Risk/Reward Vol. 187
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Pour a little sugar on it, honey
Pour a little sugar on it, babe
I'm gonna make your life so sweet."---lyrics from "Sugar, Sugar" sung by The Archies
"Communication breakdown/It's always the same
I'm having a nervous breakdown/Drive me insane."---lyrics from "Communication Breakdown" by Led Zepplin
"How to avoid defeat/Where truth and fiction meet
Why nothing ever turns out as you planned
These are the things I don't understand."---lyrics from "Things I Don't Understand" by Coldplay
Two hours before the stock market closed on Wednesday, Federal Reserve Chairman Ben Bernanke emerged from the Federal Open Market Committee meeting and announced that contrary to the market's expectation, the Fed would not begin tapering its $85billion/month asset purchase program known as QE3. From then until the market's close, Uncle Ben "made life so sweet" for those holding long positions. Deciding not to taper in September was the equivalent of "pouring a little sugar on it , honey" for the equity markets and "pouring a little sugar on it, babe" for the bond market. On the equity side, the Dow Jones Industrial Average (DJIA) shot up 125 points in an instant, and closed at a record high, as did the S&P 500. On the bond side, the 10 Year Treasury Bond ("10Year") yield fell from 2.89% to 2.70% (remember: lower yields means higher price). For income investors like me (utilities, mlp's, bdc's, reits and preferreds each of which is interest rate sensitive), it was like eating cotton candy for two hours.
But, over the next two days as the announcement's significance was absorbed and evaluated, the stock market retrenched (look at the S&P 500 because a concatenation of non market factors contributed to the DJIA's drop on Friday), and the10Year yield rose. This retrenchment bespoke disappointment (which I share) in the Fed's decision. Since I profited from the announcement, why am I disappointed? Here is my logic. As an income investor, I crave stability (see Vols. 181 and 186 www.riskrewardblog.blogspot.com ). Stability is dependent in large measure on predictable monetary policy which ostensibly is the reason that the Federal Reserve, under the chairmanship of Ben Bernanke, has emphasized its desire to give "forward guidance"; that is to communicate its future intentions thereby reducing surprise and promoting stability. Based upon Bernanke's forward guidance in May as confirmed in June. (see Vol. 175 www.riskrewardblog.blogspot.com ), both the bond and the stock markets were positioned for QE3 tapering to begin this month . Not without pain to many (including yours truly), mortgage rates rose, income securities repriced and bond prices fell---all with the expectation of a modest taper. Despite numerous opportunities to inform investors that their supposition of a September taper may be in error (e.g. the August Fed meeting in Jackson Hole, WY discussed in Vol 183 www.riskrewardblog.blogspot.com), the Fed's guidance (mostly through silence) remained "always the same"; to wit, tapering would begin in September. That is why Wednesday's announcement was nothing short of a "communication breakdown"; one big enough to "drive me insane." And, by the way, what is one to make of Fed member James Bullard's statement on Friday that tapering could begin in October? Was that a rogue statement or was it authorized by the Fed? Will anyone take forward guidance seriously in the future? I think not. One should expect increased volatilty, with the market on the edge of a "nervous breakdown" with each Fed statement---the antithesis of the stability which I crave and which the Fed intended with forward guidance.
So "how is one to avoid defeat" when, at the Federal Reserve, "truth and fiction meet" and "nothing ever turns out as planned?" Do as I have been forced to do these past few years: continue to search for overlooked opportunities---stocks that seemingly others "don't understand." Here is a recent example. On Monday, one of my favorite triple net lease real estate investment trusts, ARCP (see Vol. 184 www.riskrewardblog.blogspot.com) announced that it was selling preferred and common stock to a sophisticated private investor at a discount to the then prevailing market price. Fearing dilution, the market overreacted, selling ARCP down to $12.19 even though a careful reading of the press release indicated that the sophisticated private investor was paying $12.29 and that it was entering into a lock up agreement on the preferred stock that demonstrated a belief that within a year, the common would be worth at least $13.59. I bought that day at $12.22. ARCP has since recovered closing Friday at $12.68 which I believe still represents a bargain.
My disappointment in the Fed Chair is like a string of Led Zepplin titles. "Heartbreaker" Bernanke's "Communication Breakdown" left me "Dazed and Confused." "You Shook Me", Ben. "How Many More Times" must we listen to you "Ramble On" so ineffectively? Thankfully, "Your Time Is Gonna Come"---really soon. And based upon the failure of QE3 ( mortgage rates and long term interest rates both have increased not decreased as a result of QE3) and the damage done by your forward guidance program, your departure will be a "Celebration Day."
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