April 23, 2017 Exit

Risk/Reward Vol. 349
 
THIS IS NOT INVESTMENT OR TAX ADVICE.  IT IS A PERSONAL REFLECTION ON INVESTING.  RELY ON NOTHING STATED HEREIN.

You don't have to be a Mensa member to notice that over the past several days the yield on the all important US Ten Year Treasury Bond has come to rest below 2.25%.   Why has the bond market rallied recently?  (Remember the value of bonds increases as the yield declines.)  Is it a flight to safety occasioned by the uncertainties surrounding North Korea and the French presidential election?  Perhaps.  But more likely, it is due to Mrs. Bond's continued skepticism first reported at Vol. 341 (www.riskrewardblog.blogspot.com) that The Donald cannot deliver on his promised 3-4% growth in gross domestic product.  This is the opinion of John Authers, senior commentator for the Financial Times, Guggenheim Partners' Scott Minerd and JPMorgan's Nick Gartside, all significant bond market thought leaders.  Oh, and it is also this writer's opinion.  This point notwithstanding, I do not see the yield on the 10Year decreasing much over the next few weeks.

So what does the above mean to me?  It means that given my upcoming overseas assignment (see below), I am exiting the market once again.  Allow me to explain why. 

First let's recap my overall approach.  As I wrote in Vol 343:

"I have come to believe that one can construct a non-diverse portfolio correlated to a market singularity (the 10 Year) with movement by that singularity providing clarity on when to buy, hold or sell.   I submit that by maintaining daily vigilance, adhering to strict principles and fearing not, the buying and/or selling, in short order, of some or all of one’s portfolio, one can achieve a 6% return with minimal risk.  I do not buy the 10Year.  Instead, I buy higher yielding securities that are very closely correlated to the 10Year.  For example, through study and observation, I know that highly regarded preferred stocks maintain a roughly 320 basis point (3.2%) spread to the yield on the 10Year.  Thus if the yield on the 10 Year remains stable at 2.5% one can achieve a 5.7% return by merely holding a basket of highly rated preferred stocks (such as found in the exchange traded fund PGX) and collecting dividends.  If the yield on the 10 Year declines, in time, the yield on these preferred stocks will also decline ultimately reaching equilibrium at the aforementioned 320 bp spread.  As a result, an investor will enjoy a capital gain.  (Remember the price of an interest rate sensitive security increases as the yield declines.)  If the yield on the 10Year increases or one reasonably can anticipate such an increase, one sells thereby retaining any accrued dividends and reaping the aforementioned capital gain.  One then waits on the sidelines, safe and sound in cash, until stability returns to the 10Year and hopefully ahead of preferred stock equilibrium."

Next, remember that I most recently re-entered the market (March 16, 2017) when the yield on the 10Year was at or near 2.6%.  So, as of the end of this past week, I saw a decent capital gain.  Moreover, since I buy mostly monthly payers, I had already captured April's dividend.  Lastly, as noted above, I do not foresee any more near term downward movement in the 10Year yield.  So at a mere $7 a position in transaction costs, why not capture the gain, sit in cash for a while and enjoy my days in Provence sans souci (translated "without worries").  Given my approach, this was a no brainer.  Moreover, exiting the small positions I have in the oil patch also made sense given the bad vibes emanating from that sector recently. (e.g. anxiety arising from the upcoming OPEC meeting)

Did you also notice that Black Rock now has $5.4trillion in assets under management (AUM)?  Did you further notice, that most of its recent growth has been in low cost, low margin passive investment vehicles such as exchange traded funds?  The proliferation of passive investment is the most significant event in recent times in the world of asset management.  It also raises some interesting questions.  All is fine and dandy so long as the indices do well, but what happens if and when they correct?  Will all those index investors sink at the same time given there is no active manager to intercede?  And what about the fact that the three largest asset management groups (Black Rock, Vanguard and Fidelity) now control over $11trillion.  This is stunning considering that the total amount of AUM in the US is only $18trillion and the total worldwide is $78trillion.  Talk about market power.  Let's just say I am glad I manage most of my own money and maintain the above described flexibility.

As noted, Barb and I leave today on assignment to Provence.  We will be assessing the impact of the French presidential election up-close and first hand.  This is a sacrifice, we know, but it should be of benefit to you, our Readers.  And that is all that matters to us.  So, a bientot.