August 2, 2014 Na Na Hey Hey

Risk/Reward Vol. 230

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

“Six o’clock already
I was just in the middle of a dream
It’s just another manic Monday.”---lyrics from “Manic Monday” sung by The Bangles

“Waiting for Wednesday
My stomach doesn’t hurt bad enough
Pain always is the sign
Waiting for Wednesday.”---lyrics from “Waiting on Wednesday” sung by Lisa Loeb

“I wanna see you kiss him
I’m gonna see you kiss him/ Goodbye
Na na na na/Na na na na
Hey hey/Goodbye.”---lyrics from “Na Na Hey Hey” sung by Steam

Last week’s edition evoked a flurry of responses including one that I circulated. That loyal reader advised me to liquidate because I had surpassed my annual goal (6%) and because holding for more bespoke a lack of discipline. So what is my discipline? To answer that question, I reread several past editions (as I am wont to do) and found guidance in Vol. 221 (www.riskrewardblog.blogspot.com ). Therein, I stated that “I have come to believe that one can construct a non-diverse portfolio correlated to a market singularity with movement by that singularity providing clarity on when to buy, hold or sell.” That singularity, for me of course, is the yield on the 10 Year Treasury Bond. As the trading day began on “manic Monday”, the yield on the 10Year held steady and by “six o’clock” it had risen hardly at all. Thus, I did not sell. Come Tuesday, the continuing conflict in the Mideast spurred a further flight to safe investments, and the news from Europe was that the yield on the Spanish 10 Year bond was LESS than that on the US 10 Year. These factors resulted in an increased demand for the 10Year which in turn raised its price and lowered its yield. This action increased the value of interest rate-sensitive securities many of which I hold. Thus, on what was a down day for the Dow Jones Industrial Average and the S&P 500, the portfolios that I manage reached all time highs.

And then came Wednesday—a day which all market watchers were “waiting for” On Wednesday came the release of second quarter gross domestic product (GDP) numbers, of the quarterly personal consumption expenditure index (a/k/a PCE--- the inflation indicator deemed most reliable by the Federal Reserve) and of a statement at the conclusion of the Fed’s monthly meeting. Coming off a great Tuesday, “my stomach didn’t hurt.” But the combination of a blockbuster GDP report (up an annualized 4% in Q2) and a spike in inflation (core PCE up 1.7%--close to the Fed’s target of 2%) led Mr. Market to believe that it is now more likely that the Fed will raise interest rates sooner than expected; this despite protestations in the Fed’s press release to the contrary. This belief manifested in the yield on the 10Year spiking a whopping 9 basis points, its largest one-day move since last November. Its price fell accordingly. (N.B. A rise in yield means a drop in price) The value of those securities priced in relation to the 10Year (closed end preferred stock funds, high yield bond funds, etc.—you know, the kind I like and own) dropped as well.

Per my discipline, this was the movement in the 10Year yield which told me to sell. So come Thursday morning, it was “Na na na na/Na na na na/Hey, hey/Goodbye” to the interest rate-sensitive portion of my portfolios. I was not alone in “wanting to kiss him (Mr. Market, that is) good bye’ as the DJIA fell nearly 200 points as I sold and 316 points by day’s end. In so doing, the DJIA gave back all of its year to date gains. Meanwhile, the S&P shaved 39 points (2%!). The bloodbath continued on Friday, albeit at a slower pace due in part to the fact that Friday's jobs report was lukewarm thus lessening fears of an even sooner hike in interest rates. Would I have retained more profit had I sold on Monday or Tuesday? Yes, but that would have been undisciplined. I waited for a clear signal, the type which Wednesday provided. My one mistake was not exiting Wednesday before the market closed. Had I done so, I would have avoided a reduction in profits incident to the mass exodus on Thursday. That said, I escaped with the vast majority of my year to date gains and remain very pleased with my approach--- and my results.

I don’t know how quickly I will redeploy the considerable amount of cash I raised this week. But that does not mean I will sit idle. I will continue to study and to test. When the time is right, like The Bangles, I will

Slide my feet up the street
Bend my back
Shift my arm and pull it back.
Then, I will walk like an Egyptian

back into the fray.