May 8, 2016 0% Interest

Risk/Reward Vol. 306

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

"Candy's got some space to fill in her daydream
Living high on yesterday's lies
Talking to me about some 0% interest and,
How she got a better deal than the next guy”---lyrics from “0% Interest” sung by Jason Mraz

‘Born under a bad sign.
I've been down since I began to crawl.
If it wasn't for bad luck,
I wouldn't have no luck at all”---lyrics from “Born Under a Bad Sign” sung by Cream

“All I need is what I've got
My soul is free and I've got more than enough
Let it roll, roll, roll right off my back
Let it flow, flow, flow, that's where I'm at”---lyrics from “All I Need” sung by Natasha Bedingfield

With first quarter earnings season coming to a close, the results have been disappointing. Year over year, the average Q1 earnings of the 500 largest companies in the US (comprising the S&P 500 Index) are down 7.1%. Clearly, corporate America has “some space to fill in its daydream.” Indeed, with the two major stock indices still positive year to date (albeit barely) one could argue that Mr. Market is “living high on yesterday’s lies.” That is, of course, if the stock markets were driven by fundamentals like earnings and profits. Clearly, they are not. They are driven by central bankers who for the past several years have kept traditional savings instruments worldwide at “0% Interest” or 0%lower thereby driving everyone into stocks. In other words, stocks are the only game in town and will remain so as long as the Federal Reserve does not raise interest rates. That is why stocks rallied on Friday on the heels of a disappointing job growth report. A bad jobs number means that it is unlikely that the Fed will raise rates in June. Indeed, the futures markets now indicate only a 4% chance that the Fed will act then. With no money to be made in savings accounts, cd’s or bonds, investors have no choice but to bid up stocks. Look for the sugar high that that stocks currently enjoy (the description used this week by noted investor Stanley Druckenmiller) to continue for a while longer and for a postponement of the day of reckoning mentioned by Carl Icahn last week.

So do all of these economic “bad signs” mean that investors will have “bad luck or no luck at all?” Of course not. I, for one, intend to profit from interest rate sensitive securities that are currently mispriced in anticipation of a rate increase in June, an increase that I now do not believe will occur. And I am not alone in this pursuit. At this past week’s Sohn Investment Conference (the annual gathering of billionaire money managers), the Bond King himself, Jeffery Gundlach (cited in Vols. 220, 235, 263, 266 and 269 www.riskrewardblog.blogspot.com ) informed the group assembled that the most underpriced interest rate sensitive securities were shares in mortgage real estate investment trusts (“mREIT’s). This has always been one of my favorite sectors. Indeed, I bought CIM when I re-entered the market several days ago. Gundlach invests in REM, an mREIT exchange traded fund.

I also believe that money can be made in the oil/natural gas sector by buying on dips, collecting an occasional dividend and selling into rallies; in effect trading “bunny hop” style as discussed2016 in the three immediately preceding editions. Until this week, much of the news in this sector has been about how everyone has “more than enough”, how production just “rolls, rolls, rolls” and how crude just “flows, flows, flows.” The horrendous fire in Alberta, Canada this week, however, has had an effect. The US imports 2 million bbls/day from Canada. The fire has taken nearly 1 million bbls/day off line and more importantly has re-inserted production risk into the price of oil I say “re-inserted” because until the past year or so, the price of oil carried a significant production risk premium arising from the possibility of natural disasters (e.g. fires, pipeline breaks, etc.) and/or the politics of the locales responsible for the vast majority of the world’s production (e.g. the Mid-east, Venezuela, Africa and Russia). Recent production and, as a consequence, pricing have been set by the Saudi’s at a level designed to drive non-conventional producers (frackers) out of business. In addition, much has been made of a lack of storage for this excess production. But remember, the total US non-strategic storage capacity is only 500million barrels which is barely one month’s supply. I see oil staying above $40 given the current state of affairs which is the level I need to justify investing. In the past two weeks, in this sector, I have bought BP, RDS/B, ETP, KYN, JMF, FEI, DPM, OKE and PAA on dips. Time will tell if I have gauged this correctly.

As loyal readers know, I believe that the markets are now positioned for me to make money (see. Vols. 302 and 303): oil above $40/bbl. and the rate on the US Ten Year 016reasonably stable and comfortably below 2%. I am about 20% invested and will continue to add positions as opportunities present. I am never comfortable in the markets, but participation is a necessary evil. So please, Mr. Market, take note of Cream's famous lyric and do not disappoint:

"I've been waiting so long
To be....
In the sunshine of your love."