Risk/Reward Vol. 353
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"Gradual and predictable"; these three words sent Mr. Market into paroxysms of joy on Wednesday. Within moments of their utterance, two of the three major indices jumped to record highs where they stayed into this holiday weekend. To what do these words refer? The approach that the Federal Reserve intends to take in reducing its bloated balance sheet. As you may recall, after the 2008 financial crisis, in order to depress interest rates of any and all duration and to support the housing market, the Federal Reserve printed money which it used to buy Treasury bonds and mortgages. In the course of so doing, the Federal Reserve's balance sheet rose from $800 billion to $4.5 trillion where it has remained for the past several years. With unemployment under control and with the prospect of steady if anemic economic growth now a reality, the Federal Reserve desires to downsize---something deemed prudent by all concerned. Just how to downsize has been a major issue with some Federal Reserve staff members suggesting the Fed sell these assets (bonds and mortgages) en masse. This likely would have wreaked havoc on the bond and mortgage markets, something the Fed desperately wished to avoid. And so a gentle run off of debt as it matures has been selected as the vehicle for reducing the balance sheet--- a technique designed to make the process "gradual and predictable." What a relief, even if it further fueled an already overheated stock market.
Understandably, the Fed's announcement also served to assuage an already heady bond market. The yield on the all important US Ten Year Treasury Bond fell below 2.25% on Wednesday and finished the week at that benchmark. The yield dropped despite a June increase in short term rates being a lock. Why? Because like Mr. Market, Mrs. Bond values predictability above all else. And so do I. With clarity as to the future course of Fed activity, I was comfortable adding to my interest rate sensitive portfolio. I purchased positions in JPI and LDP. I remained disciplined and resisted buying any closed end fund that was trading above its net asset value. This is not a hard and fast rule, but so long as there are alternatives trading below NAV, I go with them.
Also this week, members of OPEC and several other petro-producing nations agreed to extend oil production limits for another 10 months. This takes 1.8 million barrels/day off the market. Total world wide production was 82mm bbls/day before the cut. How effective this will be in raising oil prices remains to be seen in light of the ability of United States frackers to increase production cost effectively and at break neck speed. As has been reported ad nauseum in this publication, the wonder that is the US fracking industry continues to outsmart its foreign competition. More and more attention is paid to this juggernaut. Indeed, Exxon, the second largest oil company in the world has shed its traditional bias against fracking and is dedicating 25% of its capital expenditures to that technology this coming year. The impact of fracking is reflected in the lessening of OPEC's influence. Despite the announced extension of the production limits, the price of oil dropped. Mr. Market wanted OPEC to make even deeper cuts. As for me, it gave assurance that the flow of domestic oil will continue to increase. Accordingly, I bought some more pipeline funds (MIE and NML) on the dip.
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