July 13, 2013 Separate Lives

Risk/Reward Vol. 177

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

"You called me from the room in your hotel
All full of romance for someone that you met
And telling me how sorry you were, leaving so soon"---lyrics from "Separate Lives" by Phil Collins

"All around, people looking half dead
Walking on the sidewalk, hotter than a match head"---lyrics from "Summer in the City" by the Lovin' Spoonful

"You can't lease my love
Oh, this was just an empty space
That both we tried to live"---lyrics from "Lease My Love" by Rihanna

As reported last week, the correlation between the bond market and the stock market caused by quantitative easing (QE3) began to disappear on Friday July 5th. Those "Separate Lives" continued through Wednesday of this week as the stock market experienced gains despite the 10 Year Treasury Bond stabilizing above a 2.65% yield and the 30 Year Bond above 3.63%; yields that anticipated the tapering of QE3 come this fall. Then on Wednesday afternoon, from "some hotel room" in Cambridge, MA, Fed Chair Ben Bernanke "told us how sorry he was" that the markets were "leaving bonds so soon." "All full of romance " for QE3, his speech threw tapering in 2013 into question, intimating that QE3 could be around for quite some time. On Thursday, the stock market and the bond market skyrocketed together, stoked once again by the sugar high of continued low interest rates (and thus high bond prices) compliments of QE3.

And it happened just as I began tip toeing back into the market! For several days I had had my eye on sectors that have been pummeled by the spike in bond yields (and the corresponding drop in bond prices) occasioned by the prospect of QE3 tapering this fall. No sector has been hit harder than the municipal bond market. This is ironic because the drop in muni's has happened at a time that has been a "Hot time/This summer in the cities": a time when state and local budgets (Detroit notwithstanding) are healthier than they have been for several years. Nevertheless, "all around" the municipal bond arena "people are looking half dead." Meanwhile the rising rates have made the sector look "hotter than a match head" to me. So on Tuesday I bought NEA and EIM, two well regarded municipal bond funds that pay a tax free return in excess of 6% (which in my hand is the equivalent of a 10% taxable return!) Bernanke's speech caused my investment to go slightly negative, but my entry point is too good to consider a sale at this time.

A second sector made attractive by the prospect of QE3 tapering this fall is "leasing" by one of "my loves"---real estate investment trusts. Take a look at long time stalwart, Realty Income Corporation (O), which has an unparalleled history of dividend performance over the past 40 years, but which has taken a beating over the past month along with every other bond like security. (see Vol. 175-176 www.riskrewardblog.blogspot.com ) I will likely buy some of its investment grade, preferred stock (OpF) which pays a 6.6% dividend on a monthly basis. Whether QE3 tapers in September or not, I doubt that you will see OpF trade as low as it is currently.

There is much to watch next week. China reports second quarter GDP on Monday, and earnings season is in full swing. But once again, nothing will be more important than Bernanke's testimony before Congress on Wednesday and Thursday. His conduct last Wednesday was disheartening to yield hunters like me. One is left to wonder why he felt compelled to infuse uncertainty into the timing of QE3's tapering since the bond market appeared to have accepted its inevitability and was beginning to stabilize---unless of course Bernanke concluded that the elevated interest rates at which longer term bonds (10-30 year) were trading made continued deficit government spending unsustainable. This is what CNBC's Rick Santelli believes. If that were Bernanke's reason, it constitutes an incursion into fiscal policy which is the bailiwick of Congress not the Fed. If so, it is time to follow Rihanna's admonition--- let's give Uncle Ben "A round of applause/A standing ovation" and then have him "Take a Bow."