February 21, 2015 Magnus Opus

Risk/Reward Vol. 255

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

"But minute by minute by minute by minute
I keep holding on"---lyrics from "Minute By Minute" sung by The Doobie Brothers

"You won't see me
Time after time

You refuse to even listen"---lyrics from "You Won't See Me" sung by The Beatles

"'Cause rockin' and rollin', it's only howlin' at the moon
It's only howlin' at the moon"---lyrics from "Magnus Opus" sung by Kansas

As an income investor, my fate often rests upon the market's reaction to Federal Reserve meeting minutes. "Minute by minute by minute/I keep holding on"---and never so much as this week. Allow me to explain. As discussed in last week's edition (See Vol. 254 www.riskrewardblog.blogspot.com), many market participants believe that the improved domestic employment picture alone will prompt the Federal Reserve to raise short term interest rates, and to do so as early as this coming June. For the reasons explained in that edition, I disagree. But Mr. Market clearly is skittish and overreacts to any signal either way. As a consequence, the bellwether 10 Year US Treasury was volatile this week in sharp contrast to the quiescent major stock indices; Friday notwithstanding. On Monday and Tuesday, the yield on the 10Year spiked 12 basis points (6%) on news that some Fed members were anxious to eliminate the word "patience" from future Fed communiques thereby signaling a desire to raise rates sooner rather than later. On Wednesday, however, minutes from the Fed's January meeting were released. They bespoke a more hesitant tone in regard any rate increase. Also on Wednesday, the Commerce Department released January's producer price index. It showed that the prices businesses received for their goods and services declined (deflated) by 0.8% between December and January and that those same prices have remained flat over the preceding 12 months. This news was disappointing to the Fed which would prefer for these and other prices to inflate at a 2% annual rate before it begins to normalize interest rates. Housing start date released that day also showed a negative trend. In response, the rate retraced back to 2.07 and then gradually moved to 2.13 by week's end.

Because I believe that the yield on the 10Year will stabilize, I have held steady even as the capital appreciation that I experienced in January has eroded. (Remember the higher the yield the lower the price). As in income investor my primary focus is dividends and interest, not capital appreciation---although the latter is welcome anytime. That said, I will not tolerate any significant loss of capital. As a consequence, if the bellwether rate, off which many of my holdings are priced (e.g. preferred stock closed end funds, municipal bond funds, real estate investment trusts and utilities), continues to rise sharply and causes my capital position to enter the red zone, "you won't see me" in the market any longer. As I have stated "time after time", my primary purpose in this entire Riskreward exercise is to avoid loss. Doing so is a victory in and of itself. The cries of anguish uttered in 2008 still ring in my ears even if "you refuse to listen."

One very bright spot for me in an otherwise disappointing February has been the performance of the preferred stock of Magnum Hunter Resources (MHRpC and MHRpD). MHR is a small exploration company engaged primarily in fracking for oil; that is until 2014. At that time, MHR began divesting its oil properties (at the market's top) and investing heavily in natural gas properties. When the price of oil plunged recently, MHR was painted with the same brush as every other small oil exploration company and lost over half of its value. Thereafter, MHR's CEO went on a public relations campaign to explain that MHR was not an oil company, but a natural gas company---one that could operate profitably even if the price of natural gas fell to $2/mmBTU (current price is $2.82). Further, he has been candid and transparent on cash flow expectations, so much so that an article appeared Thursday in the online version of Forbes in which investment advisor Jim Collins sang the praises of MHR in general and its preferred stock in particular. Indeed, the MHRpD that I bought on January 23, 2015 is up 40% while still paying a 10% annual dividend amortized monthly. Follow on purchases of it and MHRpC have also experienced double digit appreciation. I must warn those that may be interested, MHR preferreds are not for the faint of heart. They are thinly traded and have a history of volatility. They have "caused me a lot of rockin' and rollin'. And in times past, I have found myself "howlin' at the moon" for owning them. That said, I intend to buy more. This time, it looks like Magnum Hunter may actually be a "Magnus Opus".

Over the next few weeks I see both fixed income and equity markets dominated once again by Federal Reserve signals. Look for volatility on February 24th when Chair Yellen addresses Congress and again on March 18th at the conclusion of the Fed's FOMC meeting. I will take my lead from the band, Kansas. If Yellen signals that interest rates will remain low, I likely will "Carry On, My Wayward Son." If she signals that an increase is imminent, I may disappear from the market like "Dust In The Wind"---reappearing only after that dust settles and rates attain some stability.