November 8, 2014 The Locomotion

Risk/Reward Vol. 241

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

“A chug-a, chug-a motion like a railroad train
Come on baby, do the Locomotion.”---lyrics from “The Locomotion” sung by Little Eva

“You got me runnin' goin' out of my mind
You got me thinkin' that I'm wastin' my time
Don't bring me down, no no no no no”---lyrics from “Don’t Bring Me Down” sung by ELO

“Drums keep pounding rhythm to the brain
And the beat goes on/Yes the beat goes on.”---lyrics from “The Beat Goes On” sung by Sonny and Cher

Both the Dow Jones Industrial Average (DJIA) and the S&P 500 (S&P) continued to rise this week, albeit modestly, setting record highs along the way. After a volatile first few weeks of October, the indices have been running sure and steady of late-- “A chug-a, chug-a motion like a railroad train.” And with our elections over, I see little on the horizon to de-rail this “Locomotion.” Nothing on the Federal Reserve’s calendar should cause interest rates to rise. Indeed if anything, we may see more downward interest rate pressure given the fact reported last week that Japan has opened its credit floodgates with a new round of quantitative easing. Moreover, the European Central Bank has pledged to combat deflation with any and all of the ammunition it has at its disposal including its own round of quantitative easing should one prove necessary. This is all good news to rate sensitive income investors like me. Although the Middle East remains a mess, that condition is nothing more than SNAFU. And in Ukraine, the West has conceded Donetsk to Putin, a fact which should satiate his acquisitive appetite for a while. In short, I see calm market conditions through the end of the year with a slightly positive tilt.

That said, not all is rosy in my portfolio. News on Tuesday that Saudi Arabia was dropping the price of the crude oil that it sells into the United States (while raising prices to Europe and Asia) sent my domestic oil holdings sharply downward. Honestly, with crude now trading at below $80/bbl, I’m “goin’ out of my mind.” It’s “got me thinkin’ that I’m wasting my time” with the likes of Linn Energy (LNCO), Vanguard Natural Resources (VNR) and Breitburn Energy (BBEP). It seems that each morning I’m crying “no,no,no,no,no”—“don’t bring crude down.” But down it goes. That said, each of these domestic producers has given assurance that it can sustain its, now, double digit dividend even if the price of oil does not recover. Ironically, natural gas could be the cash cow savior for VNR, the production of which BBEP and LNCO have reduced in recent years. Distributions from those two should be protected by the hedging of 70% of their oil production through 2015.

If the drop in oil were not enough of a “drum that keeps pounding rhythm to my brain”, the “beat down” of American Realty Capital Properties (ARCP) “goes on/Yes the beat goes on.” On Monday, an ARCP affiliate announced that it was reneging on its agreement to purchase some non core assets that ARCP acquired as part of the Cole Realty acquisition. This news caused ARCP to fall to ridiculous depths, so ridiculous that I decided to add to my position. I may be doubling down on a loss, but I keep thinking of how solid the underlying business appears. ARCP owns a portfolio of triple net leased properties with a book value of $11 billion rented to investment grade tenants. Moreover, it pays a (now) double digit dividend amortized on a monthly basis. Yet, the market cap is only $7billion? Huh? Oh, well, I bought some more. I will either do well (up 10% so far on Tuesday's purchase) or “the beat will go on.”

The performance of the DJIA and the S&P in the past month once again is making passive index investors look like geniuses. They may attain a double digit return for the third year in a row. In contrast I may miss my more modest personal goal of 6-7% due to my overweight positions in oil companies and ARCP. That said, I do not see myself buying a basket of indexed ETF’s and then closing my eyes. What happened to passive investors in 2008-2009 still haunts me and will do so for the rest of my investing life. I remember like yesterday: “bang, bang, that awful sound/bang, bang investors hit the ground/bang, bang the indices shot them down.” That did not happen to me then, and it will not happen to me in the future.