August 17, 2013 Paint It Black

Risk/Reward Vol. 182

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

"I see a red door/And I wanted painted black
No colors any more/I want it painted black."---lyrics from "Paint It Black" by The Rolling Stones

"Opportunity, opportunity/This is your opportunity
To shop around/Follow without a sound."---lyrics from "Opportunity" by Elvis Costello

"Everybody here/Get outta control
Get yo' backs off tha' wall/Cause Misdemeanor said so."---lyrics from "Lose Control" by Missy (Misdemeanor) Elliott

As the stock market suffered its worst week of the year, "I see red charts/And I want them painted black." And no chart is redder than the preferred stock closing table http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html . That snapshot is either a signal to sell, or it represents a significant buying opportunity. I am not selling, and my research is telling me to buy. The research of which I speak is a comparative study of the yields on the 10 Year Treasury Bond ("10Year") and of various preferred stocks today, in 2003, 2006 and 2007 (before and after the 2008-2010 financial crisis, an event which skews all comparative studies involving preferred stocks). That comparison indicates to me that preferreds are oversold, trading at prices indicating that the yield on the 10Year (currently at 2.8%) will soon be at 4 to 4.5%. (Contact me if you want more information on this.) I see the yield on the 10Year rising to 3-3.5% as QE3 tapers, but I do not see 4% or higher for quite some time. If I am right, in short order the preferred stock closing table should have "no colors any more (other than green)". And my monthly statements should be "painted black."

In addition to preferred stock, "Opportunities, opportunites/Big opportunities" may be brewing in other fixed income sectors. I am "shopping around", and I would not blame you if you "Followed without a sound.". Pipeline master limited partnerships ("mlp's") are on sale, and none more than Kinder Morgan (KMP), the nation's largest and most secure mlp. Seeing KMP trading so far below its 50 and 200 day moving averages and yielding nearly 6.5% makes it nearly irresistible. Also, having Realty Income Corp. (O), a leading triple net lease commercial real estate investment trust, trading so low is equally appealing. I am partial to its investment grade preferred stock, OpF, which is now trading below its call price (below $25) and yielding 6.7% which it pays on a monthly basis. Wow, talk about hitting my sweet spot!
With all of the turmoil in the bond and stock markets, one thing is clear to "Everybody here." The bond market (the 10 and 30Year in particular) is "outta control." If the Federal Reserve wants to rein it in, it better "Get its back off tha' wall." Recall that QE3 was instituted to suppress long term (10 to 30 year) rates. At the time QE3 was instituted in 2012, the 30Year rate was 2.9% and the 10Year rate was 1.8%. A 30 year mortgage was at 3.6 %. These rates stabilized and even fell over the next several months. But with tapering on the horizon, they now stand at 3.86 and 2.84 on the bonds respectively, and 30 year mortgages are at 4.5%. QE3 is proving itself to have been a sugar high for the stock market, a quickly bursting bubble machine for fixed income assets, particularly risky debt (check the charts for JNK and HYG), and a mortgage rate teaser; but little else. Ironic for sure; a mistake perhaps; a Misdemeanor maybe.

These past several days in the stock market have been difficult to watch, "As Tears (and profits) Go By." Yet, I believe that I will receive "Satisfaction" once the rate on the 10Year stabilizes enough to "Gimme Shelter." If that does not happen soon however, my loss limits will be reached, and my profits for the year will shrink in a "Jumpin' Jack Flash."