Risk/Reward Vol. 200
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Hey life, look at me/I can see the reality
Cause when you shook me/Took me out of my world
I woke up/Suddenly I just woke up/To the happening."---lyrics from "The Happening" sung by The Supremes
"It's beginning to look a lot like Christmas/Everywhere you go
Take a look at the five and ten/Glimmering once again."---lyrics from "It's Beginning to Look a Lot Like Christmas" sung by everyone
"So they sprinkled gold dust in your hair of gold/And starlight in your eyes of blue
Just like me/They long to be/Close to you.---lyrics from "Close to You" by The Carpenters
Wow, on Wednesday Uncle Ben Bernanke and the Federal Reserve's Open Market Commitee (FOMC) "shook us/Took us out of our world." Early that afternoon, contrary to prevailing wisdom, the FOMC announced that starting in January it would reduce or "taper" by $10 billion/month its program (known as QE3) of purchasing $85 billion/month worth of Treasury securities and mortgages. The FOMC further stated that it would continue to keep short term interest rates low, but likely would reduce gradually its asset purchases down to zero by year end 2014. The "market woke up/Suddenly it just woke up to the happening." Within minutes of the announcement, the Dow Jones Industrial Average (DJIA) left negative territory and rose over 100 points. By day's end, the DJIA was up 293 points. Activity moderated on Thursday and at the close on Friday, but the DJIA was up 466 points for the week setting another record high.
With Wednesday's action, "it's beginning to look a lot like Christmas/Everywhere you go" in the stock market. Was Wednesday's meteoric rise simply an example of the oft cited but inexplicable Santa Claus effect? If you review the news stories that morning, you will see that no one predicted a huge rise in the stock indices should tapering begin. And after the fact, the rationale for the rise was poorly explained; if explained at all. I suggest the reason for the rise was the response in the underappreciated but extremely important bond market. Indeed, "take a look at the five and ten" year Treasury Bonds and in particular their yields in the wake of the announcement. Obviously, bond traders took heart in the fact that tapering, notwithstanding, the short term Treasury rates would remain at historic lows for the foreseeable future. Moreover, as discussed in last week's edition, it is my belief that tapering was already priced into bonds so I was not surprised by the traders' nonchalance. As a consequence, the yield on the 10 Year Treasury Bond (its importance to asset prices in general and income securities in particular is explained at Vol. 172 www.riskrewardblog.blogspot.com ) closed on Wednesday at 2.88; exactly where it was throughout most of the week. This stability signalled to stock buyers that the value of their assets would not be eroded by a spike in interest rates, and green lights in the stock market were "glimmering once again." The 10 Year yield closed the week at 2.89%.
For me, the bond market's muted response to QE3's tapering is tantamount to "sprinkling gold dust in my hair /And starlight in my eyes of blue." Why, you ask? I contend that the stock market has harbored a fear that tapering would result in the 10Year rate spiking well above 3% which in turn would cause the price of assets priced in relation to that rate to fall in value (remember the price of an interest rate sensitive securtiy falls when interest rates increase). It is for this reason that these assets have traded at depressed prices since the specter of tapering first arose back in May. And no asset class has suffered more than"Closed(to you") end funds, especially closed end funds comprised of preferred stocks (e.g. FFC, HPI, HPF, etc.), municipal bonds (EIM, MVF), REIT's (RQI), and utilities (UTF and BUI) many of which are trading at double digit discounts to net asset value and all of which pay handsome (often monthly) dividends. They will continue to be depressed through year end as many investors look to sell their losers in order to capture tax losses in what otherwise was a gang buster year. Thus in the short term, closed end funds may present excellent opportunities "to be long". BUT CAUTION, don't act "Just like me"---do your own homework and draw your own conclusions.
In the words of The Capenters, "We've Only Just Begun" QE3 tapering and "For All We Know" its longer term consequences could result in a series of "Rainy Days and Mondays."--- which "always get us down." But for now the markets are "On Top of The World." Moreover, no matter what, I intend to "Have Myself a Merry Little Christmas." I am wishing you the same.
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