue may portend this happening already. Keep your eye on Ray Dalio and his fellow Treasury shorts (discussed in last week's edition) who you can track by following TBT and PST!
And so I have concluded that except for an occasional purchase of massively mis-priced assets or a Treasury short, I am better off in cash. As more of us who favor high yielding instruments migrate there (junk bond funds experienced record outflows this week), maybe the Fed will conclude that QE3 has outlived its usefulness. Perhaps it is time for the Fed to start an orderly (albeit painful) taper while it still holds sway in the bond market, sway that Greenspan fears may be at an end. As Crosby Stills and Nash know, when it comes to tapering:
"It's been a long time comin', and it's goin' to be a long time gone."
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"I heard the news today, oh boy/About a lucky man who made the grade
And though the news was rather sad/Well, I had to laugh."---lyrics from "A Day in the Life" by The Beatles
"Everybody get to putting up your lighter now
Baby girl you see me shining much brighter now
Let's go to the next level."---lyrics from "Next Level" sung by Mary J. Blige featuring Busta Rhymes
"Where are you going now my love/Where will you be tomorrow
Will you bring me happiness/Will you bring me sorrow
On the questions of a thousand dreams/What you do and what you see
Lover, can you talk to me?"---lyrics from "Carry On" by Crosby, Stills and Nash
"Oh boy." On Monday and Tuesday, as "I heard the news each day", I accurately predicted the direction of the market. And it was not because I am "a lucky man who made the grade." On Monday, I simply recognized that "though the news was rather sad" (disappointing PMI numbers), the market would rise--- because, as noted last week, bad economic news increased the likelihood that the Federal Reserve will continue quantitative easing (QE3). On Tuesday, "I had to laugh" when I accurately predicted that the morning's good news (trade deficit numbers better than expected) would result in a market decline--- because that news lessened the prospect for continuing QE3. By Wednesday, however, whether the news was good or bad did not matter. Predictability gave way, as the uncertain future of QE3 dragged the Dow Jones Industrial Average (DJIA) down triple digits. Thursday's action was a roller coaster in advance of Friday's much anticipated jobs report--- which hit the sweet spot, 175,000 new jobs---high enough to indicate moderate economic growth, but not so high as to warrant tapering, at least not in the minds of the investing public. As a consequence, the DJIA skyrocketed, to end the week up 133 points. Curiously, it did so at the same time that the price of the 10 year Treasury Bond hit a 14 month low. As discussed over the past two weeks, recently, falling bond prices have resulted in lower stock prices across the board---but not on Friday. This uncoupling of bond and stock prices promises more unpredictability next week. How quickly markets change!
Unpredictability aside, recent market volatility has revealed some massively mis-priced assets; "babies" thrown out with the bath water. This situation is discussed at length in the book I just finished entitled "The Most Important Thing" written by noted investment advisor/billionaire Howard Marks of Oaktree Management. Marks' thesis is that turbulent times such as these produce opportunities that can be exploited if one can think on the "second level." Here is how the thesis works in real life. First level thinking led to the conclusion that I drew two weeks ago: to wit, because 10 year Treasury bond prices were falling quickly, income producing assets priced in relation thereto such as mortgage real estate investment trusts, junk bonds, and high dividend stocks would likewise decline quickly and should be sold if one wished to capture year to date profits. (Note: this correlation held true even yesterday as mortgage REITS, junk bond funds and business development companies continued to lose ground and utilities (VPU) traded 9% below where they were just two weeks ago--- even as the DJIA spiked.) Since income producing assets are among my favorites, I sold most of my holdings last week. Thinking on the "next (second) level" led to the observation this week that some of those disfavored assets would be oversold and thus mis-priced. Thinking on this level caused me to search for such opportunities and on Tuesday to buy FFC, a closed end fund that was massively underpriced. It is "shining much brighter now" and even rose on Wednesday while the rest of the market tanked. I used "second level" thinking on Thursday to locate and to purchase JPI, HPS and DUC. "Everybody get to putting up your lighter now!" (Email me if you want a more detailed description of my second level thought process.)
Even with the "second level" purchases discussed above, I am still 80% in cash which is where I likely will remain until there is more clarity on interest rates and/or QE3. Mr. Bernanke, "where are you going now, my love/where will you be tomorrow?" Will QE3 continue unabated or will tapering begin? I have "questions on a thousand dreams, what you do and what you see/Lover, can you talk to me?" And I am not alone. On Tuesday, Bill Gross, the founder of PIMCO and nicknamed by those in-the-know as the "Bond King," published his monthly Investment Outlook (available on PIMCO's webpage) in which he criticized QE3 and its unprecedented suppression of yields. According to Gross, its initial stabilizing aspects notwithstanding, QE3 now is negatively impacting investor appetite to "carry" risk. Even if risk is correctly priced on a RELATIVE basis (e.g. an appropriate spread between the yields on say, Treasury bonds and junk bonds), all yields are too low on an ABSOLUTE basis. Junk below 5% simply is not worth the risk; nor is committing $1000 for one year in a Treasury note for a paltry 0.14%; nor is buying a utility stock for a 3% return---especially when each can lose 10% or more of its value within a few trading sessions if and when the yield on the benchmark 10 Year Treasury Bond spikes (and its price drops) like it did in May. To quote Gross, "... never have investors received less for the risk they are taking." On Friday, former Fed Chair Alan Greenspan joined Gross' chorus and called for QE3 tapering to begin. Otherwise, according to Greenspan, other market participants may decide to abandon Treasury Bonds-- tapering or no tapering. If that happens, the Fed could lose sway over interest rates altogether which Greenspan believes would add further uncertainty to our fragile economy and more unpredictability to markets. Friday's drop in the price of the 10 year Treasury Bond despite the market's belief that QE3 will continue may portend this happening already. Keep your eye on Ray Dalio and his fellow Treasury shorts (discussed in last week's edition) who you can track by following TBT and PST!
And so I have concluded that except for an occasional purchase of massively mis-priced assets or a Treasury short, I am better off in cash. As more of us who favor high yielding instruments migrate there (junk bond funds experienced record outflows this week), maybe the Fed will conclude that QE3 has outlived its usefulness. Perhaps it is time for the Fed to start an orderly (albeit painful) taper while it still holds sway in the bond market, sway that Greenspan fears may be at an end. As Crosby Stills and Nash know, when it comes to tapering:
"It's been a long time comin', and it's goin' to be a long time gone."
Saturday, June 1, 2013
June 1, 2013 Domino
Risk/Reward Vol. 172
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"I don't ask for much/I only want your trust
And I know it don't come easy."---lyrics from "It Don't Come Easy" by Ringo Starr
"Oh oh Domino/Roll me over Romeo
There you go/Lord have mercy
I said oh oh Domino"---lyrics from "Domino" by Van Morrison
"Helter skelter in a summer swelter
The birds flew off with a fall out shelter
The players tried a forward pass
With the jester on the sidelines in a cast."---lyrics from "American Pie" by Don MacLean
The action in the bond and stock markets this week reminded me of the comments made last December by Ray Dalio, the most successful hedge fund manager in history. ( www.riskrewardblog.blogspot.com Vol. 148). Back then, Dalio boldly stated that the best profit making opportunity of his life had yet to arrive. According to Dalio, that opportunity would come when he sensed an end to QE3 at which time he would short Treasury Bonds and assets correlated thereto. (A short seller is one who borrows a security from another --usually a long term holder like a pension fund---in exchange for a small premium promising to return it on a date certain in the future. The borrower then sells the security at the current market price believing the price will fall before he is required to buy it back and return it. He profits from the difference in those prices. The more the price falls before the repurchase the more the profit.) I sense that Dalio has begun his move this week, and he looks like a prophet (or is that "profit").
An understanding of Dalio's opportunity "don't come easy." "I don't ask for much. I only want your trust" that I can explain it. So here goes. #1 Start from the premise that most income producing assets (e.g. bonds and high dividend paying stocks) are priced in relation to the safest fixed income investment in the world which currently is the 10 year U.S. Treasury Bond, behind which stands the full faith and credit of the United States. Given the choice between a Treasury Bond paying a 2% yield and a corporate bond paying 2%, a rational person will choose the Treasury because a corporation could default on its bond obligation (e.g. Lehman Brothers) while it is almost certain that the United States will not. #2 Consequently, corporate bonds generally pay a higher yield than Treasury bonds. Otherwise no one would buy them. Dividend paying stocks, which unlike bonds have no claim to assets in a liquidation scenario, must promise an even higher yield or the prospect of price appreciation. Again, these ascending rates of return are necessary in order to compensate investors for the corresponding increase in risk associated with each asset class as one proceeds up the risk curve. That curve ascends from Treasury bonds to investment grade corporate bonds to high yield or junk bonds to preferred stocks to common stocks a/k/a equities. #3 Understand that stock and bond prices rise or fall inversely to their yield. That is, the higher the price of the stock or bond, the lower the yield. For example, if a stock priced at $100 pays a dividend of $5 annually it has a 5% yield. If the price of that stock goes up to $120, it has a 4.17% yield ($5/$120= 4.17%) #4 Appreciate that many investors do not hold bonds to maturity. They buy and sell them based on the then prevailing interest rate. For example, a 10 year Treasury Bond purchased for $1000 and paying $40 in interest (or 4%) will continue to be worth $1000 so long as the prevailing rate is 4%. If the prevailing interest rate falls to, say 3.5%, that 4% bond will be worth $1142 ($40/$1142=3.5%). Conversely, if the prevailing interest rate increases over the 4% rate, the bond price will fall. # 5 Under QE3, the Federal Reserve has been up-bidding the price of longer term Treasury Bonds, buying $45 billion worth of each month's issuance (roughly 60% of the long term bonds available to be purchased) thereby depressing the yield on the 10 year Treasury Bond to 2% or below. For context, historically, 10 year Treasury Bonds have yielded 4-6%. #6 Due to this low yield (once again caused by the Fed bidding up the price), 10 year Treasury Bonds currently are not attractive to many investors (like me) who need a higher return. As a consequence, people (like me) who normally would have a large percentage of their assets in Treasury Bonds are forced to move up the risk curve to corporate bonds, junk bonds and/or stocks. Indeed this is the intended purpose of QE3---to force more private investment in corporations thus spurring the economy and creating jobs. With more people buying those riskier assets, their prices, in turn, have been bid up and their yields correspondingly lowered. For example, junk bonds yielding 10% last year, yield less than 6% this year, an historic low. #7 If and when the Fed slows or quits its $45 billion monthly buying spree, the price of the 10 year Treasury Bond will fall like a rock since the participant which has been buying 60% of the offerings (the Fed) will have left the market. Income producing assets described above, priced in relation to Treasuries, will also fall in value. Investors who time the sale of their bond and/or income producing assets in front of that fall will do well. And short sellers like Dalio will make out like bandits.
So how does the above tutorial relate to today's bond and stock markets, "Romeo"? As reported last week, the minutes of the May Federal Reserve meeting released 10 days ago indicated that, due to an improved economy and concerns about long term inflation, QE3 purchases may taper off as early as June. In response, many significant holders and/or borrowers of Treasury Bonds (perhaps Mr. Dalio) sold them, capturing profits in front of any tapering. The selling continued this week as 10 year Treasury Bond prices plummeted. Inversely, their yields spiked from 1.6% in early May to 2.23% on Wednesday, a rise of 37%! "Lord have mercy." This front running Treasury Bond selling caused a "Domino" effect up the risk curve. With the interest rates on 10 year Treasury Bonds rising, the historic low yields on assets such as junk bonds and dividend stocks are suddenly less appealing and thus worth less. As noted last week, the first to fall in price were those investments directly correlated to low Treasury rates such as mortgage real estate investment trusts (RQI, a closed end fund comprised of mREITS fell 14% in 7 trading days), and business development companies (FGD, a closed end fund comprised of BDC's fell 6% in the same time period). Over that period, bond-like stocks such as utilities and blue chip dividend payers have taken it on the chin with both NGG and JNJ falling 5%. So "there you go." As Van Morrison says, "oh, oh Domino"
So how does this impact me? In advance of the "summer swelter", with the stock market in general going "helter skelter" and with my favorite niche, dividend stocks, suffering declines greater than the general market, I decided to sell most of my positions, thereby capturing profits and raising cash. In addition to selling my REITS, BDC's and leveraged funds on Tuesday (as I wrote that I would last week), I also sold junk bond funds and those dividend payers that had run up nicely over the past few months. By Wednesday afternoon, I had sold all but PGF, PGX, CTY and GSTpA. My ground game is fine. I don't need to complete a "forward pass". My annual benchmark is 6% pre tax, and I am well above that now with 7 months to go. So, this "jester is on the sidelines" for a while, content to see what happens. Rest assured, I will be back, and maybe sooner rather than later. I am not "in a cast." I may even join Mr. Dalio on the short side. But, when good economic news (home price increases) is bad for the stock market (see Wednesday's action), and when bad economic news (rise in jobless claims) is good for the stock market (see Thursday's action)---all because the former means a quicker end to QE3---it's time for me to kick back, to switch on some Van Morrison and to do some chill-axin' with my "Brown Eyed Girl."
P.S. Oh, and as for Friday's last minute sell off, I have heard several excuses: reaction to the threat of tapering, month end rebalancing, panic, etc.---but no solid explanation. All the more reason to have sold.
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"I don't ask for much/I only want your trust
And I know it don't come easy."---lyrics from "It Don't Come Easy" by Ringo Starr
"Oh oh Domino/Roll me over Romeo
There you go/Lord have mercy
I said oh oh Domino"---lyrics from "Domino" by Van Morrison
"Helter skelter in a summer swelter
The birds flew off with a fall out shelter
The players tried a forward pass
With the jester on the sidelines in a cast."---lyrics from "American Pie" by Don MacLean
The action in the bond and stock markets this week reminded me of the comments made last December by Ray Dalio, the most successful hedge fund manager in history. ( www.riskrewardblog.blogspot.com Vol. 148). Back then, Dalio boldly stated that the best profit making opportunity of his life had yet to arrive. According to Dalio, that opportunity would come when he sensed an end to QE3 at which time he would short Treasury Bonds and assets correlated thereto. (A short seller is one who borrows a security from another --usually a long term holder like a pension fund---in exchange for a small premium promising to return it on a date certain in the future. The borrower then sells the security at the current market price believing the price will fall before he is required to buy it back and return it. He profits from the difference in those prices. The more the price falls before the repurchase the more the profit.) I sense that Dalio has begun his move this week, and he looks like a prophet (or is that "profit").
An understanding of Dalio's opportunity "don't come easy." "I don't ask for much. I only want your trust" that I can explain it. So here goes. #1 Start from the premise that most income producing assets (e.g. bonds and high dividend paying stocks) are priced in relation to the safest fixed income investment in the world which currently is the 10 year U.S. Treasury Bond, behind which stands the full faith and credit of the United States. Given the choice between a Treasury Bond paying a 2% yield and a corporate bond paying 2%, a rational person will choose the Treasury because a corporation could default on its bond obligation (e.g. Lehman Brothers) while it is almost certain that the United States will not. #2 Consequently, corporate bonds generally pay a higher yield than Treasury bonds. Otherwise no one would buy them. Dividend paying stocks, which unlike bonds have no claim to assets in a liquidation scenario, must promise an even higher yield or the prospect of price appreciation. Again, these ascending rates of return are necessary in order to compensate investors for the corresponding increase in risk associated with each asset class as one proceeds up the risk curve. That curve ascends from Treasury bonds to investment grade corporate bonds to high yield or junk bonds to preferred stocks to common stocks a/k/a equities. #3 Understand that stock and bond prices rise or fall inversely to their yield. That is, the higher the price of the stock or bond, the lower the yield. For example, if a stock priced at $100 pays a dividend of $5 annually it has a 5% yield. If the price of that stock goes up to $120, it has a 4.17% yield ($5/$120= 4.17%) #4 Appreciate that many investors do not hold bonds to maturity. They buy and sell them based on the then prevailing interest rate. For example, a 10 year Treasury Bond purchased for $1000 and paying $40 in interest (or 4%) will continue to be worth $1000 so long as the prevailing rate is 4%. If the prevailing interest rate falls to, say 3.5%, that 4% bond will be worth $1142 ($40/$1142=3.5%). Conversely, if the prevailing interest rate increases over the 4% rate, the bond price will fall. # 5 Under QE3, the Federal Reserve has been up-bidding the price of longer term Treasury Bonds, buying $45 billion worth of each month's issuance (roughly 60% of the long term bonds available to be purchased) thereby depressing the yield on the 10 year Treasury Bond to 2% or below. For context, historically, 10 year Treasury Bonds have yielded 4-6%. #6 Due to this low yield (once again caused by the Fed bidding up the price), 10 year Treasury Bonds currently are not attractive to many investors (like me) who need a higher return. As a consequence, people (like me) who normally would have a large percentage of their assets in Treasury Bonds are forced to move up the risk curve to corporate bonds, junk bonds and/or stocks. Indeed this is the intended purpose of QE3---to force more private investment in corporations thus spurring the economy and creating jobs. With more people buying those riskier assets, their prices, in turn, have been bid up and their yields correspondingly lowered. For example, junk bonds yielding 10% last year, yield less than 6% this year, an historic low. #7 If and when the Fed slows or quits its $45 billion monthly buying spree, the price of the 10 year Treasury Bond will fall like a rock since the participant which has been buying 60% of the offerings (the Fed) will have left the market. Income producing assets described above, priced in relation to Treasuries, will also fall in value. Investors who time the sale of their bond and/or income producing assets in front of that fall will do well. And short sellers like Dalio will make out like bandits.
So how does the above tutorial relate to today's bond and stock markets, "Romeo"? As reported last week, the minutes of the May Federal Reserve meeting released 10 days ago indicated that, due to an improved economy and concerns about long term inflation, QE3 purchases may taper off as early as June. In response, many significant holders and/or borrowers of Treasury Bonds (perhaps Mr. Dalio) sold them, capturing profits in front of any tapering. The selling continued this week as 10 year Treasury Bond prices plummeted. Inversely, their yields spiked from 1.6% in early May to 2.23% on Wednesday, a rise of 37%! "Lord have mercy." This front running Treasury Bond selling caused a "Domino" effect up the risk curve. With the interest rates on 10 year Treasury Bonds rising, the historic low yields on assets such as junk bonds and dividend stocks are suddenly less appealing and thus worth less. As noted last week, the first to fall in price were those investments directly correlated to low Treasury rates such as mortgage real estate investment trusts (RQI, a closed end fund comprised of mREITS fell 14% in 7 trading days), and business development companies (FGD, a closed end fund comprised of BDC's fell 6% in the same time period). Over that period, bond-like stocks such as utilities and blue chip dividend payers have taken it on the chin with both NGG and JNJ falling 5%. So "there you go." As Van Morrison says, "oh, oh Domino"
So how does this impact me? In advance of the "summer swelter", with the stock market in general going "helter skelter" and with my favorite niche, dividend stocks, suffering declines greater than the general market, I decided to sell most of my positions, thereby capturing profits and raising cash. In addition to selling my REITS, BDC's and leveraged funds on Tuesday (as I wrote that I would last week), I also sold junk bond funds and those dividend payers that had run up nicely over the past few months. By Wednesday afternoon, I had sold all but PGF, PGX, CTY and GSTpA. My ground game is fine. I don't need to complete a "forward pass". My annual benchmark is 6% pre tax, and I am well above that now with 7 months to go. So, this "jester is on the sidelines" for a while, content to see what happens. Rest assured, I will be back, and maybe sooner rather than later. I am not "in a cast." I may even join Mr. Dalio on the short side. But, when good economic news (home price increases) is bad for the stock market (see Wednesday's action), and when bad economic news (rise in jobless claims) is good for the stock market (see Thursday's action)---all because the former means a quicker end to QE3---it's time for me to kick back, to switch on some Van Morrison and to do some chill-axin' with my "Brown Eyed Girl."
P.S. Oh, and as for Friday's last minute sell off, I have heard several excuses: reaction to the threat of tapering, month end rebalancing, panic, etc.---but no solid explanation. All the more reason to have sold.
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