July 6, 2013 Bonds

Risk/Reward Vol. 176

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

"You see it's all clear
You were meant to be here
From the beginning."---lyrics from "From the Beginning" by Emerson Lake & Palmer

"Thinking all love ever does/Is break and burn and end
But on a Wednesday in a cafe/I witnessed it begin again."---lyrics from "Begin Again" by Taylor Swift

"Feel the city breakin'/And everbody shakin'
And we're stayin' alive/Stayin' alive."---lyrics from "Stayin' Alive" sung by the BeeGee's

Sitting on the sidelines, in cash, I ask myself "Were you meant to be here?" The answer is yes as I look back "from the beginning", and "I see it's all clear". Here is what I wrote in volume 1 of Risk/Reward back in June, 2010

" I am in search of a 6%, pre tax return. Throughout most of my life, this would have been a layup. From 1969 through 1997, the 10 Treasury rarely fell below 6%. From 1980 through 1985, it never fell below 10%. So, at this stage in my life all I need is a little inflation. Indeed, right now 90% of my money is parked, waiting for that to happen. Unfortunately, it looks like we are into a prolonged period of stagflation and perhaps deflation. So, Barb and I decided to get off our duffs, and to become more active money managers"

I have achieved a 6+% return for the year. Thus, the sidelines is where I should be. But, of course, it is human nature to want more, especially with the Dow Jones Industrial Average (DJIA) and the S&P 500 doing so well. Is it worth the risk?

Not for me. Not at this time. And here is why.

I am a yield hunter. My favorite sectors are high dividend payers such as real estate investment trusts (REIT's), master limited partnerships (mlp's), preferred stocks, exchange traded debt, junk bonds, floating rate loans, etc.--- all of which share one characteristic: they are all priced in relation to the 10 year U.S. Treasury Bond ("the 10Year"). Right now prices in these sectors, like the price of the 10Year, are "breaking and burning" and their meteoric rise in 2013 is at an "end." If there were any doubt about this, one only had to "witness" what "happened on Wednesday, in a cafe" or any other place that had access to market news. On Wednesday, the president of Egypt was deposed causing oil prices to spike, and mounting economic turmoil in Portugal caused its bonds to fall precipitously. As they always do, these events resulted in a flight to the safety to the 10Year, the world's most secure asset. Yet that flight-in was not enough to counter the steady sell-off of the 10Year, as frontrunners continue to anticipate the end of QE3 about which I have written over the past several weeks. Predictably, my favorite sectors likewise sold-off.

And then came Friday. The good jobs report spurred a spike in equities (the DJIA rose 147 points on Friday) but
caused a massive sell-off of the 10Year. Favorable economic news increases the likelihood that QE3, which has kept 10Year prices high and 10Year yields low, will be tapered sooner rather than later. (Remember--and never forget--a rise bond yields means a drop in bond prices.) On Friday, the yield on the 10Year rose from my benchmark of 2.5% (see last week's edition www.riskrewardblog.blogspot.com) to 2.71%, a rise of 8.56%--IN JUST ONE DAY! Of course that meant that the price of the 10Year fell correspondingly. My favorite sectors suffered an equally devastating decline.

Obviously, the bond and bond related worlds are "breakin'" with "everybody shakin." This week, PIMCO's Total Return Fund, the largest bond fund in the world, announced that $9.9billion had been withdrawn from its coffers in June, the most in its 26 year history, as investors abandoned what they perceive to be a sinking ship. Indeed, as reported by Lipper, bond funds generally are struggling, just "stayin alive/stayin' alive.". In the four weeks ending June 28th, U.S. bond funds saw $23.7billion dollars withdrawn, the most since October, 2008. REIT's, mlp's, preferred stocks, etc. are suffering a similar fate, many having gone from a year-to-date positive to a ytd negative.

In the long run, this is very good news for me. As noted above, all I have ever wanted is for longer term U.S. Treasury Bonds to pay 6%(heck, I would take 4.5% on the 10Year)---at which time I will buy a ladder full and head to the beach. Until that occurs, I will continue to dart in and out of the market, using my wits to make 6%; all the while fixating on preserving principle. So, as you can see, having already earned a 6% profit in 2013, cash is indeed where I should be--- at least until some stability returns to the bond market. In cash, I sleep very well. Were I invested in my favorite sectors today, I would have lost my ytd profits and like the BeeGee's, would be suffering "Night fever, night fever."