August 30, 2014 Reachin'/Low

Risk/Reward Vol. 233(2)

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

“And I know the sky may be high
But, Baby, it ain’t really that high
Reach for the stars
Let’s reach for the stars.”---lyrics from ‘Reach For The Stars” sung by Will.I.Am

“How low can you go?
I could go low/Lower than you know.”---lyrics from “How Low Can You Go” sung by Ludacris

“You got no guts/You get no glory
And I’m bettin’ my money on an ace in the hole
Think I’m getting’ out of control.”---lyrics from “Out of Control” sung by The Eagles

For the month of August, the Dow Jones Industrial Average is up over 3% and the S&P 500 is up nearly 4% with each index fully recovering from July's correction and each hitting record highs this week. Truly, “the sky may be high/But, Baby, it aint’ that high” when markets “reach for the stars”. And, “reachin’ for the stars” is what the stock markets are doing. Indeed, prices are so high, I had to be very selective as I began my re-entry this week. Municipal bond closed end funds, preferred stock funds and some oil plays still look attractive.

Aiding the stock market’s “reach for the stars” has been the falling yield in the bond market, most notably the yield on the all-important 10Year Treasury Bond. Traditionally, as bond yields fall, stocks become more attractive. This certainly has held true recently as the cyclically adjusted price/earning ratio for the S&P 500 (CAPE, see Vol. 226 www.riskrewardblog.blogspot.com for a discussion of this) has been stretched to historic levels. With the US 10Year yielding only 2.34% at yesterday’s close, one is left to wonder “How Low Can It Go?” “Lower than you know”, or at least lower than the experts know. Indeed, at the start of the year, any suggestion that the yield on the 10Year would be below 2.35% on Labor Day would have been deemed “Ludacris.”

And now these very same experts are questioning whether the Federal Reserve has lost the ability to raise interest rates if and when it decides the time is right. A provocative opinion piece written by George Melloan in the August 26, 2014 edition of the Wall Street Journal suggests that interest rates indeed may be “getting’ out the the Fed’s control.” I recommend the piece to your attention. Therein Melloan analyzes each of the Fed’s traditional tools for raising rates (e.g. reverse repos, raising interest rates paid on reserves, and its “ace in the hole” raising the Fed funds rate). He then concludes that none of these may be effective in a world awash in liquidity---liquidity made available through accommodative monetary policies adopted by central banks world wide. Can the Fed expect to increase the 10Year Treasury rate by tightening its short term interest rate reins if the European Central Bank loosens its belt and embarks on a new round of quantitative easing? Forty percent of U.S. government issued debt is owned by foreign interests currently, and that percentage continues to increase. And why not, when the German 10 Year Bund yields only 0.89% and the Spanish 10Year yields only 2.2%. Given a choice, who wouldn’t rather own the US 10Year, even at a 2.3% yield?

How valuable are the opinions of so-called experts in this “Desperado” world, anyway? None has provided me with a “Peaceful, Easy Feeling." How about you? None can say with any conviction whether stocks will continue to climb and/or interest rates will continue to fall. Even if one were to predict “How Long” this “Life in the Fast Lane” will continue, I, for one, would not believe their "Lyin' Eyes." The only approach an individual investor can take is to remain nimble, reserving to oneself the ability “to check out anytime you want.” That’s what I did, and what undoubtedly I will decide to do again “One of These Nights.