April 24, 2016 Doves Cry

Risk/Reward Vo. 304

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

“I said let's go crazy (Go crazy)
Let's go, let's go
Let's go”---lyrics from “Let’s Go Crazy” sung by Prince

Touch if you will my stomach
Feel how it trembles inside
You've got the butterflies all tied up
Don't make me chase you
Even doves have pride”---lyrics from “When Doves Cry” sung by Prince

“Little Red Corvette
Honey, you got to slow down
(Got to slow down)
Little Red Corvette”---lyrics from “Little Red Corvette” sung by Prince

Two weeks ago, when last I corresponded, I reported that I had sold my holdings thereby capturing an acceptable level of profit. I was awaiting the results of the oil ministers’ meeting in Doha (April 17th) and the Federal Reserve’s meeting scheduled for April 26-27th before deciding whether to re-enter the market. The meeting in Doha ended without Saudi Arabia or any other major oil exporting country (e.g. Iran or Russia) agreeing to limit production. But instead of this news causing oil prices to decline, they have risen---and risen quite sharply---8% this week alone. What? Has the oil world “Gone crazy”? Given what has also happened, probably not. Domestic production continues to fall with US daily output now below 9million bbls/day. In addition, oil workers are on strike in Kuwait and flows from Iraq and Nigeria have also been disrupted. These latter events have reduced the daily worldwide supply by 3%. Will these disruptions continue? Who knows, but those who remained in the oil patch these past two weeks have been richly rewarded.

And boy don’t I know it. Had I remained in the oil stocks that I sold two weeks ago I would have doubled my profits in that sector. Yes doubled! And with the rest of the market continuing to trade in correlation to the price of oil, the other stocks that I sold did well also. “Touch if you will my stomach/Feel how it trembles inside/Losing those profits has got the butterflies all tied up/Even doves have pride.” But I am not kicking myself. I have rethought my decision to sell several times these past few days, and I believe that my judgment was sound. You can’t always get it right. I find solace in two quotes from the legendary investor Bernard Baruch: 1) “Being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong “ ; and 2) “I made my money by selling too soon.”

One difference between now and a few years ago is my ability to resist chasing profits. In times past, when a sector sky rocketed like oil did this past week, I would have been back in as fast as “a Red Corvette.” And invariably, I would have bought just in time to see the rocket fall back from space. Nowadays, “honey, I just slow down.” Another opportunity to profit will come along. One need only be patient. Indeed, my eyes are now on the Federal Reserve meeting scheduled for next week. No one expects a rate increase this time around, but look closely at the press release following the meeting. Given the steady increase in job numbers and continued positive domestic economic news, the Fed may signal a rate increase in June. Such a “hawkish” signal would widen the divergence between the Fed and both the Bank of Japan and the European Central Bank. Each has signaled a willingness to lower rates even further into the negative and to otherwise be more “dovish.” In times past, any widening of this divergence has resulted in a stronger dollar which in turn has lowered oil prices and by correlation, the US stock market in general. A similar result next week could present a buying opportunity.

And so my education continues. I missed out on some great profits these past two weeks, but I am not second guessing myself. If investing were easy, everyone would be rich. The nice thing about Mr. Market is that he presents us with money making (and money losing) opportunities time and again. Unlike Prince, we “are not out of time.” There is no reason to party (or to invest) like its “1999”.

April 10, 2016 Bunny Market 2

Risk/Reward Vol. 303

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

“All join in the fun
Father, mother, son
Do the Bunny Hop
Hop, hop, hop”---lyrics from “The Bunny Hop” sung by Ray Anthony

“You know the good ole days weren't always good
And tomorrow ain't as bad as it seems
I’m keepin’ the faith.”--- lyrics from “Keeping the Faith” sung by Billy Joel

“Get down, get down, get down
Get down, get down tonight baby”---lyrics from “Get Down Tonight” sung by KC and the Sunshine Band

As I noted in last week’s edition, we are in a “bunny” hop market. This week, both the Dow Jones Industrial Average and the S&P 500 were up two days and down three, finishing the week off 1.2% and basically flat for the year. “Father, mother, son” have all been forced to “join in the fun.” There is no escape---unless of course one sells which is what I did this past week. I picked my spots and captured some excellent first quarter profits. I intend to stay mostly in cash until after the OPEC meeting in Doha, Qatar and the Federal Reserve meeting (about which I wrote last week www.riskrewardblog.blogspot.com ) each of which is to be held later this month.

The stock indices would have performed much worse but for oil stocks which were buoyed by an 8% increase in the price of oil. Oil now hovers near $40/bbl. Why you ask? Here are a few reasons: 1) midweek the Kuwaiti oil minister predicted that the major oil producers would limit production at the Doha meeting even if Iran balked; 2) supplies from Canada were interrupted by a leak and subsequent shut down of the Keystone pipeline (not to be confused with the ill-fated and disapproved Keystone XL pipeline); and 3) the number of oil rigs operating domestically dropped to 354, one half the number pumping just one year ago. Lost in this wave of good news for oil stocks was a report that at current production levels the world is oversupplied by 1million bbls. of oil per day (about 1.2% of daily consumption). Apparently, Mr. Market is “keeping the faith” when it comes to oil, believing that the “good ole times weren’t always good and tomorrow ain’t as bad as it seems.” I am not so sanguine. That is why I am completely out of oil until after the meetings in Doha.

Okay, that explains why I am out of oil, but why did I sell interest rate sensitive stocks when the yield on the 10Year has plummeted to 1.7%? (Remember the value of interest rate sensitive securities goes up when interest rates go down.) The simple answer is to capture profits. The nuanced answer lies in my belief that the world’s central bankers are now engaged in an all-out currency war in which each is deploying tools that heretofore have never been used such as negative interest rates. Stymied by an inability to cheapen each’s currency and thus to spur inflation (the perceived wisdom today being that inflation is a good thing), God only knows what tools each will employ next; all in a desperate effort to have the yen, Euro or dollar “get down, get down, get down” in comparison to other currencies. Worse off than most is Japan where the yen keeps appreciating and deflation keeps mounting despite drastic measures having been taken to cause the opposite. It is my belief that the Bank of Japan will take another, as yet unknown step toward debasing the yen in advance of or in response to the Fed’s meeting in late April. Hamstrung by its commitment to raise rates at least twice in 2016, at that meeting the Fed likely will signal a rate increase for June. This will exacerbate the divergence in worldwide monetary policy, the impact of which on interest rates and those securities that trade in correlation thereto is unknown---and unknowable given the lack of precedent. I find this discomforting. So why not take some time off?

In sum, I sense that in the next few weeks events may unfold that will “Shake shake shake, shake shake shake/Shake Mr. Market’s booty, shake his booty.” As set forth above, I have good reason to so believe. In times past I have not acted on such beliefs, much to my regret. So, I will let events unfold and once the dust settles (assuming there is a dust up in the market), I will re-enter. Because like KC, “That's the way, uh-huh, uh-huh/I like it, uh-huh, uh-huh”

April 3, 2016 Bunny Market

Risk/Reward Vol. 302

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

Due to travel and family commitments, this edition will not follow the usual pattern. However, important developments occurred this week which require recording and reporting.

. Both the Dow Jones Industrial Average and the S&P 500 gained each day and now reside in the green: the DJIA up over 2% and the S&P up over 1.5% year to date.

. No one can doubt the sway that the Fed holds over Mr. Market. Much of the gains experienced this week came after Janet Yellens’ speech on Tuesday. Before she spoke the DJIA was down nearly 100 points. After she spoke it spiked 200 points (1.2%), and never looked back.

. In her speech, she noted that despite several indicators pointing to a strengthening economy, inflation as measured by the Fed’s favorite yardstick (the PCE Index) remained at 1.7% year over year; stubbornly below the Fed’s desired 2%. She emphasized the “asymmetry” that now exists in the Fed’s tool box. That is, the Fed’s tools to spur inflation are nearly exhausted (zero bound interest rates and prolonged quantitative easing) while those that exist to curb inflation remain unused (higher rates and increased reserve requirements). This observation was interpreted by some to suggest that the Fed may wait until the PCE Index attains or exceeds 2% before raising rates.

. Yellen’s speech lessened the likelihood of a rate increase in April to nearly zero. The spotlight now is squarely on the June meeting. If the Fed is to maintain any credibility in regard its prognostications , one should expect the minutes following the April meeting to signal a move in June.

. Oil prices hovered just below $40 until Friday when the Saudi oil minister reversed position and said that Saudi Arabia would not support limits at this month’s OPEC meeting in Doha unless Iran and other large producers likewise agreed. This statement caused a significant drop in oil prices. Adding to the woes in the energy sector was news on Friday that natural gas reserves were at an all time high (52% higher than the five year average) just as the heating season ends. This was not good news to nat gas iproducers or to pipeline companies.

. Friday’s energy sector news notwithstanding the DJIA rose 100 points on Friday following an encouraging, but not too rosy employment report. Perhaps the correlation between oil and the indices about which I have written over the past several weeks may be coming to an end.

. Does this week's action portend that the indices will continue to rise as they have since hitting the year’s low in February? I suspect not. And I am not alone. Take a look at the most recent newsletter from James Paulsen, Chief Investment Strategist at Wells Fargo Capital Management and a frequent contributor to CNBC’s Squawk Box. http://www.wellscap.com/docs/emp/20160321.pdf . Paulsen terms the current situation a “bunny market”; one that hops up and down but does not go anywhere. Unlike most of his peers, Paulsen recommends that investors attempt to time the market, a strategy that is heresy to most money managers.

. So what does this all mean to me? As loyal readers know, I study correlations; primarily those tied to the yield on the 10 Year US treasury. That yield impacts domestic interest rate sensitive stocks (my favorite sectors) and the value of the dollar/oil internationally. As the rate on the 10 Year rises, the value of the dollar increases and the price of oil falls. Since my portfolio is premised upon 1) the rate of the 10 Year not spiking above 2% and 2) the price of oil remaining near $40/bbl. , I have done quite well so far this year as the 10 Year rate has fallen consistently and the price of oil has appreciated nearly 50% since my mid February re-entry. That said, I see little upside in remaining as fully invested as I am as mid-April approaches--- when both the Doha (OPEC) and the Fed meetings are scheduled. I see great risks to my two investment premises coming from these two events. Accordingly, I will harvest some profits soon. Hopefully, I will catch a bunny hop that will vault me to year to date highs (as experienced Thursday past), but even if I don’t I will raise cash. I intend to watch the Fed and Doha mostly from the sidelines.

March 27, 2016 Just Like Me

Risk/Reward Vol. 301

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

“Oh baby, come on, let me take you where the action is
Oh baby, come on, let me take you where the action is
It's so neat to meet you, baby, where the action is”---lyrics from “Action” sung by Paul Revere and the Raiders

“And don't it seem like
Kicks just keep gettin' harder to find
And all your kicks ain't bringin' you peace of mind”---lyrics from “Kicks” sung by Paul Revere and the Raiders

“It's just like me, it's just like me
It's just like you my baby, it's just like you”---lyrics from “Just Like Me” sung by Paul Revere and the Raiders.

One would have thought that the terrorism in Brussels would have dominated the markets this past week. Surprisingly, it did not. Indeed, by the close of business on Tuesday, all of the major market indices in Europe (CAC 40, FTSE and DAX) showed gains. In the US, the major indices gave some ground, but there was no flight to safety, with the favorite refuge of those in flight, the US 10 Year Treasury Bond, having more sellers than buyers that day. So, dear Readers, “let me take you where the action is” (or at least was this past week.)

And that was with our old friends, the Federal Reserve and the price of oil. Despite a clear signal ten days ago from the Federal Reserve’s Open Market Committee (FOMC) that no more than two rate increases should be expected this year and none before June (see Vol 300 www.riskrewardblog.blogspot.com ), Mr. Market was taken aback on Thursday by an interview given by influential FOMC member James Bullard. He indicated that the first of those rate increases “may not be far off.”’ In response, the futures market handicapped the likelihood of an April rate increase at 12%, considerably higher than the 2% odds that prevailed at the end of last week. In turn, the dollar strengthened in comparison to other currencies which (as discussed last week) caused the price of oil to fall below $40/bbl. The correlation between the price of oil and the stock indices held, so both the Dow Jones Industrial Average and the S&P 500 ended lower for the first time in five weeks. Commentators speculated that Ms. Yellen may be facing an insurrection on the FOMC. This is not good news. Given the Fed’s outsized influence on markets here and abroad, even the hint of dissension “ain’t bringin’ you, me or Mr. Market any peace of mind” and most certainly will make stock price increases “harder to find.”

So what does this mean to investor/traders “just like me” or to those “just like you”? I can’t speak to those like you, but for those like me, a sooner-than-later rate increase may cause me to exit en masse. As I discussed in last week’s edition and as I alluded to above, an unexpected rate increase would cause the dollar to appreciate versus other currencies which in turn would cause the price of oil to plummet. My portfolio is built on two assumptions: 1) the rate on the US Treasury 10 Year Bond not spiking above 2% (emphasis on spike) and 2) the price of oil remaining at $40/bbl. Mr. Bullard’s comments last week cast shade on both of these assumptions and put a corresponding dent in my year to date profits. My tolerance for losing any more is wearing thin.

One good (no great) benefit of writing Risk/Reward is the connection it maintains between my Readers (many of whom are longtime friends) and me. This week one Reader/ friend requested lyrics from Paul Revere and the Raiders. Who am I to refuse? Because in the end, it is personal relationships and not profits that are the source of life’s great joys. As Paul Revere reminds us,

“When your world don't seem just right
And life's gettin' you uptight
You can change that wrong to right
Cause I was there myself last night
We're gonna' have a good thing
Such a good thing baby”

March 20, 2016 Fool on The Hill

Risk/Reward Vol. 300

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

“(Turn around)
Every now and then
I get a little bit nervous
That the best of all the years have gone by”---lyrics from “Total Eclipse of the Heart” sung by Bonnie Tyler

“Baby you can drive my car
Yes I'm gonna be a star
Baby you can drive my car
And maybe I love you”---lyrics from “Drive My Car” sung by The Beatles

“Ooh, the beauty is there
But a beast is in the heart
(Oh-oh, here she comes)
Watch out boy
She'll chew you up”---lyrics from “Maneater” sung by Hall & Oates

It was a mere five weeks ago, February 11th to be exact, when the Dow Jones Industrial Average and the S&P 500 hit bottom; both down over 10% year to date. The investing public was “a little bit nervous/That best of all the years had gone by.” Since then however, both major indices have experienced a significant “Turn around” and are now positive for the year. The reason for the recovery can be found by simply charting the price of oil against these indices. As reported here, over the course of the past several weeks, with few exceptions (like Friday), up and down days even hours in the indices have been directly, almost perfectly, correlated to the price of oil.

So why has the price of oil improved from $27/bbl. on February 11th to $40/bbl. this week? One factor is a cut back in domestic production. Another is the hope that major international producers likewise will limit production, a hope that gained traction this week with the announcement that Saudi Arabia, Russia and other major oil exporters are meeting in Doha, Qatar on April 17th to discuss the price of crude. A third factor “driving that car” may not be so obvious---US monetary policy. What? Janet Yellen influences the worldwide price of oil? Most certainly. When it comes to oil prices, the Fed is “a star.” Like many commodities, the price of oil is denominated worldwide in dollars. The higher the dollar goes in comparison to other currencies, the more expensive oil becomes internationally. More expensive oil lowers demand, and lower demand means lower prices. With the news on Wednesday that the Federal Reserve was holding pat on interest rates and foresaw no more than two small increases during the remainder of 2016 (compared with 4 foreseen just last December), the value of the dollar sank in comparison to other currencies and the price of oil jumped $2/bbl.

So what does this mean to me? Well, if oil stays above $40/bbl. and if the interest rate on the benchmark 10 Year US Treasury Bond does not spike above 2%, I should do well with the non diverse, interest rate and oil sensitive portfolio that I began acquiring in mid February (see Vol. 296 http://www.riskrewardblog.blogspot.com/ ) The stocks in each of these sectors were bludgeoned earlier this year in anticipation of more aggressive interest rate increases and plummeting oil prices. With both of these factors moderating I should see continued capital appreciation and a few months of excellent dividend payments. I say a few months because even though “the beauty is there”, the “beast is in the heart.” By that I mean that the value of these positions is entirely within the control of Janet Yellen. If she decides to become more aggressive on rates, “watch out boy, she’ll chew you up.” Any such increase will depress interest rate sensitive stocks and as discussed above will cause the price of oil to fall thereby decreasing the value of oil related companies.

So why do I not diversify? In my humble opinion, diversification in this market is false prophecy. Asset prices worldwide are supported entirely by a debt bubble created and manipulated by a handful of central bankers who are experimenting with tools (i.e. negative interest rates) that heretofore have never been deployed. I am singularly focused on what these bankers do. Thus, my investments are in those securities that are most directly correlated to their actions. When the worm turns, I will sell everything. You may believe diversification will provide you a buffer to ride out the next bubble burst. Those who so believed in 2008 were bailed out by the world's central bankers (via quantitative easing and zero bound interest rates) and by China's central planners (via massive infrastructure improvements). The tools they used are no longer effective or are no longer available. So sell, I will. It’s a just a matter of time. A fool I may be; but, like The Beatles, I will be a “Fool on The Hill”; a hill of cash.

March 13, 2016 Beggar Thy Neighbor

Risk/Reward Vol. 299

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

As noted, my schedule does not permit a typical edition this week. However, the week was significant and worthy of some observations.

. In the face of warnings from the Bank for International Settlements (the central bank for central banks) that negative interest rates carry unknown risks, the ECB lowered rates further into the negative on Thursday. In addition, it expanded its bond buying spree to 80billion Euros per month and promised virtually unlimited liquidity to Europe’s banking community. Despite spiking the monetary punch bowl, the ECB forcasts growth across the Eurozone at only 1.4% for 2016 and inflation at 0.1%. Apparently, one can only consume so many champagne cocktails.

. The unstated reason for the ECB’s action is to “beggar thy neighbor”; that is to spur exports at the expense of other economies by cheapening the value of the Euro vs. the dollar and other currencies. Here is the logic. Lower interest rates cause those with excess cash to dump Euro bonds and to buy higher earning ones such as those of the US. In order to effect this sale and purchase, one sells Euro’s and buys dollars. In the process, the demand for and thus the value of Euros lessens and the demand/value of the dollar (or other currency) increases. Currency devaluation is one way of spurring exports since one’s goods are cheapened by definition. That said, the ECB’s plan backfired. Within minutes of the announcement, ECB president Mario Draghi was asked if there could be more accommodation in the future. He responded that he doubted the need. This caused currency speculators to support the Euro which actually appreciated in value by day’s end. Not very super, Mario!

. Pipeline master limited partnerships plummeted mid-week on news that a bankruptcy court in New York ruled that the contracts between mlp’s and drillers were executory; that is they could be rejected in bankruptcy. I would have been surprised had the ruling gone the other way, so I viewed the dip as a buying opportunity. I added to positions. By week’s end, the sector had recovered.

. The ECB’s move almost certainly dooms any threat that the Federal Reserve will raise rates in March and casts further doubt on a rate increase before this fall. This development plus the apparent bottoming of the oil market prompted me to be a buyer this week. I added to my OKE and STAG positions and bought LVS, PSEC and JMF which I viewed as undervalued. I also took a flyer on CIM, a mortgage REIT that I have owned (and been burned by) in the past. It would not have been my first choice in that sector but for the recent announcement that it was paying a special dividend in addition to its normal one this quarter. Within the next two weeks I will have earned $0.98 in dividends on a $13.76 stock, a 7% return. Comparing CIM’s performance against the mREIT market in general reveals that very little of the dividend is baked into the purchase price. In other words, I don’t’ think CIM’s price will fall much ex-dividend.

March 6, 2016 Signs

Risk/Reward Vol. 298

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

“Just gimme some kind of sign girl
Oh my baby
To show me that you're mine girl
Oh yeah”---lyrics from “Gimme Little Sign” sung by Brenton Wood

“Signs, Signs, Everywhere there's signs.
Blocking out the scenery. Breaking my mind.
Do this! Don't do that! Can't you read the signs?”---lyrics from “Signs” sung by The Five Man Electrical Band

“It's a sign of the times
That your love for me is getting so much stronger
It's a sign of the times
And I know that I won't have to wait much longer”---lyrics “Sign of the Times” sung by Petula Clark

As loyal readers know, I have been looking for “some kind of sign/Oh, my baby/To show me” some stability in the factors that influence Mr. Market. This week there were “Signs, signs/ Everywhere there were signs/Breaking my mind/Can’t you read the signs.”

Here is what I saw:
1) Oil prices rose for the third consecutive week. More importantly, they rose despite reports that crude oil inventories are at their highest level in 80 years. I believe they rose because of the continued reduction in the number of domestic rigs in operation and signs that Saudi Arabia and Russia are actually both committed to limiting production to January levels. Whatever the reasons, oil prices appear to be stabilizing above $30/bbl.
2) Although the performance of the stock indices remains tied to the price of oil, the correlation is not as lock stepped as it has been for the past several weeks. Indeed, on Monday the major indices dropped despite the price of oil increasing. Moreover, throughout the remainder of the week, the indices and the price of oil frequently diverged intraday. I view this uncoupling as a healthy sign.
3) Both major indices saw broad support as the Dow Jones Industrial Average closed the week above the all-important 17,000 level for the first time since January 5th, and the S&P 500 closed at 1999.99, just below the magical 2000 mark.
4) The yield on the 10 Year Treasury rose to 1.87% as investors rotated out of the fear-trade and into equities. That said, the rise was not a spike, and thus did not adversely impact my preferred stock and REIT holdings. This rotation notwithstanding I do not see the rate on the 10Year exceeding 2% any time soon. Several factors are at work to depress it. First, as reported on Friday, wages actually fell in February despite a healthy increase in the number of jobs. An increase in average hourly wages is the Fed’s number one indicator of inflation. So, with the prospect of wage growth and thus inflation low, I do not see the Fed raising rates in March and likely not in June. Moreover, in Europe, the ECB reported this week that prices in the Common Market deflated in January, and that in response one could expect short term rates to go even more negative. Also to combat deflation, Japan issued the world’s first negative rate 10 Year Bond this week. With negative rates prevalent everywhere but in the US, one can expect excess cash to flow into US bonds increasing their price and keeping their rates low.

So how did these “signs of the times” impact me? They made my current holdings “so much stronger” and gave me confidence that I won’t “have to wait much longer” to be a more aggressive buyer. Indeed, I have started already. As loyal readers know, going into February I held only a few positions and those were in preferred stock funds. During that month I cautiously added stocks that I viewed as extremely oversold (see Vol. 296 www.riskrewardblog.blogspot.com ). Here are some and how they have performed through yesterday:

BuyDate /Sec. /+ % /div
2/3 GM 10% 4.8%
2/4 Ford 17% 4.4%
2/16 Shell 6.5% 7.8%
2/16 BP 7% 7.7%
2/16 Ventas 15% 5.2%
2/16 Omega 15% 6.6%
2/16 Blackstone 13% 9.3%
2/17 ETP 1% 14%
2/18 Gabelli(GAB 7% 11%
2/23 Sunoco(SUN 7% 8.8%
2/26 Oneok 12% 9.2%

More importantly, nothing I bought in February is in the red. The above performances warranted adding to each position in recent days.

Due to my heavy cash position, the entire portfolio that I manage is up only 1.5% year to date which is better than the major indices which are still 2.6% underwater. With recent purchases, I am now 40% invested. I don’t expect the stocks listed above to continue to appreciate at their current rate. However, I am hoping to hold them for at least 6 months so that I can collect 2 quarter’s worth of dividends. I intend to buy some other stocks that I view as oversold, but likely I will not reduce my cash position much below 50%. This is my intended, low risk path to my desired 6% annual return. If the market turns however, I will sell it all---very quickly. At this stage in my life, preservation of principle is most important. As Petula knows, Barb and I want to continue living “Downtown” and will do whatever it takes so that we "Don't Sleep in the Subway, Darling.”

February 28, 2016 Crystal Ball

Risk/Reward Vol. 297

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

“You babe, steppin' out
Into the night
Into the light”---lyrics from “Steppin’ Out” sung by Joe Jackson

“Oh I've felt that fire and I've been burned
But I wouldn't trade the pain for what I've learned
Of the cracks in the crystal, the cracks in the crystal ball”---lyrics from “Crystal Ball” sung by Pink

“I've been saving all my money just to take you there
I smell the garden in your hair”---lyrics from “Marrakesh Express” sung by Crosby, Stills and Nash

Once again this week, the price of oil and the two major stock indices were lock “steppin” up and down; “into the night/then into the light.” If you doubt this correlation, take a look at Wednesday’s action. In the morning, the price of oil sank below $30/bbl. on news from the Saudi minister of oil that OPEC would not cut production. The drop in the price of oil caused the Dow Jones Industrial Average (DJIA) to sink 267 points. That afternoon, the Energy Information Agency announced that gasoline inventories had fallen for the week. The price of oil jumped $2/bbl., and the DJIA rebounded 320 points to close the day up 53. Is this correlation logical? How long will it last? Logical or not, it exists. And it will continue to exist until it doesn’t. This is the current state of the market, and this is why I remain mostly in cash.

As loyal readers know, I study the factors that affect the yield on the benchmark 10 Year US Treasury Bond; the yield to which my favorite securities (preferred stock, REIT’s, BDC’s, etc.) are correlated; the yield that is my “crystal ball.” Every time that I misread the signals impacting the 10Year, I “feel the fire and I get burned.” That said, “I wouldn’t trade the pain for what I’ve learned.” So what do I see? Before Friday, all inputs signaled that the yield on the 10Year would remain indefinitely below 2%, where it has resided since the end of January. Forward interest rate indicators (e.g. the 5 Year TIPS breakeven and the 5 Year/5Year Forward) were both well below 2%. But on Friday, the Commerce Department released personal consumer expenditure (PCE) numbers (the Federal Reserve Open Market Committee’s (FOMC) favorite inflation index) which showed that year over year core inflation (that which excludes food and fuel) was at 1.7% in January; not that far from the Fed’s target of 2%. These numbers do not change my opinion that no rate hike will occur in March, but they do increase the odds of a June rate hike from 25 to 34%, at least according to the futures market. I continue to like interest rate sensitive stocks, but if other indications of inflation appear, I may exit some positions.

Speaking of interest rates, it was refreshing to hear FOMC member, James Bullard, admit on Thursday’s Squawk Box telecast that the past several years of low interest rates have deprived an entire generation of a decent return on savings. Since 2008, an investor has had no chance of visiting Marrakesh or any other locale where one “can smell the garden in one’s hair” if he has merely “saved all his money just to take you there.” Reward has come only with risks that previous generations of savers have not had to face; risks inherent in equities and lower rated bonds. But, alas, fellow savers, do not look for rates to normalize. News from yesterday’s G-20 meeting confirms that the world’s central bankers will not change their easy money, low interest rate policies any time soon.

Another week has passed, and “Déjà Vu”, the correlation between the price of oil and the stock indices “Carries On.” Directionally, that has been upward these past two weeks. Reports on Friday indicate that the number of domestic oil rigs in operation has dropped to 400 from a high of 1600 in October, 2014. Is this enough information for me to significantly increase my exposure to stock? No, not until I see more stability in the price of oil. I stated so several weeks ago, and I stand by that statement. After all, in the words of CSN, “one must have a code that you can live by.”

February 21, 2016 Ahab

Risk/Reward Vol. 296

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

“Let me tell you about Ahab the Arab
The sheik of the burning sand
He had emeralds and rubies just drippin' off 'a him
And a ring on every finger of his hand”---lyrics from “Ahab the Arab” sung by Ray Stevens

“You're losing interest in me and it's showing
It is no big thing but it's growing
The pain of heartbreak I've just started knowing
Well, it is no big thing but it's growing”---lyrics from “It Ain’t No Big Thing” sung by Elvis Presley

“There's a fire starting in my heart
Reaching a fever pitch
And it's bringing me out the dark”---lyrics from “Rolling In The Deep” sung by Adele

This week, once again, the stock market was correlated to oil. This week, however, stock prices were less impacted by the hour to hour price fluctuation in the price of oil than by the release of oil related news. And the news was encouraging, a fact which caused the two major indices to enjoy their best week of the year. Early in the week, word came from a meeting in Doha that “Ahab the Arab, the sheik of the burning sand/He of emeralds and rubies and a ring on every finger of his hand“ (in the persons of the oil ministers of Saudi Arabia, Kuwait and Qatar along with Russia) was prepared to limit production to January’s level if Iran and Iraq would likewise agree. No word was forthcoming from Iraq, but the Iranian oil minister hinted that he was in favor of production limits. Next came word that savvy investor David Tepper had made a large investment in ETP, an oil and gas pipeline owner. Then came news that the oracle himself, Warren Buffett had invested in Kinder Morgan (KMI), another pipeline owner. These investments signaled to many that the smart money had determined that oil was approaching a bottom. Oil did spike above $32/bbl midweek before falling on Friday. That fall was not precipitous, however, and oil stocks retained much of Wednesday’s healthy gains.

Further contributing to Mr. Market’s good week was news gleaned from the Federal Reserve’s January meeting minutes which were released on Wednesday. In the minutes, Fed members aired their concerns that the likelihood of inflation hitting the desired 2% target was fading. The release of the minutes was followed by a statement from heretofore Fed interest rate hawk, James Bullard, that the economy was too weak to support another rate hike anytime soon. This statement pleased Mr. Market, at least in the short run. However, for those, such as yours truly, who desire rate normalization even at the cost of short term pain, the Fed minutes and Bullard's words were disappointing. When if ever will we be able to achieve a decent return on a safe investment? Maybe not for years. It is hard to fathom now, but in 2007 one could achieve a 5.4% annual return on an FDIC insured 12 month CD. That instrument pays 1.1% today. This “loss of interest” may be “no big thing” to Wall Street mavens, but it gives me and others seeking a decent safe return the "pain of heart ache.” I suggest that the inability of Mr. and Mrs. Saver to garner any return on their deposits is a major contributing factor to their obvious distrust of and displeasure with anyone associated with the Establishment.

As loyal readers know, I am a huge fan of David Tepper (see Vols. 59 and 170 riskrewardblog.blogspot.com ). His purchase of ETP “started a fire in my heart that reached such a fever pitch that it brought me out of the dark” at least in regard oil and pipelines. I opened new positions in ETP, RDS/B, and BP this week. And if James Bullard has become a rate hike dove, then I see no reason to hold back on buying heretofore oversold interest rate sensitive stocks. So I opened new positions in REIT’s VTR and OHI, preferred stock closed end fund DFP, equity play GAB, hedge fund BX and municipal bond closed end funds MQT and VGM. That said, I am not “Rolling In Too Deep." More than 2/3rds of what I manage is still in cash. But, the signposts that I watch signaled that it was time to make a move.

Like Elvis, I invest with a healthy dose of “Suspicion.” Indeed maintaining a “Suspicious Mind”, well “That’s All Right, Mama.” My purchases this week, notwithstanding I have not “Surrender”(ed) to irrational exuberance. I know Mr. Market can “Be Cruel” even to a “heart that’s true.” If the market reverses, my loss limit rules will keep me from ever spending a night in “Heartbreak Hotel.” If things get “All Shook Up”, I will enter sell orders and cash will be “Returned to Sender.”

February 14, 2015 Rubber Ball

Risk/Reward Vol. 295

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

“I'm like a rubber ball
Baby that's all that I am to you
(Bouncy, bouncy) (bouncy, bouncy)
Just a rubber ball”---lyrics from “Rubber Ball” sung by Bobby Vee

"He saw magnificent perfection,
Whereon he thought of himself in balance,
And he knew he was.”---lyrics from “The Balance” by The Moody Blues

“So don't act like it's a bad thing to fall in love with me, me
It's not a bad thing to fall in love with me, me
Not such a bad thing to fall in love with me”---lyrics from “Not Such a Bad Thing” sung by Justin Timberlake

Was Friday’s 2% gain in the major indices a sign that “like a rubber ball/Bouncy, bouncy/Bouncy, bouncy/" Mr. Market is poised to bounce back into positive territory for the year? Is Friday’s remarkable 12% rise in oil prices (to which Mr. Market is now so closely correlated---see last week’s edition www.riskrewardblog.blogspot.com ) sustainable? I suspect not given that the impetus for the upward movement in both the price of oil and the stock indices was a statement from the United Arab Emirates’ oil minister that OPEC members will not pump more oil to compensate for lower US production. Not increasing production is a long way from cutting production. And with a world already awash in petroleum and new supplies entering the market from Iran, a cut by OPEC is what is needed.

Moreover, despite the remarkable gain experienced on Friday, both major indices closed down for the week. Why? There is no one answer, but clearly a major factor is Mr. Market’s sense that the world’s central banks are no longer effective in spurring economic growth, if they ever were. With the ECB, the Bank of Japan and several other regulators now charging banks for holding funds held in reserve and with interest rates already at historic lows, borrowing remains sluggish as do corporate capital expenditures and consumer consumption. The economists that run central banks are mystified and confused. Wasn't it in December that Janet Yellen and her cohorts raised short term interest rates confident that the economy was on the mend? Can it be that a short 45 days later she is contemplating reversing course? This bespeaks self doubt among the economists who run the Federal Reserve, which is rare given that they are schooled to believe that their levers can be used to “Balance” supply and demand. For them it is an article of faith that, with their help and guidance, resources can be reallocated to dampened or spur demand as desired. At their core, they believe that markets always seek equilibrium; that state where supply meets demand in “magnificent perfection.” What we are witnessing may prove them wrong; and may prove right George Soros’ theory of reflexivity; that is, that markets, like humans, are imperfect. They are not always rational. Like the humans who created them, markets experience fear and panic which by themselves can lessen demand and cause economies to spiral downward toward recession and its evil twin deflation even in the face of lower prices and other inducements to spend.

The fact that the indices are struggling does not mean that money cannot be made. In times of fear, investors love safety, causing the price of safe havens to rise. “It’s not such a bad thing to fall in love with safe havens/Not such a bad thing.” Two classic refuges are gold and government bonds. And at least one of our fellow subscribers loaded up on both at the beginning of the year. His vehicles of choice were TLT, an exchange traded fund holding long dated Treasury bonds which is up 9% year to date and GLD, the gold exchanged traded fund, which is up 17% year to date. Good job, Mr. X! Also doing well are certain real estate investment trusts, notably, O which is up 17% year to date and which in addition pays a nice dividend.

No doubt, these are trying times for investors. But as in all of life’s endeavors, one has choices. One can be the whiny Justin Timberlake who can only “Cry Me a River.” Being that Justin Timberlake certainly is N'Sync with current market sentiment and “Not a Bad Thing.” Or one can be the Justin Timberlake who seeks opportunity when markets are down. That Justin Timberlake knows that “What Goes Around/Comes Around." That Justin Timberlake is dedicated to bringing “Sexy Back." Through continuous study that Justin Timberlake prepares for when it’s time to “Buy, Buy Buy.”

February 7, 2016 Strange Relationship

Risk/Reward Vol. 294

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

“Do U know?
I think U and I got a strange relationship
What's this strange relationship?”---lyrics from “Strange Relationship” sung by Prince

“If you're down and confused
And you don't remember who you're talking to
Concentration slips away”---lyrics from “Love the One You’re With” sung by Crosby Stills and Nash

“Tell me, tell me, tell me lies
Tell me lies
Tell me sweet little lies”---lyrics from “Little Lies” sung by Fleetwood Mac

“Do you know/I think oil and the S&P 500 got a strange relationship/What’s this strange relationship?” Lately, as the price of oil goes, so goes the S&P. At the close on Friday, that correlation is 97% year to date. Huh? OK, maybe there is some relationship between the price of oil and the stock market. Lower oil prices reflect less demand, and lower oil prices mean fewer oil patch jobs. But, logically, any such relationship should be more than offset by the positive impact that cheap fuel has on consumer pocketbooks. Shouldn’t it? Apparently not today. Now add to the mix the relationship between the relative value of the dollar and the price of oil. Look what happened on Wednesday. Influential Fed member Bill Dudley cast shade on the likelihood of a rate hike at next month’s FOMC meeting. On that comment, the dollar fell in relation to other currencies causing the price of oil to rise 8% almost immediately. That news, in turn, caused the Dow Jones Industrial Average to go from a negative 193 points to a positive 183 points in a matter of minutes. YIKES!

Recognizing that a correlation exists explains directionality, but does not address the rapidity of the reaction. Since early January, oil and stocks have traded in lockstep, minute to minute. How can so many market participants react so quickly and so uniformly? On this point, John Boy, aren’t you “down and confused?” Not really, Dear Readers. “Don’t you remember who you’re talking to?” The answer is found in the “concentration” which exists in all markets today. The total market value of the S&P 500 is $18trillion. The total market value of the US bond market is $37trillion. Combined their market value is $55trillion. According to benefits consultant Towers Watson, the top five US fund managers have $14.4 trillion under management (for illustration purposes 14.4trillion/55trillion= 25%). The top dog, BlackRock, manages $4.7trillion alone. In other words, if just a few people atop a few firms sense (create?) a correlation, they can move the needle so as to make any such prophecy self-fulfilling. I don’t believe that a grand conspiracy exists, but the above statistics go a long way in explaining the minute to minute, lockstep correlation that exists today.

Although the previous week’s gains in the indices evaporated , my portfolio (85% in cash plus a few REIT's and a few preferred stock funds) continued to gain ground, albeit modestly. That is because the yield to which REIT's and preferred stocks are correlated (that on the US 10 Year Treasury Bond) continued to move downward, and downward yields equate to increased prices. I added GM and Ford midweek after both dropped dramatically despite record earnings and upbeat guidance. Their 5+% dividends should keep their prices from falling further. I did not buy any oil as that entire sector continues to take a beating. Perhaps deservedly so. Take Conoco. In December, Conoco’s CEO reiterated that the company’s number one priority was maintaining its dividend even at the expense of capital expenditures. So you can imagine the market’s surprise when that same CEO announced this week that Conoco was cutting its dividend by 66%! “Tell me, tell me, tell me lies/Tell me lies/Tell me sweet little lies”---indeed. This is not the first time that a CEO hath protested too much when asked about the sanctity of a dividend, and sadly it won’t be the last.

This market is like a Prince best hits album. If you follow the markets minute by minute, you will go “Delirious.” So “Let’s (not) Go Crazy.” This is not “1999” with its infamous internet bubble. And it’s not 2009 either. That said, no one is profiting enough to buy a “Little Red Corvette.” Just remain calm, don your “Raspberry Beret” and stay out of the “Purple Rain.” Next week, pay attention to Janet Yellen’s Congressional testimony. If she infers that no rate hike will be forthcoming in March, the dollar will drop in value, the price of oil will increase and, as if in lockstep, stocks will rise. If she hawkishly indicates that a rate increase could occur in March, you will "hear what it sounds like when (interest rate) doves cry," and the opposite will occur.

January 31, 2016 Reverse Course

Risk/Reward Vol. 293

This will edition is truncated due to the birth of our eighth grandchild, Graham Michael McClement. Mother and son are doing well. Barb and I have had fun caring for his sisters while Amanda and Todd stay with Graham in the hospital. He comes home today.

With the surprise announcement on Friday that the Bank of Japan (Japan's central bank, like our Federal Reserve) is going to charge interest to Japan's money central banks for maintaining excess reserves, the US stock markets skyrocketed on Friday. The Dow Jones Industrial Average and the S&P 500 each rose over 2% salvaging what otherwise would have been a disappointing week. But even Friday's performance could not rescue January. US stock markets suffered their worst month since 2009.

So why did the BOJ announcement have such a whopping impact on US markets? Here is the answer. The move by the BOJ will encourage its large, money center banks to reduce the amount of funds held in reserve and to lend those reserve funds to customers at low rates. After all, charging any rate of interest is better than paying interest to keep money in reserve.. With the BOJ joining the European Central Bank and other central banks world wide in charging as opposed to paying interest on excess reserves (like the Federal Reserve does) pressure will mount on the Federal Reserve to reverse course and to either postpone its scheduled quarterly 25 basis point rate increases in 2016 or, even more drastically, to reverse the bump in rates that it implemented in December. If it does not reverse course, the Fed will be out of step with every other central bank. This would cause the value of the dollar to rise in relation to other currencies; hurting US exports and lessening even further the consumption of oil which is denominated worldwide in US dollars. If the Fed does reverse course, it will cheapen the cost of credit. Cheap credit encourages corporations to borrow money which they have used in recent times to fund stock buy backs. Stock buy backs buoy stock prices. The stock markets rose on Friday in anticipation of the Fed reversing course.

Adding to the stock market rise was news on Friday that the crude oil rig count in the US fell again last week. The number of rigs has fallen 68% since the high mark reported in October 2014. Fewer rigs means lower production, and lower production means higher prices. Thus, oil futures rose. As noted last week, recently, higher oil prices have equated to higher stock prices. In the past 20 trading days there has been a 95% correlation between the price of crude and S&P 500.

January 24. 2016 Fixin' A Hole

Risk/Reward Vol. 292

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

“He's a real nowhere man
Sitting in his nowhere land
Making all his nowhere plans for nobody”---lyrics from “Nowhere Man” sung by The Beatles

“I'm a girl watcher
I'm a girl watcher
Watchin' girls go by
My, my, my”---lyrics from “I’m a Girl Watcher” sung by The O’Kayshions

“She sells seashells by the seashore,
The shells she sells are seashells, I'm sure.
So if she sells seashells on the seashore,
Then I'm sure she sells seashore shells.”---lyrics from “She Sells Sea Shells” written by Terry Sullivan

If one looked only at where the stock market started and where it finished the week, one would see very little variance. One could conclude that Mr. Market was “a real nowhere man/Sitting in his nowhere land/Making all his nowhere plans/For nobody.” But that would belie what really happened. From trough to peak, the Dow Jones Industrial Average (DJIA) moved 821 points. At one time on Wednesday, the DJIA was down over 500 points from its Tuesday close. That same day, the VIX which measures volatility was over 30, its highest point since last August. This environment was not conducive to investing.

Why you ask? Could this all be a reaction to oil prices? Surely, not. Well, actually---maybe so. If you chart by the hour this week’s price of crude oil and compare it to the DJIA you will see an almost perfect correlation. If this correlation persists, I do not recommend initiating any new stock positions until the price of crude oil stabilizes. The nearly 20% swing from a $27/bbl low on Wednesday to a $32/bbl close on Friday is simply too much volatility. Add to this the fact that 1/3rd of the 155 oil companies covered by S&P now have junk credit ratings and the fact that Moody’s is initiating a credit review of every major oil company in the world, and you may decide, like I have, to take a pass on any stock purchases for the time being. Make like Popeye. When it comes to Miss Oil or those securities correlated to her, be “a girl watcher/a girl watcher/and just watch that girl go by/My, my, my.”

The above stated, I remain confident that sometime this year fortunes will be made in oil stocks. Among the ones upon which I remain focused is Royal Dutch Shell (RDS/A and RDS/B). With oil’s recovery on Friday, RDS rose nearly 6%, but still was down 3% for the week. It remains down 9% for the month, 24% for the quarter and 34% for the trailing twelve months. The above stock performance notwithstanding, Shell's CEO stated this week that RDS can sustain its $1.88 annual dividend (9% at current prices) through 2016 and beyond, a fact which should buoy its stock price once stability returns to the oil patch. If oil can hold above $30/bbl and if Shell secures approval of its merger with BG in next week’s shareholder vote, I may buy some. If I do and oil prices again plummet, I will “sell Shell at the seashore or elsewhere, I’m sure.”

As I review what has occurred over the past few months, I find comfort in knowing that my decisions to sell have preserved the overall profitability of my portfolio. The older I get, the more important preservation of principle becomes. Reward is less important than avoiding loss. My loss prevention rules remove much of the emotion associated with managing stocks. And let’s face it, my friends, investing involves a huge emotional component. Indeed, the entire money management industry is grounded in ascertaining, and investing consistent with, each client’s emotional tolerance for risk. My sell rules are like “fixin’ a hole where the rain gets in/They keep my mind from wanderin’/ There I will go /And it really doesn't matter if I'm wrong I'm right /Where I belong I'm right /Where I belong.”

January 17, 2016 Better Place

Risk/Reward Vol. 291

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

“We gotta get out of this place
Girl, there's a better life
For me and you”---lyrics from “We Gotta Get Out of This Place” sung by Eric Burdon and The Anim

“Falling in and out of love with you
Falling in and out of love with you
Don't know what I'm gonna do...I just keep
Falling in and out of love”---lyrics from “Falling In and Out of Love” sung by the Pure Prairie League

“This is my gimmick and I wanna win it
I'm selling out
I won't fight you no more”---lyrics from “The Sellout” sung by Macy Gray

Let’s review the news from the oil patch this week: on Tuesday it was reported that 30 oil companies have declared bankruptcy in the past few weeks and that many more are teetering on the verge of insolvency; several times this week the price of crude fell below $30/bbl closing on Friday at $29.65; despite a 51% cut in domestic capital expenditures, production continues to outpace demand; and on the international front, the sanctions against Iran are to be lifted in the next two weeks which will add another 1-2 million bbls/day to an already oversupplied market. Small wonder that I sold all of my oil positions on Monday. I barely broke even, the handsome gains about which I wrote just a few weeks ago having evaporated. I still like oil in the long run, but for now “We gotta get out of this place/Cash is a better life/For me and you.”

As for the rest of the market, Holy Pure Prairie League! Rarely have I seen such volatility; not only day to day but hour to hour. The VIX, which measures volatility, is at 28, its highest level since 2012. Check out this week’s charts. They tell a tale of “Falling in and out of love/Don’t know what to do/Falling in and out of love with you, Mr.Market.” By the end of the week however, it became clear that the falling was mostly “out.” Indeed, according to Tuesday's Wall Street Journal, pension funds are holding the highest percentage of cash since 2004. At the close on Friday, the Dow Jones Industrial Average was down 2.2% for the week and 8.25% year to date. The S&P 500 was down 2.2% and 8% for the same time periods. Panic caused a flight to safety. As a consequence, the yield on the US 10Year fell to 2.02% (remember, the greater the demand/price, the lower the yield) but not even that downward march immunized my beloved preferred shares and preferred share closed end funds from irrational selling. That said, my preferreds remain in the green. In fact, I used the stampede as an opportunity to add new positons in HPF and HPI.

What I found most compelling this week was the admonition by JP Morgan to use any rally in the stock market to sell equities. In effect, JP Morgan is “selling out/not willing to fight the bear anymore.” This is the first such advice in many years. Indeed, since 2010 JP Morgan and virtually every other investment house have advised the opposite; to wit, to use every dip as a buying opportunity. Sitting primarily in cash, I relish such advice. If followed by others, it will create great buying opportunities for me. Once again, remaining patient will be my greatest challenge. I don’t aspire to buy at the bottom---just somewhere near it. What is the bottom is anybody’s guess. I don’t need to know. I just need confirmation that it has been reached.

We may be facing a bear. So far, the stock market is on a pace to record its worst month since November, 2008. But with apologies to Eric Burdon, bear markets “Don’t Bring Me Down.” They end sometime. And when they do, profits can be made. Let’s face it folks, a bull market cannot run forever. Bulls and bears are the yin and yang of investing. “River Deep and Mountain High”, if you will. So “Don’t Let Me Be Misunderstood”. Bear markets may “Spill the wine”, but they allow smart investors to “take that pearl.”

January 10, 2016 Waterloo

Risk/Reward Vol. 290

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

“Happy New Year
May we all have our hopes, our will to try
If we don't we might as well lay down and die
You and I”---lyrics from “Happy New Year” sung by Abba

“But you ran out of gas
Down the road a piece
Then the battery went dead
And now the cable won't reach”---lyrics from “Last Chance Texaco” sung by Ricky Lee Jones

“Welcome to my nightmare
Pressures on, blood pressure racing
I calculate my next step, pacin'
Don't know if I'll meet expectations”---lyrics from “Die Hard” sung by Dr. Dre

“Happy New Year/May we all have our hopes” and “the will to try” to prosper. Based upon 2016’s first week, that won’t be easy. I am not suggesting that “we might as well lay down and die”, but I am advising caution. And for good reason. In this past week, the Dow Jones Industrial Average (DJIA) and the S&P 500 (S&P) each dropped 6%. Political unrest in the Mideast, sinking oil prices worldwide and discouraging news from China (two days of precipitous stock market drops and a report that the Chinese economy will grow at only a 6% clip in 2016) combined to cause the S&P to notch its second worst kickoff week since 1929!

The continuing drop in oil prices is of particular concern to me. I remain confident that the price of crude will rebound above $50/bbl sometime this year. I don’t want us “running out of gas” or experiencing “batteries going dead”, but hopefully production will be cut by someone, soon. The current oil glut was the subject of a thoughtful piece written by Donald Lufkin in Friday’s Wall Street Journal. He characterized the current oversupply as a classic case of innovation (to wit, fracking) “creatively destroying” the Malthusian shibboleth that population will outstrip the supply of natural resources. Lufkin is optimistic that once the price of crude is rationalized we should be in for a sustained period of prosperity, freed from the yoke of Mideast petrocrats.

So do I view 2016 as “my nightmare, with pressure on, blood pressure racin’, pacin’ , not knowin’ if I’ll meet expectations?” Abba-solutely not! Why not? Because the majority of my holdings are preferred stocks, preferred stock closed end funds, REIT’s and other securities closely correlated to the yield on the US 10Year Treasury Note. (For an explanation of why I like this non diverse approach see Vol. 221 www.riskrewardblog.blogspot.com ) So far this year that yield has fallen which means the prices of the 10Year and those securities that are correlated thereto have risen. (Remember the lower the yield, the higher the price.) Indeed, I am even this week and would have been off to a banner start but for a few disappointments in the oil patch (OKE and VNRBP). With corporate profits expected to founder, I see my approach working well this year.

With apologies to Abba, I don’t see this first week as our “Waterloo.” Nor should we be sending an “SOS.” “Knowing Me, Knowing You” we should remain calm. This may not be a year where “The Winner Takes It All.” But with a principled approach aimed primarily at avoiding loss, one should see some profits. That is why I choose to “Take a Chance on Me”---or at least on my approach.

December 27, 2015 Here Is My Handle

Risk/Reward Vol. 289

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

“Here is my handle
Here is my spout
When I get all steamed up
I just shout
Tip me over and pour me out’---lyrics from “I’m a Little Teapot” sung by Children

“So tell me why, haven't I heard from you
Tell me why, haven't I heard from you”---lyrics from “Why Haven’t I Heard From You” sung by Reba McEntire

“And when we say
Yeow! A-YIP-I-O-EE-AY
Were only say-in "you're doing fine Oklahoma,
Oklahoma OK"---lyrics from “Oklahoma” by Oscar Hammerstein II

One of the lessons taught by famed investor and stock chartist, Bill O’Neill (founder of Investor’s Business Daily), is that one needs to be watchful when buying a battered stock early in its recovery. If one charts any such recovery, one sees a cup and “handle” pattern. Indeed, O’Neill doesn’t buy until the cup is complete (that is the price has fully recovered) and a handle has formed. His reasoning is simple. There is too much resistance during any recovery from those who see any price increase as an invitation to cut losses by selling. Those sellers make the trip up the right side of the cup perilous. I faced that peril this week in some of my VNR preferred stock positions about which I crowed last week. I exited a few but I did not “get all steamed up”; nor did I “shout”; nor did those price retreats “tip me over” into a loss. Having read O’Neill, I knew the road to recovery could be rough. What I did do was sell once I approached my sell limit and buy back once recovery appeared on sounder ground. By week’s end, every position was back in black with my original investment up 53% in less than a week.

Despite Thursday’s retreat, the week was a good one for Mr. Market as both major indices finished up 2.75%. Some claim this was a “Santa Claus” rally, but I think it had more to do with the exit of the Federal Reserve as THE dominant market force. Nothing---not a peep---was heard from the Fed last week, and I do not expect much news from the Fed until well into Q1. ‘So tell me why haven’t we heard from the Fed/Tell me why?” Because along with its decision to raise short term rates last week, the Fed set a reasonable and predictable path of rate increases for the next 12 months. These increases are now factored into short to medium term bond prices including the all-important US 10Year Treasury Bond, the yield on which has held steady in the 2.2 to 2.35 range for several weeks. This is very good news for income investors such as yours truly and I believe for the stock market in general.

I continue to add to preferred stock positions and have opened a few others in the mortgage real estate investment trust sector which took a beating these past several months as the Federal Reserve dithered on a rate increase. In addition, I opened a position in Oneok (OKE) an Oklahoma based oil and natural gas pipeline company that issued guidance early last week confirming its intention to maintain a healthy 11% dividend. This was welcome news and caused me to “say/ Yeow! A-YIP-I-O-EE-Ay/ You're doing fine Oklahoma, Oklahoma OK.” Look for other pipeline companies to issue favorable guidance if and when some stability returns to the oil patch; an event which appears more likely now that the US ban on exporting crude oil has been lifted.

I hope you are enjoying your holidays. As the New Year approaches rest assured Dear Readers that this Oscar (like Mr. Hammerstein) will continue to learn and to record. Keep reading this newsletter and find comfort in knowing that in the world of investing “You Will Never Walk Alone.” It may not be all “Happy Talk”, but on occasion we will “Whistle a Happy Tune” for sure. And as for Mr. Market, well he’s just like “Ol’ Man River/He just keeps rollin’ along.”

December 20, 2015 Finally

Risk/Reward Vol. 288

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

“Finally it has happened to me
Right in front of my face
My feelings can't describe it”---lyrics from “Finally” sung by CeCe Peniston

“Nothing from nothing leaves nothing,
And I ain't stuffing/Believe you me
Don't you remember I told you
That I'm a soldier in the war on poverty”---lyrics from “Nothing From Nothing”---sung by Billy Preston

“We've all been down this road before,
I give it all, you wanted more.
I've only got myself to blame”---lyrics from “Back Again” sung by Daught

“Finally, it has happened/Right in front of my face.” On Wednesday, the Federal Reserve raised short term interest rates for the first time since 2006. That’s right---for almost a decade, interest rates have been in either a declining or zero bound state. Maybe historically low rates were necessary in 2008-2009 at the height of the credit crisis, but since then they only have disproved the long held belief of Federal Reserve wonks that cheap money alone can spur robust economic growth. Clearly, it cannot. Meanwhile, those same wonks have wiped out 10 years’ worth of returns on savings; returns upon which most Americans and every pension plan rely to grow their nest eggs. As an income investor in the twilight of his earning years, I struggle for words “to describe my feelings.”

Immediately following the rate increase announcement on Wednesday, the stock market exploded. The Dow Jones Industrial Average rose 250 points between the 1 o’clock press release and the close of trading at 4pm; a signal from Mr. Market that it was high time to start normalizing rates. Unfortunately, the stock markets could not sustain the rally. Continued weakness in the oil patch on Thursday (due in part to the rate increase and a concomitant strong dollar) and a technical trading event on Friday (the quadruple witching hour when all options expire thereby magnifying whichever way the market is trending) conspired to wipe out the mid-week gains. The two major indices finished the week below where they ended last week. “Nothing from nothing leaves nothing/Believe you me.” In other words, index investors retreated in their “war on poverty.”

But not everyone lost money as the week ended. As stated over these past several weeks, I intended to gauge the impact of the rate increase on the benchmark 10Year Treasury Bond, and if it was de minimis (as I believed it would be), I would jump “Back (in) Again.” In fact, the yield on the 10Year held steady. Accordingly, I began buying some of my favorite interest rate sensitive stocks on Thursday (PGX, HPF, HPI), many of which had been hammered; an overreaction to the anticipated impact of the Fed’s action. As the stock indices collapsed on Friday, the yield on the 10Year remained steady--- as did the value of my purchases. Some even appreciated. But where I really prospered this week was with Vanguard Resources (VNR). Before the market opened on Friday, VNR announced that it was reducing the dividend on its common stock by 75% but maintaining the dividend on its preferred. 20.VNR’s preferreds (VNRAP and VNRBP) have been favorites of mine for several years, but I have shied away from them over the past month or so due to unfavorable oil and gas developments and the belief of many that VNR’s preferred dividend would be cut along with that on its common. With Friday morning’s announcement, the safety of the preferred dividend was strengthened significantly. I bought several positions of each through the day. VNRAP rose 25% and VNRBP rose nearly 12%: in one day! If luck is the intersection of preparation and opportunity, I was lucky indeed. Overall, it feels natural to be back investing. But I’ve “been down this road before” and if it goes badly because I entered too soon, “I’ve only got myself to blame.”

I reenter the market with enthusiasm. In the words of Billy Preston, “I’m Born Again.” For the first time in years, I feel confident that a sensible and predictable path will be followed by the Fed. The Fed’s dot plot (See Vol. 259 www.riskrewardblog.blogspot.com for an explanation) also published on Wednesday foretells a series of quarterly 25 basis point increases over the next year. As an income investor predictability of rates is all that I need to make a decent return. But if it all goes awry (as it will at some point), I will not hesitate to liquidate only to re-enter when the time is once again right. Like Billy, inevitably and inexorably, Mr. Market “Goes ‘Round in Circles.”

December 13, 2015 What Goes Round

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

Risk/Reward Vol. 287

“But now the days grow short/I'm in the autumn of the year
And now I think of my life as vintage wine from fine old kegs”---lyrics from “It Was A Very Good Year” sung by Frank Sinatra

“When you hear that the preaching does begin
Bend down low for to drive away your sin
And when you gets religion, you want to shout and sing
There'll be a hot time in the old town tonight”---lyrics from “Hot Time In The Old Town Tonight” sung by Bessie Smith

“Don't want to think about it
Don't want to talk about it
What goes around, goes around
Comes all the way back around”---lyrics from “What Goes Around” sung by Justin Timberlake

“The days grow short. It’s the autumn of the year.” It’s time to assess. Was it "A Very Good Year?" Do you think of your portfolio's year to date performance "as vintage wine from find old kegs?" Or does it leave you with a sour note as if turned to vinegar? If it is the latter, you are not alone. Year to date the Dow Jones Industrial Average is down 3.1% and the S&P 500 is down 2.2%. As far as stock indices go, only the tech heavy NASDAQ Composite is in positive territory with a year to date gain of 4.1%. According to a report from the Federal Reserve released this past Thursday, the net worth of U.S. households fell in the third quarter due primarily to a $2.3 trillion drop in the value of equities. But it could be worse. You could have invested with noted money manager (and Milwaukee native son) David Einhorn whose flag ship hedge fund is down over 20% so far this year.

Recently, it has been commodities in general and the oil and natural gas patches in particular that have driven Mr. Market downward. Consistently warm temperatures have reduced the demand for fossil fuels worldwide. Indeed, it hasn’t been “preaching or getting religion or shouting or singing”, but the presence of El Nino which has produced a “Hot Time In The Old Town Tonight.” Natural gas is trading at 17 year lows, and crude oil closed the week at $35/bbl, more than 70% off of its mid 2014 price. With Saudi Arabia continuing to flood the world with petroleum, prices will continue to suffer. But, for how long? If the Saudi’s purpose in ramping up production is to ruin US producers and to curtail the miracle of fracking, then 2016 could be the year the hemorrhaging abates. Up to now, many small to medium US producers have been able to survive because of hedging. Indeed, through 2015, domestic producers hedged nearly 30% of their production at or above $50/bbl. That percentage drops to 11% in 2016. The result likely will be continued cut backs in production, reductions in capital expenditures and a series of debt defaults and/or bankruptcies. If you want a preview, look at what mighty Kinder Morgan did last Tuesday; cutting its dividend by 75%! KMI is down an astonishing 57% year to date.

So what’s going on? Oh ye of short memory! This is the stock market, bro! Unless you “don’t think about it or/Don’t talk about it”, you know that when it comes to Mr. Market “what goes around, goes around and comes all the way back around.” If you have cash on hand (and as loyal readers know I have ample having sold entire porfolios this spring and again on October 26th), a disappointing close of 2015 could present excellent buying opportunities in 2016. But where? As discussed previously, in preferred stock once the Fed raises rates as it likely will next week. And (of all places), the oil patch. Huh? That’s right, the oil patch. Chevron, Conoco, BP and Shell all recently have reiterated that maintaining their hefty dividends (5-8%) are their top priority. Each has a budget in place for 2016 which has room for dividends even at rock bottom oil prices. But do not be in a hurry to buy. The bottom may not have been reached. Buy stock on the rise. It is never wise to catch a falling knife.

To be Frank, 2015 is not looking good. The two major stock indices are struggling to break even. “From This Moment On” the time for any Santa Claus Rally is short. Even if you conclude that a bottom has been reached, remember that only “Fools Rush In.” Caution is the best approach. I, for one, don’t have “Someone to Watch Over Me.” Fortunately, I took profits in October, and unless I do something stupid, “They Can’t Take That Away From Me.”

December 6, 2015 Truckin"

Risk/Reward Vol. 286

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

‘Truckin', like the do-dah man
Once told me "You've got to play your hand"
Sometimes the light's all shinin' on me;
Other times I can barely see.
Lately it occurs to me
What a long, strange trip it's been”---lyrics from “Truckin’” sung by The Grateful Dead

“I'll never know
How the future will go
I don't know what to tell you,
I'm not a fortune teller”---lyrics from “Fortune Teller” sung by Maroon Five

“Like a rock, I was strong as I could be
Like a rock, nothin' ever got to me
Like a rock, I was something to see
Like a rock”---lyrics from “Like A Rock” sung by Bob Seger

Trying to ascertain what occurred in the stock market last week was like “Truckin’”. “Sometimes the light was all shinin’ on me”, and I thought that I grasped what was happening. At other times “I could barely see”; unable to make any sense of what was unfolding. At its end “it occurred to me”, that the week, like the entire year to date, was just “a long strange trip.” Buffeted up and down by a disappointing ISM report, an anemic ECB rate cut, news that the Saudi’s will not cut oil production, a forecasts of slower global growth and finally solid job numbers, the Dow Jones Industrial Average (DJIA) ended the week up only 0.28% despite Friday’s 2.12% jump, and the S&P 500 gained a mere 0.08% despite rising 2.05% on Friday. Year to date, the DJIA is up 0.14% while the S&P is up 1.6% despite the volatility. Are we destined like “the do-dah man” to merely “play our hand?”

Maybe; maybe not. “I’ll never know/How the future will go/I don’t know what to tell you/I’m not a fortune teller.” But, I can foresee the following holding through the first quarter of next year: 1) an accommodative ECB; 2) a 0.25% increase in the Fed Funds rate; 3) oil in the $40-45 range; 4) steady if unspectacular domestic employment; 5) near zero inflation ; and 6) global growth in the 2% range. I view last week’s activity as those in the market positioning themselves for the above described scenario; nothing more and nothing less. Of the events cataloged above, to me (not surprisingly) the most significant is the now almost certain increase in the Fed Funds rate at the FOMC meeting of mid December.

Why? Because, Dear Readers, as I have preached lo these many months and years, for income investors such as yours truly, money can be made so long as the rate on US Treasury securities remains steady “like a rock.” If the FOMC raises the short term rate in December and signals that it will be conservative in any future moves (as most now believe), the rate on the US Ten Year will stabilize as will the rates on securities priced in relation thereto; most notably preferred stocks. I see the 10Year stabilizing near 2.3% and PGX (a basket of highly rated preferred stocks) yielding a steady 5.75-5.9%. That would be “something to see”, indeed. There is no reason to jump the gun however. I will remain “as strong as I can be” and resist the urge to buy in advance of the FOMC’s meeting.

For income investors, the last several years of zero bound interest rates have been trying to say the least. Talk about sailing “Against The Wind”! But if the FOMC “Turns The Page” and begins to raise rates, like Bob Seger, I will “Lock and Load” up with several of my long time favorites. Perhaps, “You’ll Accompany Me”, but only if and when you reach your own conclusions based upon your own research.

November 29, 2015 Flowers Gone

Risk/Reward Vol. 285

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

“Where have all the young girls gone?
Where have all the husbands gone?
Where have all the soldiers gone?
Long time passing”---lyrics from “Where Have All the Flowers Gone” sung by Peter, Paul and Mary

“Money can't buy back
Your youth when you're old
Or a friend when you're lonely
Or a love that's grown cold”---lyrics from “A Satisfied Mind” sung by Johnny Cash

“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

Early reports indicate that Black Friday Weekend sales are lackluster. But even if they rebound, they cannot hide the biggest problem facing every economy in the developed world; namely, falling demand for goods and services. Merchants and manufacturers alike are asking “Where have all the young girls gone?/Where have all the husbands gone?/Where have all the soldiers gone?” The sad truth is they are “passing.” Indeed, this year, for the first time since 1950, the number of working age persons worldwide will shrink. Meanwhile, the numbers of those aged 65 and above continue to skyrocket. As warned by Harry Dent (highlighted in Vol. 218 www.riskrewardblog.blogspot.com ) this demographic shift is not good for the world’s economies. The peak age for consumption is 46 which means that Baby Boomer demand crested in 2007. And the following generations simply have not procreated like their predecessors. Who needs a five bedroom house like the Busch’s bought in 1989? Who needs a house at all? Apparently not many, as the sale of newly constructed houses has remained below 500,000 annually since 2008 even in the presence of record low mortgage rates. Between 1963 and 2005, that number averaged 700,000 peaking in 2005 at 1.3 million.

So if demand is dropping how come corporations continue to report record earnings? Remember, corporate earnings are not reported as actual earnings, but “earnings per share”. A corporation can improve its “earnings per share” by increasing actual earnings or by reducing share count. And it is the latter course of action that virtually every corporation in the S&P 500 and the Dow Jones Industrial Average has adopted. “Money can’t buy back/Your youth when you’re old/Or a friend when you’re lonely/Or a love that’s grown cold”—but it can buy back stock. Those corporations comprising the S&P 500 have repurchased over $550billion of their stock in the past 12 months thereby reducing their share count by nearly 3% and increasing “earnings per share” accordingly. In the face of ever shrinking demand, real earnings growth is hard to achieve so corporate managers can and do appease shareholders by buoying their stock price via buy backs.

So are we destined for reduced returns on our investment dollars? Absolutely not. It may not be as easy as it has been since 2010, but hopefully it will not be as difficult as it was in 2008-2009. One sector where I predict a “rock steady” annual return of 5-8% for 2016 is preferred stock. As mentioned countless times in this publication, the return on preferred stock is highly correlated to the interest rate on the US 10 Year Bond. The return on preferred stock will remain stable so long as the rate on the 10Year holds steady. With the futures market now 75% confident that the Federal Reserve will raise short term rates 25 basis points in December and that any increase thereafter will be extremely gradual if at all, one can be reasonably confident that the yield on the 10 Year will stabilize and thus the return on a basket of preferred shares will hold steady. For example, “what I feel now” is that for the foreseeable future PGX will trade between $14.50 and $15.00 and will yield between 5.75 and 6%. For those with an appetite for a bit more risk, any number of closed end preferred stock funds should deliver consistent 8-9% returns.

Throughout my life, I have fallen in love with my own ideas. I know this, and so I establish escape routes in case they don’t work. A perfect example is my 8% loss rule. Don’t any of you fall in love with them. Do your own research; reach your own conclusions. Falling in love with ideas, even one’s own, can be dangerous. In the words of Johnny Cash,

“Love is a burnin' thing,
And it makes a fiery ring
Bound by wild desire
I fell into a ring of fire
And it burned, burned, burned
That ring of fire/That ring of fire.”

November 15, 2015 Watching The Wheels

Risk/Reward Vol. 284

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

“People say I'm crazy/Doing what I'm doing

Well, they give me all kinds of warnings/To save me from ruin

When I say that I'm okay, well, they look at me kinda strange
"Surely, you're not happy now, you no longer play the game"

People say I'm lazy/Dreaming my life away

Well, they give me all kinds of advice/Designed to enlighten me

When I tell them that I'm doing fine watching shadows on the wall
"Don't you miss the big time, boy. You're no longer on the ball"

Ahhh, people ask me questions/Lost in confusion

Well, I tell them there's no problem/Only solutions

Well, they shake their heads and they look at me as if I've lost my mind

I tell them there's no hurry, I'm just sitting here doing time

I'm just sitting here watching the wheels go round and round
I really love to watch them roll

No longer riding on the merry-go-round
I just had to let it go”---lyrics for “Watching The Wheels” sung by John Lennon

OK, I admit it. For the past few weeks, my iPhone has been tuned to the Pandora Beatles station. But don’t knock the lyrics of John and Paul when it comes to financial advice (or any other advice for that matter). Ten days ago, I heard the above song while driving home from a delightful dinner with two new subscribers. They were intrigued by my investment philosophy, in particular my obsession with correlations and my rejection of a buy and hold investment orientation. Unfortunately, I did a poor job of explaining my approach that evening (which is why I described it in last week’s edition www.riskrewardblog.blogspot.com ). I wished that I had had John’s lyrics in mind to assist. "People say I’m crazy/Doing what I’m doing.” “They give me all kinds of warnings/To save me from ruin.” “They give me all kinds of advice/ Designed to enlighten me." “They shake their heads and look at me as if I’ve lost my mind.” But, “I’m just sitting here (in cash) watching the wheels go round and round/No longer riding the merry-go-round.” Because two weeks ago I did not like where my holdings were headed so “I just had to let them go.”

And it's a good thing that I sold. Last week Mr. Market experienced his worse performance since August. Had I remained invested as I was just two weeks ago my handsome profits would have disappeared. I’m not discounting the role of luck, good or bad, in my approach (or anyone else’s). But, luck is merely the intersection of preparation and opportunity. Let’s take oil stocks for example. In late September, I noticed that the price of RDS/A and BP had not recovered from the shock delivered to the oil patch in August when the price of oil fell below $40/bbl. I bought both, as well as VNRBP, ETP and KMI and saw each vault skyward as the price of oil recovered to nearly $50/bbl. On October 24th the price of oil began a rapid decline and I was able to exit all of my oil positions. I did not buy at the bottom, nor sell at the top, but I did make a good profit. Moreover, I came to believe that the foreseeable future would not be good for oil due to the increased likelihood that interest rates would be raised in December, a belief that was confirmed during Janet Yellen’s post FOMC meeting press conference on October 26th. There are direct correlations between increased interest rates and a strong dollar (Increased US bond rates attract international investors thereby raising the demand for dollars at the expense of other currencies.) and between a strong dollar and lower oil prices (All oil contracts worldwide are denominated in dollars. A stronger dollar equates to less buying power in euros or pounds or whatever currency resulting in a lessened ability to purchase and a concomitant drop in demand and price.) These correlations are at work even as I write as the Euro is now worth $1.07 compared to $1.25 last year and the price of oil is back down to $40/bbl. My moves are not infallible. I am right only part of the time. When I am right, I let my winners run until they falter. When I am wrong I sell before absorbing more than an 8% loss on any one position. “I’m not lazy or dreaming my life away; nor am I lost in confusion.” I’m looking for “solutions.”

Alright SmartyPants, it's easy to look brilliant in retrospect. How about the future? OK, this is what I see. First, the yield on the ever important US 10 Year Treasury Bond has held steady at or around 2.3% ever since the blockbuster jobs report of November 6th; this despite a 3.7% decline in the Dow Jones Industrial Average and the S&P 500 over the same period. Since the bond futures are priced with a 70% certainty that the FOMC will raise short term rates in December, I am equally certain (70%) that even with such an increase the rate on the 10Year will not exceed 2.5%. If this is correct, then one should be able to buy with confidence those income securities that are most closely correlated to the rate on the 10Year, such as preferred stocks, and thereby enjoy a 6-9% annualized return. In this sector I like PGX (an ETF) or better yet several closed end funds such as HPS or HPF which pay monthly dividends. Note, however, if you buy closed end funds, be sure to avoid any that trade at a premium to net asset value. For this reason alone, I would avoid my favorite preferred stock fund, FFC. Personally, I likely will not make such a move until after the FOMC's December meeting. Second, with the news on Friday that the world's oil surplus is currently 3billion barrels (a 30 day supply) and growing at 2million barrels a day, the price of crude hit $40/bbl again. Once it hit that level, however, it found support and closed at $40.73. In turn, several of my favorite oil plays (ETP and VNRBP) rallied in the afternoon while others trimmed their losses from earlier in the day. If its price can hold at $40/bbl., there will be some excellent buys to be had in the oil patch. As a word of caution, I would avoid buying anything on Monday due to the potentially disruptive events that occurred in France on Friday night.

I close with a note of sadness---and apprehension. Once again we are reminded that mortal combat always has been and seemingly always will be part of the human experience. At some point even France will respond in kind to violence. With apologies to John Lennon, "the world won't live as one" so long as there are those who refuse to "give peace a chance.

November 8, 2015 Correlation

Risk/Reward Vol. 283

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

Due to familial obligations, I am not publishing a typical column this week. However, as a result of the blockbuster jobs report issued on Friday, the likelihood of the Federal Reserve raising interest rates in December soared. Indeed, pundits are placing the odds at 70% or higher. Such a development deserves some reflection.

As a student of correlation (more about that in a second), Friday played out in a predictable manner. The likelihood of a rate increase triggered a spike in bond yields. The yield on the US two year Treasury bond jumped to a five year high, and the yield on the 10 Year popped above 2.3%. This of course caused a concomitant drop in bond prices and in the prices of those securities that trade in correlation thereto. (Remember, in the bond and interest rate sensitive world higher yields means lower prices). Thus real estate investment trusts (REIT's), utilities, preferred stocks and a host of other rate sensitive securities took it on the chin. The prospect of increased rates also caused the dollar to strengthen in relation to other world currency. When this happens, the price of oil, which is denominated world wide in dollars, typically falls which it did yesterday. In turn, oil stocks tanked.

As reported last week, the heightened likelihood of this scenario contributed to my recent decision to sell my holdings in oil, REIT's and other rate sensitive securities. Had I not, my profits would have been halved last week. Ironically, based on my study of correlation, these sectors now may be oversold. If this situation continues into next week, I may not wait for the actual rate increase to re-enter.

Displayed below is an excerpt from Vol. 221 (www.riskrewardblog.blogspot.com) which explains in more detail my correlation theory.

"Modern portfolio theory posits that an investor can maximize his/her return and minimize risk through asset diversification. In other words, by creating a portfolio of assets that move in different (even opposite) directions in response to any given market stimulus one can lower one’s risk and still profit. I get the theory. But, it just isn’t right for “ lovers, dreamers or me.” I have come to believe that one can construct a non-diverse portfolio correlated to a market singularity; with movement by that singularity providing clarity on when to buy, hold or sell. I believe that my “some day to find” that singularity, the “rainbow connection” if you will, has arrived. No surprise to my readers, the singularity of which I write is the yield on the 10Year US Treasury Bond (10Year). I further believe that by maintaining daily vigilance, adhering to strict principles and fearing not, the buying and/or selling, in short order, of some or all of one’s portfolio, one can prosper. In sum, predictability is more important to me than diversification.

Allow me to elaborate As loyal readers now know,” hands on your knees/hands on your hips/hands down” the benchmark interest rate against which all income securities are priced or spread is the yield on the 10Year. Based upon observation and study over the past three years, “hands on your shoulders/hands on your head/ hands down” the asset class most correlated to movement in the 10Year yield or rate is preferred stock. This is understandable since preferred stocks are a pure interest rate play and absent credit risk are unaffected by the performance of the underlying issuer. Stated alternatively, any change in the price of a credit worthy preferred stock is driven almost exclusively by the interest rate on the 10Year. Indeed, on most days I can tell whether my preferred stocks are “up or down” by simply looking at what happened to the yield on the 10Year. or vice versa Moreover, having studied and confirmed this correlation, I have increased my preferred stock income by buying preferred stock closed end funds (e.g. FFC, HPF, JPC) which enhance returns through leverage. To me, the risk associated with these leveraged funds is no greater since the correlation to the 10Year remains the same. Similar correlations to the yield on the 10Year obtain for mortgage real estate investment trusts, triple net lease investment trusts, leveraged bond funds, leveraged senior loan funds, leveraged municipal bond funds, leveraged utility funds and a host of other income securities. On average this portfolio pays an 8% annual dividend. In addition, I look for stocks or funds that distribute dividends monthly because a corollary to owning a portfolio singularly correlated to the yield on the 10Year is that one must be prepared to sell everything once the prevailing winds shift, and the yield on the 10Year starts to rise. This is what happened during the “taper tantrum” last summer when the yield on the 10Year went from 1.63% on May 2 to 2.16% on May 31 to 2.6% on July 5. Once the upward direction of that movement was confirmed (remember: upward yield means downward price), liquidation of the portfolio was in order (See Vol. 172 www.riskrewardblog.blogspot.com ). That wholesale departure was made more palatable by the receipt of monthly dividends which meant that I was not leaving a juicy quarterly dividend behind. In time, the yield on the 10Year stabilized, the typical spreads returned and I re-entered en masse. (See Vol. 200 www.riskrewardblog.blogspot.com ) If and when the 10Year yield begins to inflate in the future, I will sell and await stability again. It's a win/win because all that I have wanted from the beginning of this journey is a decent rate of return on government bonds (see Vol. 1 www.riskrewardblog.blogspot.com )"

November 1, 2015 Nae Nae

Risk/Reward Vol. 282

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

“Drop it like it's hot

Drop it like it's hot”---lyrics from “Drop It Like It’s Hot” sung by Snoop Dawg

“Now watch me whip (Kill it!)

Now watch me nae nae (Okay!)

Now watch me whip whip

Watch me nae nae (Want me do it?)”---lyrics from “Watch Me” sung by Silento

“When you were young and your heart was an open book

You used to say live and let live

(you know you did, you know you did you know you did)

But if this ever changing world in which we're living

Makes you give in and cry
Say live and let die”---lyrics from “Live and Let Die” sung by Paul McCartney

October was a good month for Mr. Market as the Dow Jones Industrial Average (DJIA) rose 8.5%, its biggest monthly percentage gain in four years. As detailed in earlier editions, I was fortunate to catch the updraft, in particular in the oil patch. But as discussed last week, that sector had begun to cool so on Monday I “dropped it like it was hot/dropped it like it was hot.” I made a small profit on KMI and ETF which have yet to rebound from the surprise equity offering that KMI launched (see Vol. 281 www.riskrewardblog.blogspot.com ). But, I profited handsomely in selling RDS/A (Shell), VNRBP and BP. Mid and long term, I see oil as a great investment, especially Shell. It has adjusted so well to the new, lower price of oil, it is able to cover operating costs, debt service, capital expenditures and, most importantly, its nearly 9% dividend all from current revenue. But given the downward bias in oil these past two weeks and the fact that my big winners were mostly in my 401k account, I decided to take a tax free time out.


How did you interpret Wednesday's Federal Reserve post meeting press release? Are we in for a rate increase in December? Clearly, Mr. Market is without a clue as the DJIA dropped 131 points in the minutes following the press release and then rebounded 203 points to close the day in positive territory. In other words, watching the Fed caused Mr. Market initially to do the “nae, nae” then to “whip, whip” back upward. Who knows, after December’s meeting maybe he'll do the “bop, bop” or the “Superman” or even the “stanky leg.” Sometimes I wish the Fed would just remain Silento.

Lost in the wake of the Fed’s press release was news this week that China adjusted downward to 6.5% the projected rate of growth of its gross domestic profit. That news broke at the same time China announced that it was abandoning its “one child rule.” This is likely too little too late as China, like Japan before it, has become a demographic time bomb. Its working age population is shrinking---fast. Today each retired citizen is supported by 5 workers; in 2040 that ratio shrinks to 2 to 1. Fewer workers means fewer consumers; fewer consumers means less production. This is bad news for the world’s economies, especially those in the developing world. They prospered from 2009 through 2014 primarily via exporting raw materials to China. Take a look at Vol. 74 where I catalog the percentage of the world’s cement, copper, iron ore, etc. that China consumes. (www.risksrewardblog.blogspot.com ). It is astounding. This is of particular concern when one realizes that the performance of 15 of the 30 companies comprising the DJIA is dependent on China. In light of this news and the Fed’s ambiguous signals, I decided to take some profit off the table in sectors other than oil. In so doing, I followed the advice of Sir Paul : “When I was young/And my heart was an open book/I used to say live and let live/But this ever-changing world in which we're livin'/Sometimes makes me give in and cry/Say live and let die”

Maybe you’re amazed that I have chosen to bail after Mr. Market’s splendid October. “Maybe I’m Amazed” myself. Am I being wise to capture what I consider an acceptable level of profit for the year or am I merely a frightened “Band on the Run.” Who knows? But, I rarely have regretted selling and often have regretted staying put. I will take certainty over "A Little Luck” anytime. I do not see myself re-entering until after the Fed’s December meeting---unless of course I hear a “Silly Love Song” and change my mind. But do your own research and do not "Listen To What The Man Said,"