October 25, 2014 Come Back, Baby

Risk/Reward Vol. 239

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

“Like a rubber ball
I’ll come bouncing back to you.”---lyrics from “Rubber Ball” sung by Bobby Vee

“Buy a bag of balloons with the money we’ve got
Set them free at the break of dawn
‘Til one by one they were gone.”---lyrics “99 Red Balloons” sung by Nena

“I’m gonna let you pass/And I’ll go last
Then time will tell just who has fell
And who’s been left behind
When you go your way and I go mine.”---lyrics “Go Your Own Way and I’ll Go Mine” sung by Bob Dylan

“Like a rubber ball” the major stock indices came “bouncing back”, experiencing their best week of the year. The Dow Jones Industrial Average gained 425 points and the S&P 500 rose 4%. In large part, the bounce came from oil prices stabilizing and a spate of strong earnings reports. The positive price action gave me the confidence to buy several new positions. In particular, I expect a nice bounce from a host of general equity closed end funds ( e.g. EOI, CHY, CHI), especially GAB, Mario Gabelli’s flagship CEF which floated a price-deflating rights offering (See Vol. 236 www.riskrewardblog.blogspot.com ) just as the market swooned earlier this month. It currently trades substantially below its net asset value which is unusual for this fund thus presenting an excellent buying opportunity.

Another source of the uptick was the European Central Bank (ECB) which this week began its own version of quantitative easing in the form of covered bond and asset backed security purchases. In effect, the ECB is buying commercial loan portfolios from Eurozone banks (like the portfolios of mortgages that our Federal Reserve purchased during QE3) in an effort to spur additional lending which it hopes leads to economic development. In other words, the ECB is “buying a bag of balloons with the money it prints and/Setting them free” The ECB is also contemplating buying corporate bonds, an aggressive move that not even the Fed attempted during QE. What will the ECB do with these newly acquired assets once the program ends? Sell them “one by one til they are gone?” Or like the Fed, keep them until maturity. Will it work? Did QE 1, 2 or 3? The jury is still out. But, the ECB’s action is at least an attempt to combat the very real threat of recession in the Eurozone, and that attempt was rewarded with a rise in European stocks which in turn helped to boost equity prices in the US.

The impact of the ECB’s actions on our domestic markets highlights the fact that the world’s economies (and by extension its markets) are becoming progressively intertwined. Today, can a single economy, even one as large as ours, “go last/and let the others pass?” Can one country simply decide to let “others go their way and I go mine?” Can one or more be “left behind” or will they all rise or “fall” together. There is no doubt that the economies of emerging markets are heavily dependent on China’s demand for natural resources. In turn, China’s economy is heavily dependent on consumer demand in the US. The question we face today is whether the US can achieve its targeted 3% growth in gross domestic product as growth in the rest of the world slows. We will have an answer very soon.

Like Bobby Vee, I have decided to “Come Back, Baby” albeit slowly and with some trepidation. In times past, my “wide-eyed innocence/Has really messed up my mind.” So if you too re-enter do so of your own volition. Don’t rely on me. “I’d rather you get your very next heartache not from me, but/Somewhere else along the line.”