August 3, 2013 Different Drum

Risk/Reward Vol. 180

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

"You and I travel to the beat of a different drum
Oh, can't you tell by the way I run
Every time you make eyes at me."---lyrics from "Different Drum" sung by the Stone Ponies

"I'll be there to comfort you
Build my world of dreams around you
I'm so glad that I found you."---lyrics from "I'll Be There" sung by the Jackson Five

"Sunshine came softly through my window today
Could have tripped out easy/But I've a-changed my way."---lyrics from "Sunshine Superman" by Donovan

As discussed in Volume 177 (www.riskrewardblog.blogspot.com), the correlation between the bond and stock markets began to break apart in early July. As demonstrated this week, the two clearly now are "traveling to the beat of a different drum." "You can tell by the way each runs" in response to economic data. No longer is good news bad for both. (See. Vol. 167). A string of good reports this week (excellent ADP numbers, a spike in the purchasing manager index, good news from China) caused the risk-on stock market to reach new highs and caused the risk-off bond market to plummet. Fundamentals have returned. The stock market has ceased rising or falling "every time Ben Bernanke makes eyes at it."

Indeed, in an obvious attempt to "be there to comfort" a badly bruised bond market, the Federal Reserve's press release following its meeting on Wednesday, purposefully omitted any reference to tapering and left open the possibility that it could continue QE3 (its monthly purchase of $85billion of Treasury securities and mortgages) indefinitely. Nevertheless, signaling that it, too, no longer "builds its world of dreams around" the Fed's every word, the bond market continued to sell off the flagship 10Year Treasury Bond ("10Year") which closed Thursday at a yield of 2.72%, its highest in over two years. (Remember, higher bond yields mean lower bond prices.)

The above notwithstanding, the investment community apparently has "a-changed its way" and is no longer "trippin out easy" by indiscriminately selling all fixed income assets in lock step with the 10Year. Discernment, like fundamental analysis, has returned. Indeed, "Sunshine came softly through the window" of mortgage real estate investment trusts this week, as better than expected results were reported by several mREIT's. MTGE, to which I alluded in Vol.178, has gained 8.8% since I purchased it on July 18th while still paying a 16% dividend. Preferred stock has also held its own during this week's bond sell-off. Here is my take on why. PGX, an exchange traded fund comprised of preferred stock, pays a 6.5% dividend which is about average for the sector and which represents a 390 basis point spread from the current (as of Friday's close) 2.6% yield on the 10Year Treasury bond. From 1997 to 2007 (before the 2008 financial crisis, which ever since has skewed all fundamentals) the yield spread between the average preferred stock and the 10Year remained at an almost constant 227 basis points. This leads me to believe that with the return of fundamental analysis, even if the 10Year yield continues to rise, I should not experience much, if any, loss of principle on PGX while continuing to enjoy its excellent yield.

My municipal bond portfolio has not fared as well. None has approached my sell limit, but they remain in the loss column. I would have done better to wait until more stability returns to that world. Patience is a virtue I need to acquire. Like the Jackson 5, once I lock on an idea, I "Gotta Be There."