January 15, 2017 Rationale

Risk/Reward Vol. 336
 
THIS IS NOT INVESTMENT OR TAX ADVICE.  IT IS A PERSONAL REFLECTION ON INVESTING.  RELY ON NOTHING STATED HEREIN.

In Vol. 333 http://www.riskrewardblog.blogspot.com/ I explained my rationale for re-entering the market in mid December.  In a nutshell, the decision was based upon the meteoric yield increase on the US Treasury 10 Year Bond;  from 1.3% in July to 1.8% on election day to 2.6% on December 7th.  I also outlined the reasons why I believed the rotation out of bonds and into equities would slow.  I predicted that the rate on the 10Year would stabilize and remain stable for the foreseeable future.  In the ensuing month, the rotation has not only slowed, it has reverse albeit marginally.  Whether this reversal is a result of the outsized spread in yields between the 10Year and every other sovereign security available (especially the German bund) or simply reflective of a technical resistance to breaching Dow 20,000 is of no moment to me.  The fact is that bond yields have fallen.

So how does this affect me?  Remember, although I do not own a lot of bonds, I invest and trade in securities that are priced in relation to the 10Year, most notably preferred stocks and preferred stock closed end funds.  Based upon several years of study, if the spread on the yield between an investment grade preferred and the 10Year exceeds 350 basis points and the price of the preferred falls below its redemption value (typically $25)  it signals a "buy".  Another buy signal for me is when the rate on the 10Year experiences a spike as occurred during the 2013 Taper Tantrum (see Vols. 211 and 172) and again recently after the election.  It is a fact, that from time to time, Mr. Market is overly exuberant in rotating out of one asset (e.g. bonds) and into another (e.g. stocks); a situation I perceived existed with the Trump rally and the incredible, one month, 44% rise in the 10Year yield.  With the yield on the 10Year currently at or below 2.4%, I am up over 3% on the portfolio that I purchased after December 19th. (Remember as yields fall, prices increase.)  That portfolio averages over 6.5% in annual dividends.  I am still 50% in cash, but will deploy more if stability persists.

The above notwithstanding, we live in interesting times.  No one predicted the Trump Rally.  And no one is offering predictions for 2017.  The closest to a prediction that I have read is contained in Bill Gross's January Investment Outlook.  It is available on Janus Capital Group's website and I recommend it to your attention.  Therein he posits the question that addresses, foursquare, my concern: are equities over priced and bonds over yielded?  He concludes that the stock market and bond yields are currently priced in anticipation of a 3% growth in gross domestic product this year, a number he does not believe is achievable.  That said, he warns that if he is wrong and the yield on the 10Year exceeds 2.6% it could signal a bond bear market, something we have not experienced in 30 years.  If I perceive that happening, I will be out of my bond correlated portfolio before you can say----.