(I have several Gateway Posts that link my discussions about the wide variety of exchange traded floating rate securities: Floaters: Links in One Post Synthetic Floaters Advantages and Disadvantages of Equity Preferred Floating Rate Securities. There are three exchange traded senior bonds that pay a spread over a CPI computation, OSM, ISM and PFK, and all of those have $25 par values. I explain their CPI computation in Item #1 OSM.)
CPI fell a record 1.7% in November as energy costs continued to plunge. This news is consistent with the deflation scenario and is consequently positive for my long bond positions. It is negative for bond positions where the interest rate is tied to CPI, including my positions in TIP and OSM. When discussing OSM, I initiated the position knowing that there would be several months of low or negative inflation numbers that would drive down the monthly interest payment which is linked to a 2% spread over CPI.
My decision to add OSM was based on several considerations. First, market participants had to know that CPI would be falling and that was one of the two main reasons OSM was selling at such a large discount to par. In other words, expectations of a fall in CPI was already largely reflected in the distressed price. A long term decline in CPI would not be reflected yet in my opinion. Second, I knew that most of my return would originate from capturing the spread between $10 and the $25 par value in March 2017. This meant to me that my primary concern was not CPI readings but credit risk, which was the second main reason OSM was selling at $10. I would only start to be concerned about CPI readings for this position in the event negative numbers continued well into next year. The stock price reaction to today's news will likely be negative. I am not concerned about those psychological issues. It may give me another chance to buy the Prudential CPI floater in my buy range when I am no longer having a deer in the headlight day.
One of my first reactions to low Treasury bill rates was to refuse to reinvest Treasury bills as they matured. Instead, I took the opportunity to lock in some CD rates in staggered maturities. I discussed this reaction in these posts
(first paragraph: Trust Certificates PJL and XFL: Verizon Bond)
(2nd paragraph: PLAN FOR MDT AND YIELD CURVE)
This is part of what I call dynamic asset allocation. I kept the money invested in short term debt instruments but switched from treasury bills to CDs issued by an internet bank that were insured by the FDIC, now up to $250,000. So, there was no loss in the security of the investment, but the yield advantage was clearly superior in favor of the bank CDs. With treasury bills now at close to zero, I am satisfied that this was the correct move. However, given the fall in CD rates, I am no longer interested in buying them with proceeds from maturing T bills. For this sub-asset class, this would necessitate yet another change in my dynamic asset allocation model to either long investment grade corporate bonds or to non-U.S. government money market funds.
I would regard the constant shaking off of bad news over the past few days to be a positive sign. The latest bad news was the earnings release from Goldman.
When investors reset their expectations from positive to negative, and prices already reflect a negative outlook, then it becomes difficult to be surprised by bad news. Then, you start to say this is not as bad as I feared, even though it was actually worse than the consensus expectations.
Another piece of bad news was the fall in housing starts by the largest amount in 25 years.
Another piece of bad news was the fall in housing starts by the largest amount in 25 years.
I have being receiving above average cash flow into my main account recently, due unfortunately to mutual funds declaring large capital gains in a year when most of them are down close to 50%. I discussed one of those distributions recently. MUTUAL FUND DISTRIBUTIONS IN A BAD YEAR
I am still trying to decide how to invest this excess cash. While I have not decided yet, and may not decide this week, I am leaning to re-establishing a position in a commodity ETF, since my allocation to physical commodities is now limited to gold and a recently added 50 share position in UNG. By adding to commodities, I mean buying the actual commodity via an ETF. I do not change my allocation to gold. The first position in gold was first established with money made from mowing lawns in Alabama when I was 14, many moons ago, with a push mower at $2 a yard (sometimes at $2 an hour working for my dad's company) with hand clipping thrown in as a bonus. I used my profits to purchase a five dollar U.S. gold coin for about $30, dated in the 1880s, and still owned with a permanent residence in a bank lock box. My cousin Joe claims to this day, like once a year, that I mistreated him by paying him two bits out of my $2 for helping me. I tell him that I was just a better capitalist in training than him (besides my contribution included developing the business). Back then, it was not legal to buy and sell physical gold but owning numismatic gold coins was okay. I have not bought any gold since it was at $300 and I have not sold any either. I treat it in my asset allocation in the same way as I treat my house and other hard assets. I just ignore it.
I have been busy over the past two weeks, mostly outside of HQ, so I am not monitoring the market and my portfolio in such a way to make an addition now.
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