May 31, 2014 Treasure

Risk/Reward Vol. 223

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

“Honey, you’re my golden star
You know you can make my wish come true
If you let me treasure you.”---lyrics from “Treasure” sung by Bruno Mars

“If you believe in magic/Come along with me
We’ll dance until the morning/Just you and me.”---lyrics from “Do You Believe in Magic” sung by The Lovin’ Spoonful

“Category 6 as I storm in
Take this as a, take this as a warning
Welcome to, welcome to global warming.”---lyrics from “Global Warming” sung by Pitbull

If, at the start of the year, you gambled that the bond market would rally, your “golden star wish has come true.” And how! Combine the following: 1) a sluggish domestic economy (revised numbers this week indicate that the US economy actually shrank in the first quarter of 2014); 2) a rise in unemployment in Europe’s crown jewel, Germany; 3) a regulatory environment that has banks clamoring for Treasury securities and eschewing loans ; 4) the recent parliamentary gains made by anti-EU parties throughout Europe; and 5) the likelihood that next week the European Central Bank will lower interest rates--- and you have the recipe for a robust bond market. In fact, according to Friday's Wall Street Journal, high grade US corporate bonds have returned 5.8% year to date compared to a 4.7% return from the S&P500 and a 1.5% return from the Dow Jones Industrial Average (DJIA) (each number inclusive of principle appreciation plus interest/dividend payments). And as for the bellwether US 10 Year “Treasury” Bond (10Year), it hit an eleven month high on Wednesday as its yield fell to 2.44% (remember the lower the yield the higher the price.)

If you “believe the magic” of low interest rates will continue, then you should consider “coming along with me” and increasing your bond sensitive investments. As noted two weeks ago (Vol. 221 www.riskrewardblog.blogspot.com ), one investment closely correlated to the yield on the 10Year Bond is preferred stock which I like to own through leveraged, closed end funds (CEF’s). Interestingly, although directionally aligned, the angle of decline in the 10Year yield has yet to be mirrored in the yields paid by preferred CEF’s, a situation which I believe presents an excellent buying opportunity. If and when these angles align (and they typically do), a significant price increase will result. I like preferred stock CEF’s that trade below net asset value, pay dividends on a monthly basis and carry at least a Bronze rating by Morningstar. HPS fits this bill, and I bought some this week. If the 10Year stays at or below 2.5% over the next several days, I see HPS rising in value even as it continues to pay me a 8+% dividend. If so, “We’ll dance until the morning/Just you and me (and anyone else who owns HPS).”

Next week, the EPA will release draft “global warming” carbon dioxide emission standards specifically aimed at coal fired electric power plants. It is anticipated that these regulations will cause a “Category 6 storm” in the coal and utility world. Don’t forget, in the US, coal still generates 40% of all electricity. “Take this as a, take this as a warning" if you own coal stocks and keep a watchful eye on electric utilities. That said, one energy source’s hurdle is another’s slide. Effectively, the only alternative to coal is natural gas. As a consequence, I bought more Kinder Morgan (KMR, KMP or KMI) which owns the largest natural gas pipeline system in the US and thus stands to gain as more natural gas is produced and consumed. I like Kinder Morgan because it pays a healthy dividend and because its stock remains depressed after a Barron’s article published in February which questioned some of Kinder’s accounting practices. On any pullback, I intend to add to my holdings in HCLP which mines franking sand used in natural gas and oil drilling. HCLP is up 54% since I repurchased it in October, 2013 and 34% since I added shares in February, 2014.

Another week, another record close for the S&P 500 and the DJIA---and another stellar performance by the bond market. The yield on the bellwether 10Year continues to fall; now hovering below 2.5% (which of course means the price of the bond continues upward). As I wrote last week, some day soon this movement in tandem by the stock and bond markets likely will end. But with the German 10Year at 1.35%, that of Spain at 2.86%, that of France at 1.74%, that of Italy at 2.95% and that of Japan at 0.57%, the US 10Year still looks like a bargain. No one---I mean no one--- predicted this. Indeed, most market savants opined that the 10Year yield would be above 3.25% by now. I took the counter bet, but not even I saw 2.44% coming. Events next week (e.g. the jobs report) may cause a reversal of fortune for me, but I really like my interest rate sensitive portfolio at this juncture. Absent some massive market upheaval I intend to stay pat. Like the great Bruno Mars

“Today I don’t feel like doing anything
I’m going to kick up my feet and stare at the fan
Cause today I swear I’m not doing anything
Nothing at all.”