September 13, 2014 Worry,Worry

Risk/Reward Vol. 235

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

“Worry, worry, worry, worry
Worry just will not seem to leave my mind alone.”---lyrics from “Trouble” sung by Ray LaMontagne

“Slow ride/Take it easy
Slow ride/Take it easy.”---lyrics from “Slow Ride” sung by Foghat

“Love til you hate
Know that we all fall down.”---lyrics from “All Fall Down” sung by One Republic

This week’s drop in the stock market resulted from “Worry, worry, worry, worry” that the Federal Reserve (Fed) will amend its forward guidance at its meeting next week. Specifically, the “worry” is that the Fed will announce that it may not wait a “considerable time” (at least six months) after quantitative easing (QE3) ends in October before raising short term interest rates. On Friday one of my favorite market gurus, Mohamed El-Erian, handicapped at 50/50 the likelihood of a change in Fed guidance. As a consequence of this “worrying”, the bond market experienced a sell-off causing the yield on the benchmark US10 Year Bond to climb to 2.61% at Friday's close. (N.B. falling prices mean rising yields). This in turn caused yields to rise worldwide. Stocks took a breather as well, as investors mulled the potential consequences of the Fed’s first rate increase since 2006. As an income investor, thoughts of rising interest rates “will not leave my mind alone”---at least not until after next week’s Fed meeting.

One notable dissenter from the “worry” crowd is Jeffrey Gundlach. If Bill Gross is the Bond King, then Gundlach is the Crown Prince. During his webcast last Tuesday, Gundlach advised fixed income investors to “Take it easy.” He sees no reason for the Fed to change its forward guidance or to otherwise signal an increase in interest rates. He cites the following facts as evidence that economies worldwide continue on a “slow ride” which he believes will grow even “slower” if the Fed even hints of a rate increase next week:
• Wage inflation for the lower 70% of US wage earners is non-existent, and wage inflation is Janet Yellen’s major concern. The prospect of wage inflation appears even less likely in light of the most recent, disappointing jobs number and the increase in jobless benefit claims reported last Thursday.
• Other drivers of inflation are moderating with oil prices dropping 15% since June.
• Domestic new home starts, traditionally a Fed bellwether, continue to fall despite low interest rates.
• The Chinese economy which served as a major catalyst for the post 2008 worldwide economic recovery (See Vol. 74 www.riskrewardblog.blogspot.com ) has been downgraded and is scheduled to grow at only 7.4% annually, its lowest rate since 1990. Evidencing this is the 40% year-to-date decline in the price of iron ore. China buys 2/3rd’s of all of the iron ore mined in the world, and iron ore drives the economies of many emerging markets like Peru, Brazil and Australia.

Gundlach cites these facts as further reasons for fixed income investors to “take it easy”:
• Quantitative easing in the Eurozone and elsewhere makes US 10 Year rates look attractive---above or below 2.5%. In last Wednesday’s $21bn auction of US10Year Bonds, 53 % were purchased by “indirect purchasers”, a group that includes foreign central banks; the highest percentage since Dec. 2011
• Even if the Fed does raise short term rates, it will only flatten the yield curve. Longer term rates (e.g. 10Year Bonds and longer) will experience little if any disruption due to the unprecedented amount of liquidity worldwide; in other words there is just too much demand for safe haven securities.
I recommend that you listen to a replay of Gundlach's presentation which was closely followed in real time on Twitter. It can be found at www.doubleline.com/webcasts.php .

As noted above, the price of oil continues to “All Fall Down” with the world’s benchmark, Brent oil, below $100/bbl and the domestic benchmark, WTI, near $90/bbl. And demand continues to drop. China is the second largest consumer of oil in the world, and its crude oil imports fell 2.4% in August. Meanwhile, production continues to increase. Thanks to hydraulic fracturing (“fracking”), US domestic crude production is now at 8.5million bbls/day (up from 5million bbls/day in 2007) and is projected to rise to 9.5million bbls/day in 2015 (more than half of US daily consumption and equal to the daily production of Saudi Arabia). Oil stocks, like all securities, are ones that investors “love till you hate.” Well, if falling prices are a sign of hate, then the hatin’ has begun. That said, there are some excellent companies on sale at present. Last week I highlighted Vanguard Natural Resources (VNR). Next week take a look at Breitburn Energy (BBEP) an acquisitive exploration and production company that pays a 9% dividend as one waits for the price of oil (and BBEP stock) to recover. With all of the turmoil in the world today, I am confident both will occur. A safer way to play Breitburn is its preferred stock (BBEPP) which is less volatile but still yields over 8% annually, amortized monthly. If big oil suits your fancy, Jim Cramer and some of my readers are pushing Royal Dutch Shell (RDS).

With so much riding on what happens at next week’s Federal Reserve meeting, I added very little to my holdings this week and remain 2/3rd’s in cash. I like counting the dollars that I have earned so far this year. I don’t want to spend any restless nights living the following One Republic lyric:

“Lately I been, I been losing sleep
Dreaming about the things that we could be
But baby, I been, I been prayin' hard
Said no more counting dollars
We'll be counting stars”