July 27, 2013 Summer(s)time

Risk/Reward Vol. 179

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

"The Big 3 baby and the finest cars
We spend our days on the line
And our nights in the bar."---lyrics from "Detroit, Michigan" by Kid Rock

"So you gotta have a swan/Or you're out of luck
And besides you couldn't say/I saw a chicken leg ballet."---lyrics from "The Swan" by Fanny Brice (from "Funny Girl")

"Sometimes I wonder/What I'm gonna do
Cause there ain't no cure/For the summertime blues."---"Summertime Blues" sung by The Who

As the Dow Jones Industrial Average continued to reach record heights this week, my portfolio fell 0.5%. One reason was expected; the other was a "black swan."

As loyal readers know, a few weeks ago I started buying municipal bond funds despite (actually because of) the precipitous drop in prices (and concomitant increase in yields) in the sector due in part to Detroit's recent bankruptcy filing. Some may say that I am way out "on the line" and would have done better to spend our money on the stock of the "Big 3" or one of their "finest cars" or even in "a bar." I disagree. Municipal bond funds are trading at historic lows despite the uptick in the fiscal health of most state and local governments. But, so long as Detroit is prominently discussed in the news, the downward trend will continue. Thankfully, the fall did slow considerably this week. Risky as it may seem, a taxable equivalent yield of 10+% on closed end funds that hold mostly AAA or AA bonds is just too tantalizing for me to resist.

But what sent me for a loop this week was not Detroit: it was a "Black Swan". A "black swan" is a random, surprise event that has a major impact. It was first applied to market behavior by statistician/author/trader Nassim Nicholas Taleb in his book "Fooled by Randomness" which I recently completed. I have found this read extremely valuable in giving context to my own anxiety and in coming to grips with my risk tolerance: especially my feeling "chicken" when I am "out of luck."

This week's Black Swan was the unexpected emergence of Larry Summers as the leading candidate to replace Ben Bernanke as Federal Reserve chair come year end. My "Summer(s)time Blues" manifested in an unanticipated drop in the 10Year Treasury Bond (and the concomitant spike in its yield from 2.49% last Friday to 2.61% Thursday). In turn, this caused the value of my recently reacquired portfolio of preferred stock, mortgage REIT's and business development companies to fall. "What am I gonna do?" All of this was because Summers, unlike Janet Yellen, the other leading candidate, is on record as disliking QE3 and would undoubtedly end it sooner rather than later. There was a "cure" however. An open letter from leading Democrats in support of Yellen was sent to the White House on Friday, an act which bolstered bond prices and caused my portfolio to recapture much of what it had lost. "Sometimes I wonder" if the White House is completely clueless. There is no more critical appointment than Bernanke's replacement, and that choice should not be driven by rumor or open-letter lobbying.

As proven once again this week, my approach to the market is too much like "Tommy" playing pinball: "Plays by intuition/Plays by sense of smell." Until Friday, randomness rendered my intuition faulty, and my sense of smell stunk.