July 31, 2016 Exit

Risk/Reward Vol. 316

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

Having reached my goal for the year on the portfolio that I manage, I decided to sell on Tuesday. As described back in March and April (Vols. 300 and 302 www.riskrewardblog.blogspot.com ) that portfolio was constructed based upon two premises: 1) the rate on the US Ten Year Bond staying below 2% and 2) the price of oil staying above $40/bbl. The events of the past few months have permitted this portfolio to produce a capital return much better than I had expected with oil touching $50 in May and June and the 10 Year Yield hitting all time lows in the wake of Brexit. That said, the price of oil has slipped below $42/bbl. and over the next few months, the yield on the 10Year is more likely to rise than to fall. (Remember a rise in yield means a drop in value). Accordingly, I reaped my profits and headed to the sidelines. Below is a further discussion of my rationale.

As I expected on Wednesday, the Federal Reserve Open Market Committee voted to keep short term interest rates at their current 1/4 to 1/2%. I read the press release following the FOMC meeting to be more upbeat on the economy. This attitude normally prompts the Fed futures market to increase the odds of a rate increase, and this time was no exception. The odds of a September rate hike rose that afternoon from 25% to 30%. Do I believe that rates will be increased at the next FOMC meeting in September? No. We will be in the thick of the election cycle, and the Fed will avoid anything that would disrupt the markets to the detriment of the establishment candidate, HRC. Doubt me? Read the article on Fed Governor Lael Brainard in last week's NYTimes, and you too will conclude that she aspires to a top policy position in the Clinton administration. A further reason to hold steady on rates was the disappointing gross domestic product report issued on Friday. The US economy year to date has only grown at an annualized rate of 1%, well below the 2-2.5% expected. Thus, the current rate on the 10Year remained in the 1.5% zone through the week. Frankly, my desire to exit interest rate sensitive securities was not as pronounced as my desire to exit oil, but I saw no compelling reason to stay. So I sold. As I have said repeatedly, selling on a high note is good for the soul. Or as Bernard Baruch remarked "I made my money selling too soon."

As to the price of oil, several factors have contributed to its retrenchment. First, recent articles have brought into question the accuracy of reports tallying the quantity of stored oil worldwide. Several countries, most notably Russia, do not report stored oil figures to the markets, nor do those private entities that own oil tankers currently moored off shore. Second, the disruption in the flow from Canada incident to the fires in Alberta has been all but eliminated. Third, I am concerned by the steady increase in the number of rigs operating domestically. Fourth, the supply of gasoline in the US continues to build even in the midst of the summer driving season. None of these factors bodes well for oil or oil related stocks. Accordingly, I chose not to risk losing the gains that I have achieved. The decision to sell on Tuesday appeared prescient on Friday as Exxon and Chevron reported disappointed earnings.

Some may wonder whether my buying and selling creates a tax nightmare. The answer is no---for the most part. I use a 401k and some IRA's as trading accounts. Trading there does not generate any capital gains tax. I try to keep the personal assets that I manage in cash. The only exceptions are master limited partnerships which are not suitable for tax deferred accounts. Remember that for the past year or so, I have rarely invested more than 40% of available capital. In disinflationary (nay deflationary) times, cash remains king. Furthermore, when opportunities arise (e.g. buying GM in the wake of Brexit or OKE when it carried a sustainable 13+% dividend), I have plenty of dry powder.

Don't take my actions as a sign that the asset bubble about which I often write is about to burst. I believe that the central banks of the world will continue to subsidize financial assets even in the face of declining economic growth. Europe and the US are the new Japan where secular stagnation persists. But please note that as of last month the cumulative wealth of the US (e.g. the total value of stocks, bonds, houses, etc.) is now 5 times the gross national income. This bloated ratio has only been achieved two other times in our history: 1999-2000 and 2004-2005. In other words, just before the two most recent stock market crashes. At some time even cheap money cannot keep the bubble from bursting. Undoubtedly, I will dart in and out of the market several more times before that occurs, but I am ever watchful for signs of it approaching