Risk/Reward Vol. 186
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Can we go back/This is the moment
Tonight is the night/We'll fight 'til it's over
So we put our hands up/Like the ceiling can't hold us
Like the ceiling can't hold us."---lyrics from "Can't Hold Us" by Macklemore and Ryan Lewis
"Out in the club
And I'm sippin' that bubb
And you're not gonna reach my telephone"---lyrics from "Telephone" by Lady Gaga
"You're knocking me off my feet again
Got me feeling like I'm nothing
Why you got to be so mean?"---lyrics from "Mean" by Taylor Swift
All quiet on the Syria and QE3 tapering fronts allowed the stock market to soar this week with the Dow Jones Industrial Average registering three consecutive days of triple digit gains, finishing with its second best weekly performance of the year.. But the folks who should really "put their hands up" based on this week's action are fixed income investors such as yours truly. Although barely noticed, two important events occurred this week that lead me to believe that the interest rate "fight is over"; that "tonight is the night"; that "this is the moment" that the 10Year Treasury Bond ("10Year Treasury") interest rate has stabilized at or below 3%; and that the 3% "ceiling can hold us/the ceiling can hold us" during the first phase of QE3 tapering..
The most significant event this week for fixed income investors, the one that should cause us to "sip the bubb/Out in the club", was the pricing of $49billion of Verizon (VZ) corporate bonds, the proceeds of which VZ will use to buy back Vodafone's VZ shares. To put this event into perspective, heretofore the largest corporate bond issuance of all time was the $17billion floatation of Apple bonds last April. This week VZ was hoping to float $20billion in bonds, but the demand was so strong, it was able to sell more than twice that amount---and more importantly in so doing VZ only had to pay 5.2% in interest on the 10 year tranche. This is a slim 2.3% (230 basis point) premium (or spread) over the all important prevailing 10Year Treasury rate of 2.9% (see e.g Vol. 172 www.riskrewardblog.blogspot.com ). This is one of the smallest corporate/10Year Treasury rate spreads since 2007---since which spreads have fluctuated between 250 and 350 basis points. Indeed, the VZ deal could be a harbinger of the 10Year Treasury rate receding. What gives even more hope that the 3% "ceiling can hold" is this week's second event. On the same day the VZ bond was priced, the Treasury sold $21billion of new 10Year Treasuries at 2.946% at an auction in which there were almost 3 times more bidders than buyers. Of course, all of this encouraging interest rate news is premised on a belief that next week the Federal Reserve will announce the first phase of its tapering program and that it will taper no more than a modest amount from its monthly $85 billion QE3 purchases (say a taper of $8-15billion). But, if that expectation is met, I'll be "reaching for my telephone" to enter more fixed income buy orders. (N.B. Some wags believe the VZ sale will have the opposite effect. They argue that it will encourage others to float bonds thereby flooding the market with debt and causing prices to drop and rates to go up. Hey, if market prognostication were easy, we'd all be rich---at no risk.)
What will I be buying? As I have detailed in previous editions, over the past few months, the rising 10Year Treasury interest rate has been "knocking me off my feet"; making me "feel like I'm nothing" for having bought into sectors like preferred stock, real estate investment trusts, business development companies and master limited partnerships--all of which decline in value during times of increasing interest rates. But if I am correct and the 10Year Treasury stabilizes at or below 3%, then these oversold sectors should revert to the "mean" and once again trade at normal spreads. For example, over the past 10 years, on average, credit worthy preferred shares have traded at rates 350 basis points above the 10Year Treasury rate (only 227 basis points on average before the 2008 financial crisis). This "means" that a credit worthy preferred should be yielding 6.5% if the 10Year Treasury rate is at 3%. If you peruse the Wall Street Journal preferred closing table ( http://online.wsj.com/mdc/public/page/2_3024-Preferreds.html?mod=mdc_h_usshl#C) you will see many credit worthy preferreds trading at substantially higher yields making them very attractive indeed. After all, if there is an insatiable appetite for VZ bonds at 5.25%, that hunger should benefit other fixed income sectors paying even higher rates. REIT and BDC prices should also stabilize if not appreciate (frankly, at their current yields, stability is all that I need) because they too are trading as if the 10Year Treasury rate will continue to escalate.
Yes, I am making an interest rate prediction---something only a fool should or would do. And, whatever YOU do, DON'T ACT ON WHAT I SAY! Indeed, if I were smart, I would maintain a "Poker Face." But I am constantly in search of "Applause", so here I go, subjecting myself, once again, to the risk of public humiliation. I can't help it, Gaga--- "I Was Born This Way."
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