March 28, 2015 Two Steps Back

Risk/Reward Vol. 260

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

“We've given each other some hard lessons lately

But we ain't learnin'

We're the same sad story that's a fact

One step up and two steps back”---lyrics from “One Step Up” sung by Bruce “The Boss” Springsteen

“For a small piece of paper/ It carries a lot of weight

Oh, that mean, mean, mean, mean, mean green”---lyrics from “For the Love of Money” sung by the O’Jays

“I got no fever/But I'm feeling the heat

Oh boy, someone get me out of here”---lyrics from “Get Me Out of Here” sung by Paul McCartney

Both the Dow Jones Industrial Average and the S&P500 fell this week. Year to date, both sit in the red. There are many cross currents at work (e.g. the divergent monetary policies here and in Europe, the rise in the dollar, the crisis in the Arabian peninsula, etc.) Indeed, it seems this year we take “one step up and two steps back.” “We’ve given ourselves some hard investing lessons lately”, but “we ain’t learning"”---at least I'm not. If you can make sense of it all, please contact me. Indeed, it is this pervasive uncertainty that caused me to sell several positions earlier this month (as discussed in Vol. 258 www.riskrewardblog.blogspot.com ). And I am not alone. So far this year, net outflows from equity exchange traded funds (ETF’s) total $44billion, more than at any time since the crash of 2009. SPY, the S&P500 ETF, alone has experienced $26billion in net outflows.

I still am heavily in cash. In the absence of inflation and without any ability to receive a return on short term deposits (have you checked money market and cd rates lately), cash is not a bad place to be. “For a small piece of paper/It carries a lot of weight/That mean, mean, mean, mean, mean green.” I am locked and loaded and ready to invest. I just don’t see many desirable targets. Again, I am not alone. Where are we headed? After six years of zero bound interest rates, we have a Federal Reserve which seems hell bent on raising rates in the face of contrary moves by virtually every other central bank in the world and, as noted above, in the complete absence of inflation. In so doing, corporate profits will suffer, and our balance of payments will worsen as consumers opt for cheaper imported items. To add to this uncertainty, the Fed has become more opaque in its communications.

Even though “I got no fever” to invest at present, I have repurchased some irresistibly cheap oil and gas plays and some preferred stock positions. These were made without great conviction, so if “I’m feeling the heat” from rising interest rates or otherwise, I will “get me out of here.” Accordingly, a major consideration in this round of investing was liquidity---the ability to sell at or near the last quoted price. The best way to insure liquidity is to purchase securities for which there is a robust market; to wit a lot of volume. Much of what has appealed to me in the past (e.g. closed end funds) is thinly traded. From time to time I have been disappointed by the spread between what is asked and what is bid on these. Volume lessens this spread. How has this affected my recent purchases? Here is an example. I opted for more PGX than FFC in the preferred stock fund space because PGX trades at 10 times the average daily volume of FFC. I did so even though PGX pays a substantially smaller dividend. For a discussion of the role of liquidity in investing, read Howard Marks’ ( see Vols. 173 and 234 www.riskrewardblog.blogspot.com ) excellent memo on the topic published just this week. It can be found at www.oaktreecapital.com/memo.aspx .

What I have written above reads negative. Truthfully, I am less negative than I am frustrated. But frustrated I must not become. I remain convinced that someday, I will find the secret sauce to investing. In that regard, I am like The Boss:

“Oh-oh, someday girl
I don't know when

We're gonna get to that place
Where we really wanna go 

And we'll walk in the sun 

But till then, tramps like us, 

Baby we were born to run”