Risk/Reward Vol. 231
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“You don’t know what you’ve got
‘Til it’s gone
They paved over paradise
And put up a parking lot.”---lyrics from “Yellow Taxi” sung by Joni Mitchell
“And now my baby’s playing musical chairs
Round and round
And when the music stops
She’s not there.”---lyrics from “Musical Chairs” sung by Yung Berg
“Nobody gets too much heaven no more
It’s much harder to come by
I’m waiting in line”---lyrics from “Too Much Heaven” sung by the Bee Gees
As noted last week, my sell signal came on July 30th in the form of a nine basis point spike in yield on the 10Year Treasury Bond(10Year) to which much of my portfolio was correlated. Since that time, those nine basis points have retrenched, and as of Friday's close the yield on the 10Year was at a year-to-date low of 2.42%. So why have I not repurchased that portfolio? The answer is simple---because the securities comprising that portfolio continued to drop in price despite a rally in the 10Year. Does this mean the correlation no longer applies? Is Joni right that “You don’t know what you’ve got/Til it’s gone?” Yes and no. I believe that the correlation holds, but not in the presence of the current combination of exogenous threats: the continued unrest in the Gaza and Iraq, the threat of retaliation by Russia and most importantly the ever weakening economies in Europe and South America. I am not alone in this belief. In an article in Thursday’s edition of the Financial Times, market guru Mohamed El Erian blamed last week’s across-the-board sell-off on the “…cumulative impact of multiple causes …cover(ing) geopolitical, financial, economic and policy factors,…(which caused) conventional correlations among asset classes to break down.” Safety became and remains paramount. Investors seeking to park funds in a safe place have few, if any, alternatives to Treasury securities. The only real alternative, the German bund, is ridiculously more expensive in comparison. Thus, now more than ever, the US is the financial world’s “paved paradise” and the 10 Year is the world’s “parking lot.” Not so, the securities otherwise priced in relation thereto such as high yield bonds, senior loans and closed end funds. Check the last 10 trading days of activity in the relevant exchange traded funds (ETF): JNK (high yield bonds), BKLN (senior loans) and PCEF (closed end funds).
Why not? Here’s my take. When the yield on the 10Year spiked on July 30th and its price correspondingly fell, those securities priced in relation thereto fell much more quickly and much more precipitously. Indeed, those of us who use limit orders found them going “round and round.” It was like playing “musical chairs” and when the “music stopped”, buyers at or above the limit price “were not there”. I had to sell at the price that Mr. Market bid—something I dislike. The very situation about which I had written in Vol. 227 (www.riskrewardblog.blogspot.com ) had occurred. Due to Dodd-Frank and other regulations, commercial banks were not there as backstop buyers. News articles over the next several days noted the absence of backstop buyers (a/k/a market makers) and the resultant lack of liquidity in these sectors. It is small wonder that the very investors that had driven the prices of these securities so high (and their yields so low) are continuing to exit. Indeed, Friday's Wall Street Journal reported that, as of Wednesday, junk bond funds experienced the largest weekly net outflow in history---$7.1billion eclipsing by a mile the previous weekly net withdrawal record of $4.6billion experienced during the "taper tantrum" of June 2013. To give some perspective on this, in May these same funds had a net inflow of $2.61billion. I have no doubt that I will own these securities again, but not until prices stabilize at a level that rewards me for this liquidity risk.
Remember just a few short years ago when our lament was that “Nobody gets too much oil no more/It’s much harder to come by/I’m waiting in line.” The recent drop in the US domestic (WTI) price of oil suggests that this is no longer the case. XOP, the domestic oil exploration and production ETF, has fallen 11% in value since its June high, and the price of AMLP, the master limited partnership ETF (which should be insulated from price swings) has fallen 6% since then. That stated, VNR, LINE, LNCO, KMR, KMP, BBEP and ETP (all which I sold last week) have stabilized and have begun to regain this week. Some commentators suggest that next month, once a refinery in Coffeyville, KS comes back on line, WTI should rise again. In any event, prices throughout the oil patch are very attractive.
Friday's action turned an otherwise bad week positive. Until then it seemed that nothing worked---not even market correlations. It is for this reason that I remain on the sidelines. But whether you join me there, you hold pat or you buy, remember the investors credo (with attribution to the Brothers Gibb):
“Whether you're a brother or whether you're a mother,
You're stayin' alive, stayin' alive.
Feel the city breakin' and everybody shakin',
And we're stayin' alive, stayin' alive.
Ah, ha, ha, ha, stayin' alive, stayin' alive.
Ah, ha, ha, ha, stayin' alive.”
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