April 19, 2015 Malaise

Risk/Reward Vol. 263

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

The dog ate my homework. Not really, but something just as incredible did occur. My computer chose to “refresh” as I was doing final edits to this week’s edition. When it rebooted all of my work product was gone. I walked away in frustration and decided not to publish this week. But what happened on Friday was too important to let pass without comment. So I will dispense with the usual format and go directly to the point.

According to the financial press, the 279 point (1.5%) drop in the Dow Jones Industrial Average (DJIA) on Friday resulted from a change in the rules applicable to the Chinese stock market, concern over Greece’s possible exit from the Eurozone and a few notable quarterly earnings misses (e.g. GE). Really? These unremarkable events may have caused a negative day but were they enough to wipe out all of the DJIA’s year to date gain? Methinks not. I suspect that the malaise exhibited by market mavens Fink, El Erian, Summers and Gundlach which I have reported over the past few weeks is beginning to in-fect (or at least af-fect) others. This week the most prominent buzz kill came in the form of a transcript of a conversation between billionaire investors Ken Langone and Stanley Druckenmiller (George Soros’ former colleague) in which Druckenmiller likened the current stock market bubble to 2005-06---just before the subprime fiasco. He sees the current situation "ending badly."

No one is saying that the stock market will crash tomorrow, next month or even this year. That said, one must balance risk with reward. Personally, I see little reward from investing in any risk assets at present: bonds or equities with bonds being the riskier of the two. Obviously, Friday’s action demonstrates that I am not alone. So again this week I held pat; not selling anything but overweight cash.

Next week’s calendar is full of earnings reports. Track how many companies meet top line (sales) expectations. (Earnings per share have become less indicative of a company's performance due to the plethora of distortive share buy back programs.) Also, keep an eye on the guidance that companies provide for coming quarters. Guidance could foretell if any stock gains can be expected for the year.

April 12, 2015 Bubble Pop

Risk/Reward Vol. 262

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

“More and more each day

It's not supposed to hurt this way

Tell me, why”---lyrics from “Why” sung by Avril Lavigne


“This is out of our reach

Out of our reach

Negative creep”---lyrics from “Negative Creep” sung by Nirvana

“I got my bubble, hey, I got my bubble, hey hey

I got my bubble, yeah, I make my bubble pop”---lyrics from “Bubble Pop” sung by Rihanna

Contrary to last week's prediction, the stock markets this week were calm with both of the major US indices gaining nearly 1.5%. Their movement was steady, and with the exception of Tuesday, stocks rose “more and more each day.” So, Mr. Know-It-All, “tell me why?” “Tell me why” we are approaching record highs on both the S&P 500 and the Dow Jones Industrial Average when the consensus is that corporate earnings will disappoint this quarter? “Tell me why” the CAC 40 (France), the DAX (Germany) and the FTSE 100 (Great Britain) are at multiyear highs when Europe continues its march toward deflation? “Tell me why” this is occurring when the Chinese economy is now predicted to grow at less than a 7% clip, and the emerging markets are struggling? “Tell me why?”

As demonstrated week after week, my powers of prognostication are questionable at best. Knowing what will happen is clearly “out of my reach/Out of my reach.” But here is my take on where we are. Those of you fully invested in the market are continuing to enjoy the fruits of worldwide quantitative easing (QE). Although our Federal Reserve stopped printing money to buy assets last October, it continues to suppress interest rates and to encourage more risk by rolling over its massive $4.5 trillion balance sheet and by keeping short term yields near zero. In addition, this year the European Central Bank embarked on its own QE-buying spree purchasing 60billionEuro’s worth of sovereign debt every month for the foreseeable future. The impact is obvious. With short to medium duration bonds throughout Europe doing a “negative creep”, with the German 10 Year Bund yielding only 0.15%, the French 10Year bond yielding 0.43% and the Spanish 10Year bond yielding only 1.22%, investors in search of a return have few choices: buy US debt (US 10Year yielding a mere 1.9% and investment grade corporate bonds only 2.9%) or buy progressively more expensive equities in the hope that they will continue to appreciate.

With stocks trading at record multiples of earnings, are we “in a bubble, hey/a bubble hey”? Don’t rely on me for an answer. Read Larry Fink’s letter to shareholders. For those who don't know, Mr. Fink is the founder and chairman of BlackRock, the world's largest asset manager with $4.5trillion (yes, that's trillion) under management. The letter can be found at www.blackrock.com . In pertinent part, it reads: “The mix of growing assets and shrinking yields is creating a dangerous imbalance. Yet monetary policy makers (read: central bankers) seem insufficiently attuned to the conundrum their actions are creating for investors: reach for yield and continue to fuel the expanding bubble or remain on the sidelines...” Fink calls the search for yield the “greatest source of prudential risk in the financial system.” How close are we to having the “bubble pop?” I don’t know. I do know that one of my favorite market guru’s, Mohamed El Erian, said last week that he is now mostly invested in cash because "asset prices have been pushed by central bankers to very elevated levels.” I too remain overweighted in cash.

And so, two weeks in a row this publication bears a negative tone while the markets continue to rise. Come to your own conclusions, and share them with me. Maybe I am too much like Rihanna. Instead of pleading "Please don't stop the music", I am living in “Disturbia”, opening an “Umbrella” and “Taking a Bow.” I can't help it. I am uneasy. Thus I am cautious. “Sticks and stones may break my bones”, but I am not “just gonna stand there and watch my nest egg burn.”

April 4, 2015 Bottom Line

Risk/Reward Vol. 261

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

‘I won't pay, I won't pay ya, no way

Why don't you get a job?

Say no way, say no way ya, no way

Why don't you get a job?”---lyrics from “Why Don’t You Get A Job” sung by The Offspring

“I'm dying to(o)

The sun will shine

The bottom line

I follow you”---lyrics from “Bottom Line” sung by Depeche Mode

“Why's this fussing and a-fighting?

I want to know, Lord, I want to know

Why's this cheating and backbiting?

I want to know, oh, Lord, I want to know now”---lyrics from “Fussing and Fighting” sung by Bob Marley

With both the Dow Jones Industrial Average and the S&P500 flat year to date, one wonders what the second quarter will bring. The employment news reported on Friday does not bode well for the economy and thus casts doubt on the markets. Only 126,000 jobs were added in March, well below the 245,000 that were expected. Moreover, adjustments to previously reported numbers lowered average monthly job growth for the first quarter of 2015 to 197,000 as compared to 324,000 in the last quarter of 2014. It appears that the answer to the question “Why don’t you get a job” is because “I won’t pay, I won’t pay ya, no way.” On the positive side was news that the unemployment rate remained at 5.5%, but even that was tempered by the fact that the employment participation rate fell to 67.8%, the lowest percentage since 1978.

So why has job growth slowed? Many commentators place the blame on an anticipated drop in corporate earnings. They fear that that this quarter and indeed this year “the sun will not shine” on “the bottom line.” One reason lies in the strong dollar. A strong dollar versus other major currencies has the effect of lowering foreign based revenue. A Euro’s worth of earnings last year at this time was worth $1.37. It is worth $1.08 today. Stated differently, the same amount of sales in Europe (Euros) this year means 26% less in reported dollar revenue. This has proven problematic for every major company with significant international operations and/or sales. In short, the strength of the dollar is a major headwind for earnings, and earnings are the major determinant of a stock’s price. With the average S&P500 stock trading at an historically rich 17 times expected future earnings, any drop in those earnings (even if the reason is solely the dollar/Euro exchange rate) will undoubtedly exert downward pressure on stock prices. Without earnings growth and stock appreciation, corporate managers will not hire.

So what does this all mean to an income investor such as yours truly? If next month’s job report also disappoints, we likely will not see the Federal Reserve raise interest rates in June. Indeed, the immediate reaction to Friday’s jobs number upon the yield of the bellwether 10Year Treasury Bond so portends, as it fell to 1.84%. For me, nothing is more important than knowing the timing and extent of any interest rate change. “I want to know, Lord, I want to know now.” The Fed itself will not tip its hand, but look for a public debate by and between individual Fed members and Fed watchers as rate hawks and rate doves engage in “fussing and a-fighting” over the next few weeks and months. In the meantime, I remain overweighted in cash.

Next week should prove interesting as Alcoa kicks off the first quarter’s earnings report season. Between earnings and Fed watching, I see a period of volatility in the markets with as many boo days as yea days. All the while, market commentators will be overreacting both to the positive and to the negative, as if taught by that noted financial journalist, Bob Marley:


“Come on and stir it up; ..., little darlin'!

Stir it up; come on, baby!

Come on and stir it up, yeah!

Little darlin', stir it up! O-oh!”

March 28, 2015 Two Steps Back

Risk/Reward Vol. 260

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

“We've given each other some hard lessons lately

But we ain't learnin'

We're the same sad story that's a fact

One step up and two steps back”---lyrics from “One Step Up” sung by Bruce “The Boss” Springsteen

“For a small piece of paper/ It carries a lot of weight

Oh, that mean, mean, mean, mean, mean green”---lyrics from “For the Love of Money” sung by the O’Jays

“I got no fever/But I'm feeling the heat

Oh boy, someone get me out of here”---lyrics from “Get Me Out of Here” sung by Paul McCartney

Both the Dow Jones Industrial Average and the S&P500 fell this week. Year to date, both sit in the red. There are many cross currents at work (e.g. the divergent monetary policies here and in Europe, the rise in the dollar, the crisis in the Arabian peninsula, etc.) Indeed, it seems this year we take “one step up and two steps back.” “We’ve given ourselves some hard investing lessons lately”, but “we ain’t learning"”---at least I'm not. If you can make sense of it all, please contact me. Indeed, it is this pervasive uncertainty that caused me to sell several positions earlier this month (as discussed in Vol. 258 www.riskrewardblog.blogspot.com ). And I am not alone. So far this year, net outflows from equity exchange traded funds (ETF’s) total $44billion, more than at any time since the crash of 2009. SPY, the S&P500 ETF, alone has experienced $26billion in net outflows.

I still am heavily in cash. In the absence of inflation and without any ability to receive a return on short term deposits (have you checked money market and cd rates lately), cash is not a bad place to be. “For a small piece of paper/It carries a lot of weight/That mean, mean, mean, mean, mean green.” I am locked and loaded and ready to invest. I just don’t see many desirable targets. Again, I am not alone. Where are we headed? After six years of zero bound interest rates, we have a Federal Reserve which seems hell bent on raising rates in the face of contrary moves by virtually every other central bank in the world and, as noted above, in the complete absence of inflation. In so doing, corporate profits will suffer, and our balance of payments will worsen as consumers opt for cheaper imported items. To add to this uncertainty, the Fed has become more opaque in its communications.

Even though “I got no fever” to invest at present, I have repurchased some irresistibly cheap oil and gas plays and some preferred stock positions. These were made without great conviction, so if “I’m feeling the heat” from rising interest rates or otherwise, I will “get me out of here.” Accordingly, a major consideration in this round of investing was liquidity---the ability to sell at or near the last quoted price. The best way to insure liquidity is to purchase securities for which there is a robust market; to wit a lot of volume. Much of what has appealed to me in the past (e.g. closed end funds) is thinly traded. From time to time I have been disappointed by the spread between what is asked and what is bid on these. Volume lessens this spread. How has this affected my recent purchases? Here is an example. I opted for more PGX than FFC in the preferred stock fund space because PGX trades at 10 times the average daily volume of FFC. I did so even though PGX pays a substantially smaller dividend. For a discussion of the role of liquidity in investing, read Howard Marks’ ( see Vols. 173 and 234 www.riskrewardblog.blogspot.com ) excellent memo on the topic published just this week. It can be found at www.oaktreecapital.com/memo.aspx .

What I have written above reads negative. Truthfully, I am less negative than I am frustrated. But frustrated I must not become. I remain convinced that someday, I will find the secret sauce to investing. In that regard, I am like The Boss:

“Oh-oh, someday girl
I don't know when

We're gonna get to that place
Where we really wanna go 

And we'll walk in the sun 

But till then, tramps like us, 

Baby we were born to run”

March 21, 2015 Say What You Mean

Risk/Reward Vol. 259

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

“Say what you mean

Mean what you say
Think about the words
That you’re using”---lyrics from “Say What You Mean” sung by The Moody Blues

“And I don't give a damn about a greenback dollar

Spend it fast as I can/For a wailin song and a good guitar

The only thing that I understand, poor boy”---lyrics from “Greenback Dollar” sung by Hoyt Axton

“It was an itsy bitsy, teenie, weenie, yellow polka dot bikini

That she wore for the first time today”---lyrics from “Itsy Bitsy….” sung by Brian Hyland

Going into this week’s meeting of the Federal Reserve’s Open Market Committee (FOMC), the conventional wisdom was that if the FOMC removed the word “patient” from its forward guidance, an interest rate increase could be expected in June. In addition, it was believed that any such removal would cause the dollar to rise, the interest rate on the 10Year US Treasury to spike, the price of oil to drop and the stock market to plummet. “Patient” was removed, but in so doing the FOMC did not “Say what it meant/Or mean what it said. Instead, Chair Yellen emphasized that removal of the word “patient” does not mean that the FOMC will be “impatient” when it comes to any rate increase. Really? How disappointing, Janet. Is this casuistic double speak any kind of guidance? Did you really “think about the words/That you’re using?” To explain the ensuing spike in the stock market, the precipitous drop in the rate on the US Treasury 10Year Bond (10Year), the decline in the dollar vs. the euro and the rise in oil prices (all of which occurred in the 90 minutes between the issuance of FOMC press release and the end of Yellen’s press conference), commentators pointed to the obvious synonymity of “patient” and “not impatient” and to the following data points. First, the FOMC lowered the natural unemployment rate (that is, the rate at which wages will impact inflation) from 5.5-5.2% to 5.2-5% thereby effectively removing low unemployment as a reason to raise rates (as predicted in Vol. 254 www.riskrewardblog.blogspot.com ). Second, the FOMC lowered its 2015 GDP growth forecast from 2.6-3.0% to 2.3-2.7%. Third, the FOMC is now predicting ultra-low inflation for 2015 of 0.6-0.8%, well below its target of 2%. All of these augur a later rather than sooner rate increase, if one at all.

Mentioned only in passing by Yellen, but of equal importance to the three points above was the FOMC’s concern about the currency war of which I wrote last week. (See Vol. 258 www.riskrewardblog.blogspot.com). Raising rates any time soon will have the side effect of strengthening the dollar even more versus every other world currency. And a strong dollar already has begun to negatively impact our economy. As discussed last week, corporate profits for multinational corporations are down due in large part to currency exchange rates. Exports are suffering. And foreign tourists are staying home in droves. After all, one hundred dollar’s worth of entertainment which cost Eurotourists only sixty nine euros last year now costs them ninety six euros. By its charter, the Federal Reserve is to address only domestic economic issues. But clearly, domestic issues are “not the only thing it understands.” Indeed, it would be folly for the Fed to “not give a damn about (anything other than) a greenback dollar” because in this world, no currency exists in a vacuum.

The above points may have grabbed the attention of commentators this week, but I predict that the data point with the most significant long term impact is the shift in the individual FOMC member’s predictions as to what the year-end 2015 and 2016 overnight borrowing rates will be. These predictions are plotted on a graph called the “dot plot.” From these “itsy, bitsy, teeny, weeny polka dots”, one could see “for the first time today” a significant slowing of the pace of rate increases should they ever begin. The consensus of the members is now that at year end 2015 the overnight (or Fed funds) rate will be 0.625% as opposed to their consensus just three months ago that the rate would be 1.125%. Equally telling was the lowering of the consensus year end 2016 rate from 2.5% to 1.875%. These changes are significant for all investors, but particularly for income investors; those whose securities are priced in relation to the yield on the benchmark US 10Year. Once the dust settles from this week’s volatility, I can repurchase what I sold with more confidence that any profit I garner will not be eroded by a spike in the 10Year rate and a concomitant drop in price---even if a modest rate increase is instituted in June.

On Wednesday between 1:30 and 3:30 pm, the DJIA average spiked 2% and the yield on the bellwether 10Year dropped 6%. Billions of dollars were made or lost, all because a few, enigmatic words were written and/or spoken by a handful of economists. This leads one to ponder the awesome power that we have conferred on the Federal Reserve Board. No member is elected, and during one’s term, no member is answerable to anyone. Is this wise? Well, at present, perhaps. The alternative is leaving such weighty decisions to a community organizer or to an overly tanned, weepy weekend golfer. In the long run, however, the role of the Fed should be re-examined. Until then, we, like the Moody Blues, are left with the following “Question” about the Fed:

“Why do we never get an answer

When we're knocking at the door
It's not the way that you say it

When you do those things to me.

It's more the way that you mean it

When you tell me what will be”.

March 14, 2014 Blurred Lines

Risk/Reward Vol. 258

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

 "Over there/Over there
Send the word/Send the word over there
That the Yanks are coming/The Yanks are coming "---lyrics from "Over There" sung by George M. Cohan

"You have to learn to pace yourself
Pressure
You're just like everyone else
Pressure"---lyrics from "Pressure" sung by Billy Joel

"Can't let it get past me
You're far from plastic
Talk about getting blasted
I hate these blurred lines."---lyrics from "Blurred Lines" (apparently) written by Marvin Gaye

George M. Cohan wrote "Over There" when the US became embroiled in Europe's Great War.  As described in Vol. 254 (www.riskrewardblog.blogspot.com ), the US is once again embroiled in a European war.  This time it is a currency war.  Since January, 2014 the Euro has dropped 25% against the dollar, falling over 12% in the past three months.  It now sits at $1.04.  Why is this important to US investors?  It means that the profits earned by US companies with sales "Over There/Over there" are worth 25% less than a year ago.  According to Thomson Reuters, this currency differential alone will cause the companies comprising the S&P 500 (which,combined, derive 35% of their total revenue from outside the US) to report 2.8% lower earnings in the first quarter of 2015 compared to last year.  Lower earnings translates into lower valuations since the primary determinant of a stock's value is its earnings per share times a generally static market multiple.  The converse is true for European companies, particularly those with a large presence in the US. "Send the word/send the word". Eurozone multinationals such as Luxottica, the eyewear manufacturer (e.g. Lenscrafters, Pearle Vision, RayBan, Oakley, etc.), are seeing their Euro denominated profits soar simply as a result of an appreciating dollar.  One hundred dollars of profit earned from US sales translated into 69 Euros of profit one year ago.  That same US profit today translates into 95 Euros of profit.  With European companies booming as a result of the Euro's devaluation, "the Yanks are coming/The Yanks are coming."  Or at least their investment dollars are.  Several European stock indices including the broad based Stoxx Europe 600 are hitting multiyear highs.

The impact of the Euro's devaluation undoubtedly will put "Pressure" on the Federal Reserve's Open Market Committee (FOMC) when it meets next week.  Any signal that the Fed is more resolute to raise interest rates in June will cause the dollar to appreciate even more against the Euro.  This in turn will further depress US corporate profits.  Several major US corporations such as Procter & Gamble, Apple, Intel and the auto manufactures already have warned that the strong dollar is impeding their ability to compete in the world market.  With the US's recovery still very tenuous, any drop in sales by these and/or other US based multinationals could be deleterious to our economy.  Add to this the deflationary effect of $45/bbl. oil and there is "Pressure", indeed, on the Fed not to act.  As much as its hawkish members may want to raise rates, the entire FOMC may "have to learn to pace themselves." "Like everyone else", keep a close watch on the language of the FOMC's March 18th press release.

So what does all of this mean to an income investor like me?  On the one hand, as demonstrated last week, the mere threat of an increase by the Fed can cause interest rate sensitive securities to tank.  (Remember an increase in a security's interest rate means a decrease in its value).  On the other hand, the major engine of the Euro's devaluation; to wit quantitative easing (bond purchasing) by the European Central Bank, has resulted in the yield on the bellwether US 10 Year Treasury Bond to fall despite the specter of the Fed moving rates up.  After all, given a choice, with the German 10 Year Bund yielding only 0.26%, what rational investor wouldn't rather purchase a US 10Year yielding 2.11%?  In short, I am seeing conflicting signals; signals which produced last week's volatility in both the stock and bond markets. "I hate these blurred lines."   Wanting to avoid "getting blasted" by a precipitous rate hike (and price drop) which could come if the FOMC's communique next week bespeaks a June rate increase, I reduced my exposure to interest-rate-sensitive securities such as preferred stock closed end funds, real estate investment trusts and utilities.  I may repurchase all that I sold this week as early as next week depending on the outcome of the FOMC meeting.  I held most of these in tax deferred retirement accounts so the only costs associated with the sale were some modest trading fees ($7-9/transaction) and the off-chance of rapid capital appreciation.

With Marvin Gaye so prominent in the news this week, I sought inspiration from his song titles.  The "Blurred Lines" described above make it nearly impossible to determine "What's Going On".  Having "All I Need to Get By", I don't need to speculate.   So instead of relying on what "I've Heard Through the Grapevine", I decided to "Give It Up"--for a short while at least.

March 7, 2015 Long Time Comin'

Risk/Reward Vol. 257

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

"Oh, bring it to me/Bring your sweet lovin'
Bring it on home to me."---lyrics from "Bring It On Home To Me" sung by Sam Cooke

"She's so European/She's one of a kind
And she's so European/I found out today."---lyrics from "She's So European" sung by KISS

"It's going down for real
It's going down for real"---lyrics from "GDFR" sung by Flo Rida

On Monday, the NASDAQ, the technology index, closed above 5000; up nearly 20% over the past 12 months and up 170% since I first began writing this blog in 2010. Oh, such "sweet lovin" it would have "brought home to me" had I invested in QQQ (the exchange traded fund that tracks the NASDAQ) back then. But the news of the NASDAQ attaining 5000 also "brought something else home to me,"--- very unpleasant memories. You see, it was March, 2000 when the NASDAQ last hit 5000. It has taken 15 years to reach that mark again. Back in March, 2000, I was a tech stock devotee and was riding very high. However within a matter of weeks of the NASDAQ hitting 5000, tech stocks generally and mine in particular (remember JDSUniphase, Nortel, Corning, etc.) began to fall. I rode them down to nearly nothing. That was a bitter lesson, but one I have not forgotten. That experience and the Crash of 2009 (which through dumb luck I avoided in its entirety ) have shaped my investment philosophy. Rule #1: Sell any stock before absorbing an 8% loss. Rule # 2: Never forget Rule #1.

If you read financial newspapers or blogs, you have noticed that nearly everyone is advocating exposure to European stocks. Many market gurus believe that the launching of quantitative easing there will have the same effect that it had here; to wit, to drive investors out of bonds and into equities. Indeed, if you have not noticed it before now, you are "finding out today" that Mrs. Market is "so European/She's so European." The exchange traded fund (ETF) that I use to invest in Europe, HEDJ, is up 18% year to date, and I continue to add positions. There are several other ETF's that invest in European stocks (e.g. Vanguard's VGK). I chose HEDJ because, as its name suggests, its holdings are hedged against the deflating Euro which now is worth only $1.08, its lowest point in 13 years.

Investing in oil became a bit riskier this week. Although the price of domestic crude held above $49/bbl., two news stories caused second thoughts in regard my re-entry into the sector. First, the storage facilities for domestic crude located at the US hub in Cushing, OK are nearing capacity. Should domestic oil supply outstrip storage capacity, the price of crude is "Going down for real/It's going down for real.". Some market watchers see a free fall to $25/bbl or lower. Second, the CEO of Exxon stated this week that investors should expect an extended period of depressed oil prices. The impact of hydraulic fracturing ("fracking") has yet to be fully felt even with the cutbacks in production announced recently by virtually every oil exploration and production company. Put simply, oil is becoming more plentiful everyday. I am keeping my oil stocks for now, but will watch crude prices like a hawk.

My discussion above of other market trends notwithstanding, I remain laser focused on the yield on the 10Year US Treasury ("10Year"). A better than expected jobs report on Friday and comments this week by several members of the Federal Reserve's Open Market Committee (FOMC) improved the odds that a rate increase will come as soon as June. The yield on the 10Year is now so portending as it skyrocketed to 2.24% on Friday, its highest close since December 26, 2014. Oh, and don't tell me that the major indices are not impacted by the yield on the 10Year as the Dow Jones Industrial Average gave up 279 points on Friday. It now stands where it was at year end 2014. The FOMC meeting on March 17-18 could be very telling on the timing of any rate increase; so much so that in advance of it, I may reduce temporarily my exposure to the most interest rate sensitive portion of my portfolio. To quote Sam Cooke, when it comes to any interest rate increase

"It's been a long time, a long time coming
But I know a change gonna come, oh yes it will."

And despite my heretofore belief to the contrary, it is looking more and more like it will come in June.

February 28, 2015 (New England) Patriot

Risk/Reward Vol. 256

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

"Come on, all you people, say
W-O-R-D up/W-O-R-D up"---lyrics from "Word Up" sung by Cameo

"And I ain't no democrat
And I ain't no republican
I am/I am/I am a patriot."---lyrics from "I Am a Patriot" sung by Jackson Browne

"Pump it up/Show me love
Pump it up/Let me see what you workin' wit' "---lyrics from "Pump It Up" sung by Missy Elliott

As predicted, Fed Chair Janet Yellen's testimony before Congress dominated the financial news this week. Although she hinted that the "W-O-R-D" "patience" would be eliminated in future Federal Reserve communiques regarding the timing of any rate increase, the yield on the bellwether 10Year US Treasury Bond ("10Year") did not go "up" as many had predicted. Instead it fell to 2% where it hovered for the remainder of the week. Why, you ask? Because the key determinant of any rate increase now has shifted from the unemployment rate to the rate of inflation/deflation; a switch this writer foresaw a few weeks ago. (See Vol. 254 www.riskrewardblog.blogspot.com ). Here is the portion of her testimony that signaled this switch: "Provided that the labor market conditions continue to improve and further improvement is expected, the committee anticipates that it will be appropriate to raise the target range for the federal funds when, on the basis of incoming data, the committee is reasonably confident that inflation will move back over the medium term toward our 2% objective."

Accordingly, now more than ever, income investors (those with holdings priced in relation to the 10Year) must be students of the presence or absence of inflation. On this point "I ain't no democrat/And I ain't no republican". I just want to know the direction. The data reported this week indicates that we are still nowhere near 2% inflation. Both existing and new home sales missed expectations, jobless claims increased and most significantly, the consumer price index (CPI) fell 0.7% between December and January and fell 0.1% over the past 12 months. Stripping food and energy from the equation (leaving the so-called "core inflation") results in the CPI increasing at an annual rate of only 1.6%, still quite far from 2%. And don't look for any inflationary trend elsewhere in the world. Deflation has hit the Eurozone. Consumer prices there have dropped 0.6% over the past year. Germany just issued 5 year bonds at a negative interest rate---that's right, those purchasers willingly bid upon and received the right to receive LESS in five years than what they paid this week! What? In short, incoming data indicates that every major economy in the world is deflating, not inflating It's no wonder the US bond market, including the bellwether 10Year, traded as if a rate increase were in the distant future. As an income investor, "I am/I am/ I am like a (New England) Patriot." I win with deflation---at least in the near term.

One sector in which prices appear to have bottomed is oil. A spate of production cuts has "pumped it up" with the price stabilizing just below $50/bbl. This has emboldened me to tiptoe back into the arena. As discussed last week, I have initiated several positions in the preferred stock of Magnum Hunter (MHRpC and MHRpD) which is really a natural gas play. These positions continue to "show me love.". This week I bought the preferred stock of Vanguard Natural Resources (VNRBP) after reading the transcript of a February 17, 2015 guidance call (available at www.vnrllc.com ). Therein, VNR's CEO "let me see what he was was workin' wit'. " He stated that VNR had reduced substantially its common share distribution, had strengthened its balance sheet and had solidified its hedges, all of which added to the credit worthiness of VNR's preferred. I am not alone in recognizing VNRBP as a bargain. It has appreciated 6.5% since I bought it on Monday. To reiterate, I believe that the recent stabilization of oil prices provides clarity as to which of the small oil and gas producers will survive and prosper. And I am betting on MHR and VNR.

For the second week, the major stock indices have remained remarkably stable. Given the negative incoming economic data, this performance is as good as one can expect. Through it all, I remain a student of that which impacts the yield on the 10Year. (See Vol. 221 www.riskrewardblog.blogspot.com ) To quote Jackson Browne:

"Doctor my eyes have seen the years
And the slow parade of fears without crying
Now I want to understand."

February 21, 2015 Magnus Opus

Risk/Reward Vol. 255

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

"But minute by minute by minute by minute
I keep holding on"---lyrics from "Minute By Minute" sung by The Doobie Brothers

"You won't see me
Time after time

You refuse to even listen"---lyrics from "You Won't See Me" sung by The Beatles

"'Cause rockin' and rollin', it's only howlin' at the moon
It's only howlin' at the moon"---lyrics from "Magnus Opus" sung by Kansas

As an income investor, my fate often rests upon the market's reaction to Federal Reserve meeting minutes. "Minute by minute by minute/I keep holding on"---and never so much as this week. Allow me to explain. As discussed in last week's edition (See Vol. 254 www.riskrewardblog.blogspot.com), many market participants believe that the improved domestic employment picture alone will prompt the Federal Reserve to raise short term interest rates, and to do so as early as this coming June. For the reasons explained in that edition, I disagree. But Mr. Market clearly is skittish and overreacts to any signal either way. As a consequence, the bellwether 10 Year US Treasury was volatile this week in sharp contrast to the quiescent major stock indices; Friday notwithstanding. On Monday and Tuesday, the yield on the 10Year spiked 12 basis points (6%) on news that some Fed members were anxious to eliminate the word "patience" from future Fed communiques thereby signaling a desire to raise rates sooner rather than later. On Wednesday, however, minutes from the Fed's January meeting were released. They bespoke a more hesitant tone in regard any rate increase. Also on Wednesday, the Commerce Department released January's producer price index. It showed that the prices businesses received for their goods and services declined (deflated) by 0.8% between December and January and that those same prices have remained flat over the preceding 12 months. This news was disappointing to the Fed which would prefer for these and other prices to inflate at a 2% annual rate before it begins to normalize interest rates. Housing start date released that day also showed a negative trend. In response, the rate retraced back to 2.07 and then gradually moved to 2.13 by week's end.

Because I believe that the yield on the 10Year will stabilize, I have held steady even as the capital appreciation that I experienced in January has eroded. (Remember the higher the yield the lower the price). As in income investor my primary focus is dividends and interest, not capital appreciation---although the latter is welcome anytime. That said, I will not tolerate any significant loss of capital. As a consequence, if the bellwether rate, off which many of my holdings are priced (e.g. preferred stock closed end funds, municipal bond funds, real estate investment trusts and utilities), continues to rise sharply and causes my capital position to enter the red zone, "you won't see me" in the market any longer. As I have stated "time after time", my primary purpose in this entire Riskreward exercise is to avoid loss. Doing so is a victory in and of itself. The cries of anguish uttered in 2008 still ring in my ears even if "you refuse to listen."

One very bright spot for me in an otherwise disappointing February has been the performance of the preferred stock of Magnum Hunter Resources (MHRpC and MHRpD). MHR is a small exploration company engaged primarily in fracking for oil; that is until 2014. At that time, MHR began divesting its oil properties (at the market's top) and investing heavily in natural gas properties. When the price of oil plunged recently, MHR was painted with the same brush as every other small oil exploration company and lost over half of its value. Thereafter, MHR's CEO went on a public relations campaign to explain that MHR was not an oil company, but a natural gas company---one that could operate profitably even if the price of natural gas fell to $2/mmBTU (current price is $2.82). Further, he has been candid and transparent on cash flow expectations, so much so that an article appeared Thursday in the online version of Forbes in which investment advisor Jim Collins sang the praises of MHR in general and its preferred stock in particular. Indeed, the MHRpD that I bought on January 23, 2015 is up 40% while still paying a 10% annual dividend amortized monthly. Follow on purchases of it and MHRpC have also experienced double digit appreciation. I must warn those that may be interested, MHR preferreds are not for the faint of heart. They are thinly traded and have a history of volatility. They have "caused me a lot of rockin' and rollin'. And in times past, I have found myself "howlin' at the moon" for owning them. That said, I intend to buy more. This time, it looks like Magnum Hunter may actually be a "Magnus Opus".

Over the next few weeks I see both fixed income and equity markets dominated once again by Federal Reserve signals. Look for volatility on February 24th when Chair Yellen addresses Congress and again on March 18th at the conclusion of the Fed's FOMC meeting. I will take my lead from the band, Kansas. If Yellen signals that interest rates will remain low, I likely will "Carry On, My Wayward Son." If she signals that an increase is imminent, I may disappear from the market like "Dust In The Wind"---reappearing only after that dust settles and rates attain some stability.

February 14, 2015 War, What Is It Good For?

Risk/Reward Vol. 254

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

"Tell me why
Why, tell me why."---lyrics from "Tell Me Why" sung by Taylor Swift

"War, huh Good God
What is it good for?"---lyrics from "War" sung by Edwin Starr

"Like electricity, electricity
Sparks inside of me and I'm free, I am free."---lyrics from "Electricity" sung by Elton John

As the March meeting of the Federal Reserve approaches look for a shift away from employment and toward deflation as the key determinant of if and when the Fed begins to raise interest rates. As discussed here over the past two years (See e.g. Vols. 201 and 204 www.riskrewardblog.blogspot.com ) deflation is a central banker's greatest fear. And we appear to be headed in that direction. This week the Commerce Department announced that aggregate consumer spending (read, demand) dropped for the second consecutive month. So, "tell me why/Why tell me why" this is to be feared? The best explanation is contained in a speech given in 2002 by then Fed Chair Ben Bernanke ( www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021121/default.htm ) . As explained by Bernanke, deflation almost always results from a collapse in aggregate demand, the economic effects of which are recession, rising unemployment and financial stress. The Great Depression is the most recent example of sustained deflation, and it haunts this generation of central bankers like no other historical event. Why? Because central bankers have very few conventional tools to combat deflation. Indeed, the solution of the Great Depression had nothing to do with central banks. It was WWII which spurred unprecedented economic activity; first in arming the world and then in its wake, rebuilding virtually every city and town in Europe and Japan.

So, Edwin Starr, in answer to your question, "war is good for" for something---spurring economic activity Admittedly, the human cost is too great to desire a physical war. But wars come in many varieties, and we are in the midst of one right now---a currency war. Allow me to explain. One remedy for deflation in any one country is what Adam Smith phrased "beggaring thy neighbor": that is, in a world beset by lessening demand adopting economic policies that worsen other countries' ability to compete in comparison to yours. The easiest and most obvious means of accomplishing this is devaluing one's currency. Here is an example. If one wants more tourists to visit the Eurozone (tourism is Italy's largest industry and constitutes 7% of France's gross domestic product), devaluing the Euro from $1.40 to $1.14, as has occurred in the past twelve months, makes European travel very attractive to those outside the Eurozone. Indeed, a friend of ours is renting a beautiful three bedroom apartment in Grenada, Spain for $1000/month---much cheaper than living comparably in the US! And how does one devalue the Euro? The easiest way is to set interest rates at zero or below thereby punishing anyone who elects to hold Euros---just as the ECB has done. Savers of euros become losers. The thinking quickly becomes: "dump Euros and buy dollars even below the prevailing exchange rate because it will be worse tomorrow." And, this approach is spreading. Sweden's central bank announced this week that it will charge depositor institutions for retaining cash, a penalty which will trickle down to individual depositors in short order. In sum, a currency war is now fully underway with the US dollar appreciating versus every other major currency. That is not good news for US domestic industries. As a consequence and to complete the point made in the first paragraph, if for no reason other than to remain competitive in a deflationary world plagued by lessening aggregate demand, I do not see the Federal Reserve raising interest rates (and thereby strengthening the dollar even more) any time soon.

What does this mean for investors? I believe that the recent upward trend in the yield on the bellwether 10Year Treasury (from 1.6 % to 2% in two weeks) occasioned by the belief of many that the continuing improvement in employment numbers alone will cause to Fed to raise interest rates will abate or even reverse once the Fed's focus switches away from employment and toward deflation. I see that happening as soon as the Fed's March meeting. If I am right and the yield on the 10Year stabilizes near 2% or drops, a buying opportunity for interest rate sensitive stocks will present. One sector negatively impacted by the recent spike in rates has been utilities---"like electricity, electricity". Utilities as a group have experienced a 5% or more decline this month despite the broader market registering record highs. This sector did very well last year, and utilities are still relatively expensive. They are by no means "free." But, the dividends paid on some are now above 4%. If and when they approach 5%, they will be a bargain and will send "sparks inside of me." (Remember the higher the yield on dividend paying stocks, like bonds, the lower the price.)

We are at war---no doubt. But I have faith that our Federal Reserve will do the right thing and will keep interest rates low. Like Taylor Swift, Janet Yellen sees deflation for what it is:
"Trouble, trouble, trouble."

February 7, 2015 Too Marvelous For Words

Risk/Reward Vol. 253

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

“For nobody else, gave me a thrill/ With all your faults, I love you still
It had to be you, wonderful you/ It had to be you”---lyrics from “It Had To Be You” sung by Frank Sinatra

“On the rebound, it's a replay
On the rebound, it's a replay
Your love was on the rebound”---lyrics from “On the Rebound” sung by Uriah Heep

“Were you the last to know?
Were you left out in the cold?
What you did was low”---lyrics from “Low” sung by Kelly Clarkson

If ever a week exemplified the adage “There is No Alternative” (to United States equities, that is), it was this one. (TINA discussed in Vols. 164, 201 and 250 www.riskrewardblog.blogspot.com ). The two major indices regained all of their year-to-date losses with the Dow Jones Industrial Average closing 660 points higher and the S&P 500 up 60 points above last Friday’ close. This was achieved even though Europe remains in the dumps with the European Central Bank balking at buying Greek debt.
China’s growth prospects are so dim, its central bank loosened reserve requirements hoping to encourage more lending. Literally, “nobody else gave me a thrill/ With all your faults, I love US equities still/ It had to be you, wonderful you/ It had to be you.”---if you want any return on your investment. And I see no end in sight.

The guidance given during the most recent earnings season (which just now is concluding) indicates that, cumulatively, the companies comprising the S&P500 will grow profits 3.5% this year which is well above an earlier forecast of 1.1% growth. Moreover, oil prices are “on the rebound.” I’m not sure we will experience “a replay” of $100/bbl. oil, but seeing the price rise above $50 has given Mr. Market assurance that the all- important domestic energy industry will continue to grow and prosper. Adding further encouragement is the growth in employment. A report on Friday indicated that 257,000 net new jobs were added in January.

The only negative on the domestic front this week was the sharp increase in the yield on the 10Year US Treasury Bond. This bellwether against which all income securities are priced spiked from 1.67% last Friday to 1.94% at the close yesterday. Bond traders are signaling their belief that the good news described above will justify the Federal Reserve raising short term rates sooner than 2016. This week's spike negatively impacted my interest rate sensitive portfolio, but I am holding pat. (Remember higher rates mean lower prices.) Certainly, I don’t “want to be the last to know” or to otherwise be “left out in the cold” should rates continue to rise sharply. But, I believe the rise will moderate if not reverse. I see too many headwinds to the Fed taking action this year. For example, on Monday the U.S. Commerce Department released last month’s personal consumption expenditure (PCE) index upon which the Fed relies for measuring inflation. That index indicated that we are well below the Fed’s targeted 2% annual inflation rate. Raising interest rates would only dampen inflation more. Moreover, other Commerce Department numbers indicate that US exports are declining. This is a direct result of the strength of the US dollar versus other world currencies. Raising interest rates strengthens a currency and thus would only exacerbate this problem. Time will tell, but I am still of the belief that interest rates will remain low. That said, my eye remains focused on the yield/rate on the 10Year.

Investors in US equities this week were “On the Sunny Side of the Street”, “Come Rain or Shine.” They reaped more than just “Pennies From Heaven” and “Three Coins in a Fountain.” Moreover, their good fortune was not the product of “Witchcraft” and was not a gift from some “Stranger in the Night.” It came from understanding that opportunities exist here unlike anywhere else in the world. And with apologies to Ol’ Blue Eyes, that is “Too Marvelous For Words.”

January 31, 2015 They Can't Take That Away

Risk/Reward Vol. 252

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

“The way you haunt my dreams.
No, no - they can't take that away from me”---lyrics from “Can’t Take That Away From Me” sung (originally) by Fred Astaire

“You got my cellphone number
Make that call”---lyrics from “Cell Phone #” sung by The Plain White T’s

“The world that we’re livin’ in
People keep on giving in
Making wrong decisions
Only visions of the dividend”---lyrics from “Where Is The Love” sung by Black Eyed Peas

Volatility continued this week. The Dow Jones Industrial Average had positive and negative triple digit days, closing down 508 points. The S&P 500 closed down 57 points. January saw each drop more than 3%. Clearly, we are in the throes of what market guru Mohamed El Erian terms “divergence.” Good job growth and encouraging earning reports in the US are trumped by continuing problems in Europe and Asia. As an example, the Eurozone’s economic powerhouse, Germany, this week reported that it is in a state deflation. The composite price of goods and services there has fallen 0.3% year to year as of January. And then there is Greece. Adding to the uncertainty this week was the enigmatic press release issued by the Federal Reserve at the conclusion of its mid week meeting. Some interpreted the statement as signaling that short term interest rates will rise as soon as June. Others read it to mean no rate increase until 2016. So which is it? We must not forget that Janet Yellen is a student of the Great Depression. As such, her “dreams are haunted” by the Fed’s decision to raise rates in 1937, just as the country was emerging from the Depression’s trough. That premature move caused the economy to tumble again. With inflation still far below the Fed’s target of 2% and with gross domestic product growth languishing below 3%, I simply don’t see the Fed raising rates anytime soon---especially when every other central bank is cutting rates. My prediction---the Fed “won’t take that (low rates) away from me” until September, at the earliest. Even then, any increase will be modest and likely will not adversely affect my bellwether, the 10 Year US Treasury Bond. (10Year) (By the way, "Can't Take It Away From Me" was #3 on the 1937 Hit Parade.)

Whatever challenges face global economies generally, they do not affect Apple. Did you see the “cellphone number” it reported this week? In the first quarter alone (Apple’s fiscal year began October 1, 2014), Apple sold 74 million iPhones---that’s 34,000 iPhones per hour, 24 hours per day, seven days per week. That incredible performance translated into $3.08 of profit per share---for the quarter. Despite paying a decent dividend and sponsoring the largest share buyback in history (Apple reduced its share count by 10% last year), Apple still has $175 billion of cash and marketable securities on its books. To put that in perspective, there are only 46 companies in the world that Apple could not buy----using only its excess cash and cash equivalents. If it so desired, without any debt, Apple could buy Disney, Visa, Amazon, Citigroup or countless others. And yet, Apple trades at only 13 times its forward price/earnings ratio (much less if you subtract its cash)--- well below the market’s average. If you don’t own Apple, you should give serious consideration to “making that call” to your broker.

In the volatile “world we’re livin’ in”, “people keep giving in” to their fears. As a consequence, they “make the wrong decisions.” They sell everything: even income producing (read, dividend paying) securities which are a safe harbor in a low interest rate environment. And that is where we are today. The interest rate on the 10Year ended the week at 1.67%, its lowest close in nearly 2 years. For those who have a “vision for dividends” such as yours truly, sell-offs of income producers provide excellent buying opportunities. Two cases in point arose this week. ETP, one of my favorite pipeline master limited partnerships, announced an acquisition which many viewed negatively due to its short term cost. ETP’s stock plummeted below $59, a buy signal to me. Under no foreseeable circumstance will the acquisition negatively impact ETP’s juicy dividend. By Friday, ETP was back over $61 despite the general market’s downward trajectory. On Friday, SO one of my favorite utilities reported cost overruns on one of its major projects. The stock fell 4% in one day. I’m betting that it will recover fully by the end of next week, buoyed by its consistent and attractive dividend.

For many, stock market volatility is like a Black Eyed Peas’ greatest hit album. Some days you feel “love drunk” as the market moves up the “Hump.” Other days you get pummeled---"Boom, Boom, Pow." But for me, volatility is a side show. My focus remains the 10Year yield; the lower it goes, the better I do. Times have been very good recently. And the good times will keep on rollin' so long as forces do not cause the yield on the 10Year to spike. So Janet, don't cause rates to rise. Once you “Get It Started", I may have to exit.

January 24, 2015 Droppin' Like Flies

Risk/Reward Vol. 251

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

“You're a three-decker sauerkraut
And toadstool sandwich,
With arsenic sauce!”---lyrics from “You’re A Mean One, Mr. Grinch” sung by Thurl Ravenscroft

“Oh, we're dropping; like flies.
Bye, bye.
You're droppin' like flies”---lyrics from “Droppin’ Like Flies” sung by Motley Crue

“And honey you should know
That I could never go on without you
Green eyes”---lyrics from “Green Eyes” sung by Coldplay

For the first time in a while, the most significant news of the week came from Europe. On Thursday, Mario Draghi the head of the European Central Bank (ECB) announced that the ECB is embarking on its own version of quantitative easing. The ECB will be purchasing 60billion Euros worth of public and private securities each month for a minimum of 20 months. The purpose of this campaign is to spur economic growth and to stave off deflation. Draghi wants to depress interest rates so that investors will be forced to invest in riskier assets, and consumers will be incentivized to purchase goods by accessing cheap debt. This ambitious move was done despite Germany’s opposition. In effect, the ECB is now Santa Claus for some weaker members of the Eurozone, handing them a blank check. But for Angela Merkel, the ECB is Mr. Grinch, serving her “a three-decker sauerkraut and toadstool sandwich with arsenic sauce.”

But how effective will Europe’s version of QE be in spurring economic growth? Apparently, Mr. Market thinks it will work. The Dow Jones Industrial Average rose 259 points or 1.48% and the S&P rose 31 points or 1.53% on the news that day (although they gave back half of those gains on Friday). I am not so sure. After all, the yields on the benchmark sovereign bonds of Europe’s largest economies have been “droppin’ like flies/ Bye bye/ droppin’ like flies” without QE. Even before the ECB’s announcement, the yield on the German Bund was 0.51%; on the French 10 year 0.72%; on the Italian 10 Year 1.71%; and on the Spanish 10 Year 1.55%. How much lower will they/can they go? That said, one benefit for me from the ECB’s move is that QE likely will keep the yield on the bellwether US Ten Year Treasury Bond in check. It finished the week at 1.82% (exactly where it was last Friday) despite a Wall Street Journal article authored by Federal Reserve insider Jon Hilsenrath reporting that the Fed was still on track to raise short term rates this year: this despite the ECB's contrary move and despite inflation running well below the Fed's target of 2%. All eyes and ears will be on the Fed meeting next week for any signal as to when a rate rise may occur.

So how do low yields on the 10Year benefit me? “Honey, you should know” by now. If the yield on the US Ten Year is held down, then the yields on the securities correlated to the 10Year (e.g. preferred stock, real estate investment trusts a/k/a REIT’s and municipal bonds) will likewise remain low and concomitantly their price/value will rise. (Remember, lower yields mean higher prices) (See the exhaustive discussion of correlation at Vol. 221 www.riskrewardblog.blogspot.com ). Indeed, “green” is what you see when you look at the year-to-date returns on the preferred stock closing table found at www.online.wsj.com/mdc/public/page/2_3024-Preferreds.html . I hold preferred stock in closed end funds which provide diversification and leverage at the same time. My favorite preferred closed end fund, FFC is up 9% so far in 2015 while paying an 8% dividend amortized monthly. My favorite REIT, Realty Income Corporation (O) is up 14% year to date while paying a 4.2% dividend amortized monthly. And my favorite municipal bond closed end fund MQT is up nearly 2.5% year to date while paying a tax advantaged dividend of over 6% amortized monthly.

I am comfortable with my portfolio, but it is interest rate sensitive. Thus I must be vigilant. With the ECB embarking upon an ambitious QE program, yields on longer term bonds, such as the US 10Year, should remain low even if the Federal Reserve raises rates at the shorter end. That said I have been unpleasantly surprised by sudden yield hikes in the past. When last that happened I felt like Coldplay:

“One minute I held the key

Next the walls were closed on me

And I discovered that my castles stand

Upon pillars of salt and pillars of sand”

January 17, 2015 Sweet Child O' Mine

Risk/Reward Vol. 250

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Oh, baby
I, I, I, I’m fallin’”---lyrics from “Fallin’” sung by Alicia Keyes

“Take me down to the paradise city
Where the grass is green and the girls are pretty.”---lyrics from “Paradise City” sung by Guns N Roses

“There’s a million oil rigs pumping
That black gold all over the world”---lyrics from “One Good Well” sung by Don Williams

Year to date, both the Dow Jones Industrial Average (DJIA) and the S&P 500 Index are down about 2%. “Oh, baby”, should one be worried that stocks will continue “fallin’”? After all, earnings season is underway, and it has been underwhelming to say the least. That said, let’s not forget what happened last year. Remember? Between the close on December 31, 2013 and February 4, 2014, the DJIA fell 1131 points or 6.8% only to rebound sharply and to finish the year with a total return of nearly 10%. (See Vols. 205-207 www.riskrewardblog.blogspot.com ) I see nothing to indicate that the year-to-date dip is anything other than profit taking and repositioning. Friday's solid move upward corroborates this belief. As emphasized repeatedly here, where else can money go if one wants any return at all? The answer is the same as it was in 2013 and 2014 (See Vols. 164 and 201 www.riskrewardblog.blogspot.com ) --- TINA---There Is No Alternative--- to US equities.

Well maybe one—municipal bond funds. In 2014, muni/bond funds were a “paradise city” with the S&P Municipal Bond Index (Index) seeing a double digit total return, much of it tax preferred and with very little volatility. Talk about “where the grass is green and the girls are pretty!” On a personal level, I held my municipal bond closed end funds for the entire year, and my return mirrored that of the Index. If the yield on the bellwether 10 Year US Treasury Bond (to which muni bond funds are correlated) does not rise too quickly and stays below 2.5% (and year to date it has been sinking, closing at 1.81% on Friday), municipal bond funds should have another good year. Adding to their attraction are the following facts: 1) fewer municipalities are floating bonds thus increasing the appeal of those bonds already in the market; and 2) repayment risk is very low with only 57 defaults last year out of 20,000 issuers. As noted, I invest in this sector through closed end funds because they employ leverage to enhance returns. I employ a triangular selection process, choosing those funds that trade below net asset value, have a greater than 6% tax preferred annual dividend and garner at least a Bronze rating on Morningstar. I hold currently MYI, EIM, VGM, MQT, MVF, PML, MYD, PMO, OIA, MUA and MNP, all in my personal (non 401k or IRA) account.

I am not calling a bottom on oil prices (or am I?), but did you notice the resistance this week to prices below $44/bbl and the 10% rebound that followed? Right now “There’s a million rigs pumping/That black gold all over the world”. But with all of the cut backs in capital spending (this week Shell walked away from a massive project in Qatar and Statoil abandoned several Arctic Circle leases), the glut will diminish. On the domestic side, producers have done much to reduce the cost of hydraulic fracturing (“fracking”). Conoco announced recently that its fracking operations would continue to be profitable even at $40/bbl. EOG reported that it could make a 10% profit on $40/bbl. oil. I have a feeling that we may have seen oil's nadir.

The market has displayed some negative vibes so far this year, but certainly not an “Appetite For Destruction.” By no means is Mr. Market “Knockin’ on Heaven’s Door.” As Axl, himself, advises, “all we need is a little patience”. Certainly, that virtue paid off last year. And as noted above, if one wants a return on one’s investment, the US stock market is the only game in town---make that, in the world . Unlike Mr. Rose, one need not ask:

“Where do we go
Where do we go now
Where do we go
Sweet Child ‘O Mine?”

January 10, 2015 Rescue Me

Risk/Reward Vol. 249

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

“Can’t undo a fall like this
Cause love don’t know what distance is
Yeah, I know it’s crazy.”---lyrics from “I Want Crazy” sung by Hunter Hayes

“I’m down/I’m really down
I’m down/Down on the ground.”---lyrics from “I’m Down” sung by The Beatles

“Rescue me/Take me in your arms
Rescue me/I want your tender charms.”---lyrics from “Rescue Me” sung by Fontella Bass

At one time during the trading day on Tuesday, the Dow Jones Industrial Average (DJIA) hit 17,262; more than 570 points below its close the previous Friday. This drop caused many talking heads to predict that 2015 would be the year of the Bear; that Mr. Market “can’t undo a fall like this.” After all, the price of oil, the fuel upon which the entire world runs, had fallen below $50/bbl. But by Thursday’s close the DJIA had gained 645 points, ending 3.7% higher than where it had been just two days previous. "Yeah, I know it's crazy." Friday saw some profit taking and some negative reaction to last month’s reported average wage decrease. But the week ended at 17,737 just 0.5% below where it ended last week.

So what is an investor to make of this roller coaster market? Down 3% one day, up 4 % the next with the VIX (which measure market volatility) itself trading wildly. How is one to interpret Friday’s jobs report which has US unemployment at 5.6% yet wages continuing to fall? Does the fact that the Eurozone is now in a state of deflation (with consumer prices having fallen 0.2% year to year as of December, 2014) pose a threat to our economy? Is oil at $47/bbl. indicative of an economic slowdown or will cheap oil boost consumer spending? Where can one look for guidance? I, for one, pay little heed to these conflicting signs and continue my laser focus on the benchmark US 10 Year Treasury. And “its yield is down/it’s really down/it’s down/Down on the ground” finishing the week at 1.97%.

So what does a low yield on the 10Year mean to me? It means that the rest of the world has capitulated. Investors worldwide are looking to the US to “Rescue me/Take me in your arms/Rescue me/I want your tender charms.” Capital is flowing stateside. And why not? The German 10 Year Bund is yielding 0.49%, the Spanish 10 Year 1.71%, the French 10 Year 0.78%----this as the European Central Bank (ECB) is contemplating a round of quantitative easing (purchasing sovereign and corporate debt) which will only depress yields further. The resultant global search for yield combined with a concern for safety (which events in France this week only heightened) should equate to continued market appreciation here in the US. Moreover, the strengthening of the dollar versus every other currency in the world will put a damper on the Federal Reserve’s appetite to raise short term interest rates ( whose impact on longer term rates such as that on the 10Year is questionable anyhow--- see last week’s edition discussing same www.riskrewardblog.blogspot.com ). The easy money punch bowl provided by the Fed very well may continue into the third quarter of 2015. In sum I see favorable conditions for US- centric equities in general (other than those in the oil patch), and US-centric income securities (real estate investment trusts, municipal bond funds, preferred stock, etc.) in particular.

The world’s economy is struggling just as that of the US is turning the corner. As discussed above, this likely is good news for the US stock market in the short to intermediate run, but may drag all financial assets down in time. I see the Federal Reserve paying closer attention to foreign affairs in the coming months as suggested in its December meeting minutes released this week. I can hear Mario Draghi of the ECB on the telephone with Fed Chair Yellen even now, quoting the following Beatles refrain:

“Help me if you can, I'm feeling down
And I do appreciate you being 'round
Help me get my feet back on the ground
Won't you please, please help me”

January 3, 2015 Feelin' Groovy

Risk/Reward Vol. 248

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

"It's of utmost importance
We're dealing with a volatile substance."---lyrics from "Never Tell" sung by The Violent Femmes

"What you think isn't always true
And you don't know where your interest lies."---lyrics from "You Don't Know Where Your Interest LIe" sung by Paul Simon

"Wait till next year/Wait till next year
I've got an image to nurse
And a role to rehearse."---lyrics from "Wait Til Next Year" sung by Eric Burdon and The Animals

Those who simply bought index funds triumphed once again in 2014. The Dow Jones Industrial Average provided nearly 10% in total return (appreciation plus dividends) and the S&P nearly 13%. But 2014 also proved that when we are dealing with equities, "we're dealing with a volatile substance." Remembering this is "of utmost importance." Indeed, a mere three weeks ago the Dow was trading 800 points below its year end close at which time it was heading toward a total annual return of less than 5%. I fell just short of my 6% annual goal, but did so holding considerable cash and with considerably less volatility. Indeed, had I not been defrauded by ARCP and had I been able to unload my oil stocks within my 8% loss limit, I would have done much better. For me, the key to profitability lies in minimizing losses. In fact, in retrospect I should have sold back in July when I was up 10% and was contemplating liquidation. (see Vol. 229 www.riskrewardblog.blogspot.com ) Coulda, woulda, shoulda---volatile indeed!

Many stories have and will be written about the stock market's performance in 2014. But what the commentators "think isn't always true." For me, the story of the year is "where your interest (rate) lies." As 2014 dawned, quantitative easing was coming to an end, and as a consequence, very few wags predicted that the rate on the bellwether 10 year US Treasury Bond would go down as the year progressed--- let alone prognosticated that it would end the year at 2.17%, 86 basis point below where it started. This year-long continuation of low rates made bond buying unattractive for anyone seeking a yield thereby pushing even widows and orphans into equities. More significantly, it fueled the incredible stock buy back spree about which I wrote in Vol. 245 (www.riskrewardblog.blogspot.com). With the rest of the world foundering, where else could one put one's money but US equities. That is plain to see in hindsight, but was not so obvious as we lived Fed meeting to Fed meeting anticipating an interest rate hike that never came. Hopefully, Chair Yellen's clearer vision will reduce volatility in 2015.

So what will "next year" bring, Mr. Market? "I've got an image to nurse." 2015 again will be about interest rates. I am confident that the Federal Reserve will not raise short term rates until June, and I continue to believe that a rise in those rates will have minimal impact on longer term ones(10-30 year bonds). Longer term rates respond more to inflation which I see remaining in check (below 2% here, much lower worldwide) for the foreseeable future. Demand for goods and services is waning here and abroad for a host of reasons including demographics. With demand low, unemployment worldwide will remain high and wages, the primary driver of inflation, will remain stagnant. Low inflation and thus low long term rates is good news for my favorite income plays (preferred stock, utilities, municipal bond funds, mlp's and real estate investment trusts) all of which do well in such an environment. Cheap credit also will continue to fuel stock buy backs. This year's wild card is energy. No one predicted the dramatic decrease in oil and natural gas prices experienced in the second half of 2014. I do not see them remaining depressed all year as more companies cut back on their capital expenditures and exploration efforts. Buying solid companies (CVX, COP, ETP, KMI) on dips and looking for a confirmed rise in prices as a signal to buy more speculative plays should reward market watchers this year.

I close on some personal news. After 38 years of practicing law with Michael Best & Friedrich LLP, I decided to retire as of December 31, 2014. My years at MBF were rewarding on so many fronts, but the lure of MBF's pension plan, devised to incentivize people of my age to leave, proved irresistible. That said, I am not ready to abandon completely the profession that I was born to practice. And so, effective January 1, 2015, I have associated in an "of counsel" capacity with the law firm of Hansen Reynolds Dickinson Crueger LLC (www.hrdclaw.com). HRDC is a litigation boutique founded by four of my former partners a few years ago and now has offices in Milwaukee, Madison and Chicago. You will hear more about my professional plans in the coming days and weeks, but with the New Year dawning, I am living a Paul Simon lyric: I am

"Lookin' for fun and feelin' groovy!"

December 27, 2014 Predictable

Risk/Reward Vol. 247

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

"So you don't have to call
Or say anything at all
You're so predictable."---lyrics from "Predictable" sung by Good Charlotte

"Let it grow/Let it grow
Let it blossom/Let it flow."---lyrics from "Let It Grow" sung by Eric Clapton

"Cover you in oil/Let me cover you in oil
I wanna cover you in oil/Cover you in oil."---lyrics from "Cover You In Oil" sung by AC/DC

I take one week off and WOW. Talk about a Santa Claus Rally! The spectacular two week performance began with Janet Yellen's press conference on December 17th. Since the market's close on December 16th, the Dow Jones Industrial Average (DJIA) has gained nearly 1000 points or 5.8%, a percentage increase mirrored by the S&P 500! Why you ask? The answer lies in the road map for interest rates that Chair Yellen outlined. Indeed, when it comes to rates, "you don't have to call/Or say anything at all. It's now so preditable" Here is what will happen. No rate increase will occur for at least two meetings (read June, 2015) and the increase(s) thereafter will be slight and gradual. So let's see: with historic low interest rates continuing and with China, Japan, Europe, Russia and the emerging markets in the tank, where can one get ANY return on one's money? Duh---there is only one place: US equites, assuming, of course, our economy continues to grow.

And continue to grow, it does. On Tuesday, the Commerce Department issued revised gross domestic product numbers showing the US economy grew in the Third Quarter at an annualized rate of 5%, the highest rate of growth in over a decade. That number blew the doors off market expectations. "Let it grow/Let it grow/Let it blossom/Let it flow." Indeed, GDP growth was so stunning one would have expected interest rates to sky rocket in anticipation of a sooner-rather-than-later tightening of monetary policy (the fear of which in recent years has caused equity markets to drop)---had not the Fed laid out its course of action just the week before. The rate on the bellwether 10 Year US Treasury Bond did rise to 2.25% by week's end, but this is well within its several month trading range. Indeed, securities tied to the 10Year rate (e.g. municipal bonds, preferred shares, real estate investment trusts, utility stocks) held steady all week, once again compliments of a clearly articulated monetary policy. Another factor keeping longer term US rates low is the spread between the two most stable debt issuing countries in the world---Germany and the US. The German 10Year Bund carries a rate below 0.6% compared to 2.25% on the US 10 Year a spread of nearly 1.7%--an historic high. As stated in the last edition ( Vol. 246 www.riskrewardblog.blogspot.com ) given a choice why would one buy a Bund and not a US 10Year? So again, with interest rates low, the US economy growing and the rest of the world in the tank, US equities are the best game in town.

Contributing to the good news is the incredible drop in the price of oil and natural gas. AAA estimates that with oil at $55/bbl. and gasoline nearing $2/gallon at the pump US disposable income could increase as much as 3 1/2% over last year. This should result in a big bump in consumer spending. From an investment perspective, one should not expect a turnaround in oil prices any time soon. The Saudi Oil Minister announced this week that OPEC will not reduce production even if the price of oil falls to $20/bbl. Clearly, Saudi Arabia sees the drop in prices as an opportunity to reduce competition from higher priced producers such as Russia, Nigeria, offshore drillers and the frackers here in the US. That said, the world runs on oil, and oil is a depleting asset. Someday the price will stabilize and start to rise. Those who have the stomach to invest in it will be rewarded handsomely. "I don't wanna cover you in oil/Don't let me cover you in oil"---not yet at least. But initiating a quarter or a half position in any established oil company at current price levels makes a great deal of sense. CVX, ETP and COP are recovering nicely, and KMI barely dipped at all. I bought some of each recently. However, holding one's powder on more speculative oil plays until a turnaround is confirmed seems prudent at this time.

Two weeks ago, the DJIA was languishing, up just 2% for the year. But thanks to Janet Yellen, the Dow shot "Back Into the Black" like it was "Thunderstruck." It was not such a "Long Way to the Top" after all. All it took was some unambiguous policy guidance from the Fed Chair. As AC/DC puts it:

"She's got style, that woman
Makes me smile, that woman
She's got balls."
(Think not? Check the accompanying photo)

December 13, 2014 Oil Trick Or Treat

Risk/Reward Vol. 246

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

“Now won’t you treat me, baby
I’ve been tricked so many times before
I can’t wait til Halloween to find out
If it’s trick or treat.”---lyrics from “Trick or Treat” sung by Otis Redding

“Now is the time/The time is right
We’ve got no reason to wait/Let’s do it tonight.”---lyrics from “Now Is The Time” sung by The Jefferson Airplane

“I go up/I go down
I go crazy/When you’re around.”---lyrics from ‘Up and Down” sung by The Pet Shop Boys

Eurozone deflation fears and domestic prosperity have been two of the three drivers of stock market performance for the past month. This week, however, both took a back seat to the third driver---the decline in the price of oil. On Friday, the price of domestic oil (WTI) fell below $58/barrel for the first time since the recession of 2009. Until this week, lower oil prices have been a boon to stocks (other than those in the oil patch). But, this week oil prices sank so low, so fast, many have come to believe that they are a harbinger of slowing economic growth worldwide and that they could lead to the collapse of oil dependent economies. Bears took control of the markets with the Dow falling 678 points (3.8%) and the S&P falling 73 (3.5%). So what DO lower oil prices mean? Are they a “trick or a treat?” I do not know. I DO know that “I’ve been tricked by oil prices many times before” and as a consequence I am out of the sector at present. That said, I doubt that we will have to “wait til Halloween to find out.”

Several subscribers contacted me this week to inform me that they believe “Now is the time” to start buying oil company stock. One is so convinced that “the time is right” and that “we’ve got no reason to wait,” he sold a substantial position in Apple (AAPL) (which he had held for years) and purchased Chevron (CVX) which hit a 52 week low on Wednesday. He views CVX’s decision, announced this week, to slash next year’s exploration budget as a shareholder-friendly move. Moreover, he likes being paid a 4% dividend while he waits for the stock price to recover. Other subscribers are buying Conoco and Shell. One of my fellow preferred stock devotees initiated a position in MHRpD which I have held from time to time over the years. It is trading so low that it yields a double digit return amortized monthly. Both of us saw MHR’s (Magnum Hunter) CEO on “MadMoney” where he made a compelling case that MHR should no longer be considered an oil play. Ninety percent of its revenues are from natural gas, and it can remain profitable so long as natural gas trades above $2.50/mmBTU. Natural gas currently trades at $3.70/mmBTU.

If oil drove the markets this week, news from the December meeting of the Federal Reserve will dominate next week. According to Jon Hilsenrath of the Wall Street Journal (see Vol 236 www.riskrewardblog.blogspot.com ), the Fed will consider dropping its assurance that short term interest rates will stay near zero for “a considerable time.” This would signal a rise in those rates in mid-2015. If the Fed retains that assurance, short term rates are likely to be zero bound until the fall of 2015 or after. So, if the assurance is dropped, what impact would it have on longer term rates including the rate on the bellwether US 10 Year Bond? Will longer term rates “go up/go down/or drive me crazy by going around?” As noted in earlier editions, the power of the Fed to affect longer term rates has diminished in recent times due to the persistence of low rates paid on comparable securities throughout the rest of the world. In the global bond market, given a choice, why would one own a German 10 Year Bund paying 0.68% or a French 10 Year bond yielding 1% when one can own a US 10Year yielding 2 to 3 times as much--- even at Friday's closing yield of 2.10%? Moreover, there are direct relationships between the price of oil and the rate of inflation, and between the rate of inflation and the yield on government bonds. Thus, if the price of oil continues to drop, the yield on bonds likely will continue to fall---at least according to newly crowned Bond King, Jeffrey Gundlach ( see Vol. 235 www.riskrewardblog.blogspot.com ). Gundlach opined this week that the yield on the US Ten Year could dip below 2% if the price of oil falls below $40/bbl. This would enhance the value of the interest rate sensitive portion of my portfolio.

Although I resisted buying oil stocks this week, the conviction shown by several subscribers is tempting me to re-enter the sector once a turnaround is confirmed. I am holding a lot of cash and am itching for an opportunity to profit. Last year, I bought preferred stock and municipal bond closed end funds when they were down---and to great advantage. Maybe oil is THE play as we head into 2015. When that sector does recover (and it will), I do not want to be singing Otis’ refrain:

“I was sittin' on the dock of the bay
Watchin' the tide roll away, ooh
I was just sittin' on the dock of the bay
Wastin' time”

December 6, 2014 Buy Backs

Risk/Reward Vol. 245

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

DUE TO THE PRESS OF OTHER BUSINESS, THIS WEEK’S FORMAT HAS CHANGED. ONE LYRIC AND ONE REFLECTION IS ALL YOU GET.

“I think you will find/When your death takes its toll
All the money you make/Will never buy back your soul.”---lyrics from “Masters of War” sung by Bob Dylan

Domestically, we see a good jobs report, an "ok" wage growth number and inflation in check. But internationally, China, the emerging markets and Europe are on downward trajectories. The US economy by itself may justify an average year in the stock market, say a 7% return. So why is the S&P 500 headed to another double digit gain in 2014? Moreover, how can the stock indices continue to rise year after year when equity (stock market) exchange traded funds and mutual funds have experienced a net OUTFLOW of over $100billion in the past five years? (See Friday’s Financial Times for these and other statistics cited herein) Why hasn’t this outflow of "all the money" “taken its toll” on share prices?

The answer lies, in part, in the number of massive share “buy backs” which are underway. These buy backs (corporations purchase their own shares on the open market thereby reducing the total number of shares outstanding and increasing their all important earnings per share) are how Corporate America has decided to deploy its excess capital. For example, Apple (AAPL) spent $45billion in share buy backs in just the past 12 months. And mega companies are not the only ones involved. In the third quarter of 2014 alone, one fourth of all of the companies constituting the S&P500 reduced their share count via buy backs by at least 4%! Assuming each’s multiple remained constant, this effort alone would account for a concomitant per share price increase. According to Friday’s Financial Times, Corporate America's buy back pace of $40-50 billion per month experienced during the first 10 months of 2014 is likely accelerating even as I write. So it's no wonder stock prices continue to rise.

How long will this continue? With cheap credit plentiful, with world wide economic growth faltering, with populations dwindling (did you read this week that the birthrate in the US is at an all time low of 1.86 births per woman of child bearing age) , with corporations balking at dividends as a means of returning capital and with increasingly pro-active shareholders, I see a protracted period of substantial share buy backs. The simple truth is that corporations are long on cash and short on product demand. Enjoy it while it lasts. But be mindful of what Dylan preaches,

"As the present now/Will later be the past/The order is rapidly fadin'
And the first one now/Will later be the last/The times they are a-changin' "

November 29, 2014 How Low

Risk/Reward Vol. 244

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

“It hurts like hell/To be torn apart
And it hurts like hell/To be thrown around.”---lyrics from “Torn Apart” sung by Bastille

“Go low/Lower than you know
Go low, Go low/Lower than you know”---lyrics from “How Low”---sung by Ludicris

“Though I can't seem to let you go.
The one thing that I still know is that you're keeping me down”---lyrics from “Gravity” sung by Sara Bareilles

The big event this week occurred on Thanksgiving when our markets were closed. The oil ministers of OPEC met in Vienna that day and afterward announced that a majority had voted to maintain current levels of oil production despite a lessening of world demand and a glut in production. By Friday afternoon, the price of oil plummeted below $67/bbl., a drop of more than 30% since June. This is good news for oil consumers, but if you own the shares of domestic oil exploration companies or you are Nigeria, Venezuela or Russia (the economies of which are dependent on oil trading above $100/bbl.) “it hurts like hell.” They must feel “torn apart” and/or “thrown around.” Thank goodness I sold Breitburn (BBEP) and Linn (LNCO)) last week. Both experienced double digit percentage declines on Friday alone with LNCO plunging over 18% . Ouch!

Speaking of “going low/Lower than you know” the Eurozone continued its march toward deflation and recession this week. Reports issued Friday detailed that the annualized rate of inflation for November was 0.3%, down from 0.4% in October, and that the Eurozone unemployment rate remains at 11.5%. The concern, of course, is that if deflation takes hold and Eurozone consumers come to understand that they can achieve a better return from holding cash than from investing and/or that they can purchase goods at a lower price by simply waiting another day, week or month to buy, Eurozone economies will degrade from a downward trend into a tailspin. Look for the ECB to advocate even more aggressive quantitative easing in the coming days.

So what do lower oil prices and Eurozone deflation mean to me? “The one thing I know is, like Gravity, they will keep domestic interest rates down.” Indeed, on Friday after the full impact of the above described developments had been absorbed by the U.S. markets, the rate on the 10 Year U.S. Treasury Bond fell to 2.19%. The lower the rate on this bellwether, the better my interest rate sensitive, income securities do. Indeed, on what otherwise was a flat trading day Friday, my preferred stock closed end funds (FFC, HPF, HPS), each of which pays at least an 8% dividend, each gained at least 0.5%. Now that I am back in sync with my principles (see last week's edition www.riskrewardblog.blogspot.com ) I should do well with these for the foreseeable future.

The Dow Jones Industrial Average and the S&P500 remained remarkably steady this week, at or near record levels. How long can this last given the economic turmoil in Europe and Asia? Who knows, but it sure feels good. That said, if and when I see the market in general or any segment thereof falter (e.g. as oil has), I will be brave and hit the sell button. As Sara Bareilles admonishes:

“Say what I wanna say
And let the words fall out
Honestly I wanna see me be brave”

November 22, 2014 Say Something

Risk/Reward Vol. 243

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

“These oldies but goodies remind me of you
The songs of the past bring back memories of you.”---lyrics from “Oldies But Goodies” sung by Little Caesar and The Romans

“These last few weeks of holding on
The days are dull/The nights are long
Guess it’s better to say
Goodbye to you/Goodbye to you.”---lyrics from “Goodbye to You” sung by Scandal (featuring Patty Smyth)

“Everybody’s got an opinion now, don’t they
I’m here to stay/I’m here to stay.”---lyrics from “Here To Stay” sung by Christina Aguilera

“Oldies but goodies.” They not only “bring back memories”; they also “remind me” of first principles. So this week I reread several past editions in which I summarized my investment philosophy including Vols. 1 and 156 (www.riskrewardblog.blogspot.com ). In those posts, I pledged my allegiance to Bill O’Neill’s 8% Rule ( he, of Investor’s Business Daily fame). That is; do not suffer an 8% loss on any position. That allegiance notwithstanding, in the past few weeks I have faced situations with American Realty Capital Properties (ARCP) and certain oil companies where the loss far exceeded 8% before I could exit. I did not sell in a panic, but it caused me to contemplate the following: assuming the positions do not fall significantly more, do I take a double digit loss or do I hold?

The mere passage of “these last few weeks of holding on” and rereading excerpts from Jack Schwager’s “Market Wizards---How Winning Traders Win” supplied the answer. Sell. The reason has little to do with logic and much to do with psychology. Holding losing positions makes “the days dull/and the nights long.” Winning wizards know this simple truth: looking at red on the computer screen saps one’s enthusiasm and infects one with negativity. The wizards are right; when it comes to losers “it’s better to say/Goodbye to you/Goodbye to you.” And so I did—and my focus improved instantly.

But what about the stock market? Monday through Thursday, both the Dow Jones Industrial Average and the S&P 500 continued to sit, rock steady, with little volatility. Once again, the positive impact of solid domestic economic data was tempered by troubling news from abroad. On Tuesday, Japan reported that its economy contracted for the second consecutive quarter and that it now, officially, is in a recession. On the European front, Standard & Poor’s chief economist stated on Wednesday that the Eurozone was in “dangerous territory,” facing the dual threat of recession and deflation if its central bank did not implement aggressive quantitative easing soon. Then came Friday. China's central bank lowered rates and the European Central Bank announced that it had begun aggressively buying assets. Both of the major stock indices reacted favorably, jumping 0.5% that day. As for me, these moves signal that interest rates likely will remain at historic lows well into 2015, and that the interest rate sensitive portion of my portfolio (e.g. leveraged closed end funds and preferred stocks) should fare well. So, “I’m here to stay/I’m here to stay.”

In closing, I want to thank one of my subscribers. He called to tell me that in recent postings he could feel my pain. I hadn’t noticed, but in rereading them I detected a decidedly negative vibe. That detection led me to question why, which in turn caused me to review whether my holdings matched my principles. As discussed above, clearly they did not, a situation I rectified this week. Thanks again for “saying something.” As the great Christina warns:

“Say something, I'm giving up on you
I'll be the one, if you want me to"

November 15, 2014 Rock Steady

Risk/Reward Vol. 242

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

“Rock steady, baby/That’s what I feel now
Let’s call this song exactly what it is.”---lyrics from “Rock Steady” sung by Aretha Franklin

“I’m a lonely little petunia in an onion patch
In an onion patch/An onion patch.”---lyrics from “Lonely Little Petunia” sung by Arthur Godfrey

“The best is barely enough
But if that’s it/Then it will have to do.”---lyrics from “Barely Good Enough” sung by John Kay (of Steppenwolf fame)

With the Dow Jones Industrial Average gaining 61 points and the S&P 500 gaining 8 points this week, “let’s call this market exactly what it is/Rock steady, baby.” That said, “rock steady is not what I (or any other investor) feels now.” But why? Russia’s further incursion into Ukraine and the mishigas that is the Mideast notwithstanding, there is no immediate threat of war. Corporate profits, at least in the US, are acceptable if not spectacular. Interest rates remain low. In addition we are on the cusp of energy independence. Who would have believed that gasoline would be selling for under $3/gallon in 2014? So why the unease?

Perhaps it arises from the realization that the US economy is a “lonely little petunia in an onion patch/ The onion patch” that is the world’s economy. In advance of this weekend’s meeting in Brisbane of the world’s twenty largest economies (“G20”), Secretary of the Treasury, Jack Lew, expressed frustration and disappointment in the fiscal and monetary policies of Europe and China. He considers them too conservative and thus incapable of spurring growth. Although I rarely find myself aligned with the current administration, I do agree with Mr. Lew on one point: to wit, continued reliance on the American consumer to drive worldwide demand is not a formula for sustainable economic growth.

Nevertheless, the US stock market continues to set record highs. As stated ad nauseam here and elsewhere, the reason is obvious; there is no alternative. Simply put, U S equities are the best investment around. “That’s it/It will have to do.” Even if “ the best is barely enough.” Really, where else can one achieve any return on an investment? Evidencing this grim reality is a conversation that I had this week with a slightly older contemporary (age 67) who is in the process of selecting a wealth manager. In a recent interview with the most conservative institution in our city, the assembled investment team ( led by a 61 year old) told him that it would allocate NOTHING, not a dime, not a penny, into bonds or bond funds. The team had concluded that with interest rates so low (the benchmark 10 Year Treasury Bond closed Friday at 2.32%) the paltry returns available in bonds are not worth the risk of principal depreciation before maturity. What! What happened to the 60%/40% Rule? And then it struck me. Perhaps the fact that US equities are the only game in town is the real source of investor unease---as well it should be. Because when all of the money flows one way, bubbles ensue.

When the Federal Reserve adopted its zero-bound interest rate policy (ZIRP) in 2008, it did so with the intent of temporarily inflating asset (read, stock) prices knowing that in so doing it would discourage capital from being allocated into traditional “safe” investment vehicles such as money markets and bonds, those favored by retirees. No one foresaw that 6 years later ZIRP would still be the order of the day with no end in sight. Given our demographics and Japan’s 20 year experience with ZIRP, perhaps someone should have. But, no one did and so today, risk assets continue to soar while safe investments languish. This situation is not ideal for someone on the cusp of retirement. In the words of the great Aretha:

‘I ain't no psychiatrist
I ain't no doctor with degrees
But, it don't take too much I.Q.
To see what you're doin' to me”

November 8, 2014 The Locomotion

Risk/Reward Vol. 241

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

“A chug-a, chug-a motion like a railroad train
Come on baby, do the Locomotion.”---lyrics from “The Locomotion” sung by Little Eva

“You got me runnin' goin' out of my mind
You got me thinkin' that I'm wastin' my time
Don't bring me down, no no no no no”---lyrics from “Don’t Bring Me Down” sung by ELO

“Drums keep pounding rhythm to the brain
And the beat goes on/Yes the beat goes on.”---lyrics from “The Beat Goes On” sung by Sonny and Cher

Both the Dow Jones Industrial Average (DJIA) and the S&P 500 (S&P) continued to rise this week, albeit modestly, setting record highs along the way. After a volatile first few weeks of October, the indices have been running sure and steady of late-- “A chug-a, chug-a motion like a railroad train.” And with our elections over, I see little on the horizon to de-rail this “Locomotion.” Nothing on the Federal Reserve’s calendar should cause interest rates to rise. Indeed if anything, we may see more downward interest rate pressure given the fact reported last week that Japan has opened its credit floodgates with a new round of quantitative easing. Moreover, the European Central Bank has pledged to combat deflation with any and all of the ammunition it has at its disposal including its own round of quantitative easing should one prove necessary. This is all good news to rate sensitive income investors like me. Although the Middle East remains a mess, that condition is nothing more than SNAFU. And in Ukraine, the West has conceded Donetsk to Putin, a fact which should satiate his acquisitive appetite for a while. In short, I see calm market conditions through the end of the year with a slightly positive tilt.

That said, not all is rosy in my portfolio. News on Tuesday that Saudi Arabia was dropping the price of the crude oil that it sells into the United States (while raising prices to Europe and Asia) sent my domestic oil holdings sharply downward. Honestly, with crude now trading at below $80/bbl, I’m “goin’ out of my mind.” It’s “got me thinkin’ that I’m wasting my time” with the likes of Linn Energy (LNCO), Vanguard Natural Resources (VNR) and Breitburn Energy (BBEP). It seems that each morning I’m crying “no,no,no,no,no”—“don’t bring crude down.” But down it goes. That said, each of these domestic producers has given assurance that it can sustain its, now, double digit dividend even if the price of oil does not recover. Ironically, natural gas could be the cash cow savior for VNR, the production of which BBEP and LNCO have reduced in recent years. Distributions from those two should be protected by the hedging of 70% of their oil production through 2015.

If the drop in oil were not enough of a “drum that keeps pounding rhythm to my brain”, the “beat down” of American Realty Capital Properties (ARCP) “goes on/Yes the beat goes on.” On Monday, an ARCP affiliate announced that it was reneging on its agreement to purchase some non core assets that ARCP acquired as part of the Cole Realty acquisition. This news caused ARCP to fall to ridiculous depths, so ridiculous that I decided to add to my position. I may be doubling down on a loss, but I keep thinking of how solid the underlying business appears. ARCP owns a portfolio of triple net leased properties with a book value of $11 billion rented to investment grade tenants. Moreover, it pays a (now) double digit dividend amortized on a monthly basis. Yet, the market cap is only $7billion? Huh? Oh, well, I bought some more. I will either do well (up 10% so far on Tuesday's purchase) or “the beat will go on.”

The performance of the DJIA and the S&P in the past month once again is making passive index investors look like geniuses. They may attain a double digit return for the third year in a row. In contrast I may miss my more modest personal goal of 6-7% due to my overweight positions in oil companies and ARCP. That said, I do not see myself buying a basket of indexed ETF’s and then closing my eyes. What happened to passive investors in 2008-2009 still haunts me and will do so for the rest of my investing life. I remember like yesterday: “bang, bang, that awful sound/bang, bang investors hit the ground/bang, bang the indices shot them down.” That did not happen to me then, and it will not happen to me in the future.