March 20, 2016 Fool on The Hill

Risk/Reward Vol. 300

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

“(Turn around)
Every now and then
I get a little bit nervous
That the best of all the years have gone by”---lyrics from “Total Eclipse of the Heart” sung by Bonnie Tyler

“Baby you can drive my car
Yes I'm gonna be a star
Baby you can drive my car
And maybe I love you”---lyrics from “Drive My Car” sung by The Beatles

“Ooh, the beauty is there
But a beast is in the heart
(Oh-oh, here she comes)
Watch out boy
She'll chew you up”---lyrics from “Maneater” sung by Hall & Oates

It was a mere five weeks ago, February 11th to be exact, when the Dow Jones Industrial Average and the S&P 500 hit bottom; both down over 10% year to date. The investing public was “a little bit nervous/That best of all the years had gone by.” Since then however, both major indices have experienced a significant “Turn around” and are now positive for the year. The reason for the recovery can be found by simply charting the price of oil against these indices. As reported here, over the course of the past several weeks, with few exceptions (like Friday), up and down days even hours in the indices have been directly, almost perfectly, correlated to the price of oil.

So why has the price of oil improved from $27/bbl. on February 11th to $40/bbl. this week? One factor is a cut back in domestic production. Another is the hope that major international producers likewise will limit production, a hope that gained traction this week with the announcement that Saudi Arabia, Russia and other major oil exporters are meeting in Doha, Qatar on April 17th to discuss the price of crude. A third factor “driving that car” may not be so obvious---US monetary policy. What? Janet Yellen influences the worldwide price of oil? Most certainly. When it comes to oil prices, the Fed is “a star.” Like many commodities, the price of oil is denominated worldwide in dollars. The higher the dollar goes in comparison to other currencies, the more expensive oil becomes internationally. More expensive oil lowers demand, and lower demand means lower prices. With the news on Wednesday that the Federal Reserve was holding pat on interest rates and foresaw no more than two small increases during the remainder of 2016 (compared with 4 foreseen just last December), the value of the dollar sank in comparison to other currencies and the price of oil jumped $2/bbl.

So what does this mean to me? Well, if oil stays above $40/bbl. and if the interest rate on the benchmark 10 Year US Treasury Bond does not spike above 2%, I should do well with the non diverse, interest rate and oil sensitive portfolio that I began acquiring in mid February (see Vol. 296 http://www.riskrewardblog.blogspot.com/ ) The stocks in each of these sectors were bludgeoned earlier this year in anticipation of more aggressive interest rate increases and plummeting oil prices. With both of these factors moderating I should see continued capital appreciation and a few months of excellent dividend payments. I say a few months because even though “the beauty is there”, the “beast is in the heart.” By that I mean that the value of these positions is entirely within the control of Janet Yellen. If she decides to become more aggressive on rates, “watch out boy, she’ll chew you up.” Any such increase will depress interest rate sensitive stocks and as discussed above will cause the price of oil to fall thereby decreasing the value of oil related companies.

So why do I not diversify? In my humble opinion, diversification in this market is false prophecy. Asset prices worldwide are supported entirely by a debt bubble created and manipulated by a handful of central bankers who are experimenting with tools (i.e. negative interest rates) that heretofore have never been deployed. I am singularly focused on what these bankers do. Thus, my investments are in those securities that are most directly correlated to their actions. When the worm turns, I will sell everything. You may believe diversification will provide you a buffer to ride out the next bubble burst. Those who so believed in 2008 were bailed out by the world's central bankers (via quantitative easing and zero bound interest rates) and by China's central planners (via massive infrastructure improvements). The tools they used are no longer effective or are no longer available. So sell, I will. It’s a just a matter of time. A fool I may be; but, like The Beatles, I will be a “Fool on The Hill”; a hill of cash.