1. Principal Protected Notes: One point to always keep in mind about the special investment products (commonly referred to as principal protected notes) is that they are unsecured obligations of the issuer. If the bank which issues them fails, like Lehman Brothers, then the notes will lose almost all of their value. Anyone who bought this kind of product issued by Lehman Brothers had to learn about that fact the hard way. If I become uncomfortable with the credit risk of the issuer, I will not hesitate to sell all of its "principal protected" notes. My first purchase of one of these products occurred just a few weeks ago.
The following assumes familiarity with the principal protected notes recently purchased and discussed in several recent posts: Bought 100 MYP at $10.12 Bought 100 MOU at $10.12 Bought 100 MKN at 9.85
The reason for adding them now is that they offer a conservative (except for the issuer's credit risk) way to participate in the rise of an index without assuming the downside risk. For example, I have bought recently some Citigroup funding notes that may provide me with a percentage return based on the performance of the S & P 500, the Russell 2000 and the DJ-UBS Commodity indexes. Provided Citigroup survives to pay off the note, I have no risk of losing the $10 par value of the notes or the guaranteed annual interest payments. I do not face the risk experienced by investors in those indexes in 2008 and early 2009, when many investors lost as much or even more than 50%. Since most of those issues were bought at less than the $10 par value of the notes, or slightly above for some others, I do not face the risk of a principal loss associated with a fall in the relevant indexes for each of these securities. I do have, however, the potential of participating in the rise of the relevant index, provided the rise does not exceed the maximum level provided in each of the prospectuses. I recently received an 18% annual interest payment on MKN based on the rise in the DJ-UBS commodity index. The lowest payment that I could have received would have been 3% applied to the $10 par value. Since I am not completely comfortable with Citigroup, I will limit my overall risk to 6 or 7 thousand, that is my limit on exposure to Citigroup's credit risk, which is the main risk with these notes. The main risk for the Lehman Brothers' offerings was without question the credit risk of Lehman itself.
The purchase on Friday of 100 PGEB required a different analysis than the Citigroup Funding principal protected notes. For one, the prospectus of PGEB pointed to a tax issue which required me to place it in a retirement account. One reader inquired about this purchase. While this security is different than the ones from Citigroup which I recently purchased, the basic reason for buying it is the same. I view it as a conservative way to participate in the rise of the three indexes tracked in this security without having to assume more than 10% of the potential downside risk. And, most of the possible downside was due to buying the security at a premium to its par value and to the guarantee that Merrill provides of paying no less than 97% of the $10 par value ($9.7 guaranteed value per share). Unlike the Citigroup notes, I do not have to worry about losing the increase in value due to a maximum level violation. That is an important consideration. Investors in MYP and MOU lost the benefit of the increases in the S & P 500 and the Russell 2000 in the first year due to those indexes rising too much which caused a reversion back to the 3% guarantee. For PGEB, my upside is theoretically unlimited but my downside is capped based on the percentage decrease from my purchase price to $9.7. I do not have to worry about a 50% loss but I could receive conceivably receive a 20%, or 30% or even a 40% gain, depending on the rise in the value of the 3 indexes being tracked.
2. Alcoa (owned): The last purchase of Alcoa was at $5.6 in March 2009. You do not have to be a financial wizard to make money in stocks. It helps just to have some common sense. When Alcoa hit $5.6 in March 2009, the collective judgment of the rational man, so treasured by practitioners of the dismal science, had to be that aluminum demand would not return for at least five years, possibly for as long as a decade. The $5.6 price for Alcoa was prevalent in 1987. Alcoa Inc. Common Stock Share Price Chart | AA Was the market pricing Alcoa efficiently at the time? The market was dominated by irrational pricing behavior that failed to take into account the massive efforts undertaken by governments and central banks around the world to stabilize the financial system. It was evident by March 2009 that those efforts would succeed. The here and now crowd were pricing stocks then, as if nothing would improve for years to come and consequently it was appropriate to value companies as if the recessionary earnings were the new normal. Sort of like the entire world channeling the spirit of Alan Abelson.
I still own my Alcoa shares and have no intention of parting with them. My shares were bought between $5.6 and around $11. The share price closed last Friday at $14.39, falling 48 cents after a downgrade from another myopic analyst, this time a wizard from J. P. Morgan who reduced AA to neutral from buy. MarketWatch The analyst cut the 2011 earnings forecast to 48 cents based on an aluminum price forecast in 2011 of 92 cents per pound or $2027 per tonne. This is what I call short term thinking. The analyst apparently acknowledges that Alcoa has used the Near Depression period to take significant costs out of its operation. This appears to be the case. And, wouldn't this be good long term for the business? And how does one, by the way, come up with a 2011 forecast for aluminum prices? The current spot price is around $1.08 per pound if the Reuters numbers are correct from a story published last Friday. ( Reuters says the current price is $2400 per tonne and there are 2204.622 pounds in a metric ton)
But, in the last analyst, it does not matter whether the J P Morgan's pessimistic forecast for aluminum prices proves to be prescient, though I would question the wisdom of that forecast. What matters is whether the current price is a good entry point for someone willing to hold for five years, giving time for the demand cycle to return, as opposed to focusing one's attention on the hear and now and trying to predict what will happen just in the next year. A rise in price to $20 from $14.4 at any point within five years would give the investor a 38.8% return before taking into account any dividend payments. Yet a $20 price would have been the time to buy, not sell, Alcoa in 1999 and 2002 based on subsequent price movements to the low 40s: Alcoa Inc. Common Stock Share Price Chart | AA
3. NYSE Complaint and Inquiry Web Page: Based on my recent experience in trying to convince a brokerage firm to do the right thing about an obviously bad fill, I have decided that it is not worth my time and effort to even try and convince a broker to do the right thing unless I have been screwed out of at least $100. And, I will not initially take the matter to the broker who may fill me with an array of erroneous information about why the fill will stand even though it is patently unfair. Instead, I will take the matter directly to the exchange to gather the relevant information before I talk to the brokerage firm.
I was told by the NYSE ARCA representative that round and odd lots were treated the same. I did not attempt to research that issue in depth, but I found language in the ARCA rules virtually identical to the statement made by that representative to me: ARCA Rule 7.38 (b) NYSE Arca Bylaws and Rules { "(b) Ranking and Execution. Round lot, mixed lot and odd lot orders are treated in the same manner in the NYSE Arca Marketplace; provided, however, the Tracking Order Process treats odd lot orders in a different manner from mixed lot and round lot orders."}
In my most recent problem, none of the information told to me by the representatives of the brokerage firm jived with the information conveyed by the NYSE representative after an investigation. And I mean no single piece of relevant information was corroborated by the NYSE and some of the information was also clearly inconsistent with exchange rules relevant to odd lot trading and information that I had at the time the order was received by my broker.(e.g. the bid was 18.45 and the ask was 18.49 both before and after the entry of my order). The thrust of a brokerage firm's effort, when the customer is screwed, will invariably be to justify what is indefensible. By using discount brokers I simply avoid most-not all- of the problems that investors have experiened over the past decade.
The web page for filing complaints and inquiries with the NYSE can be found at NYSE, New York Stock Exchange > Regulation > Complaints & Inquiries. I have bookmarked that page. I found the NYSE to be thorough and conscientious in their investigation even though they knew ahead of time that the amount in controversy was small and involved only an odd lot purchase. I only have positive things to say about their response.
To cut down on future problems, I have started to enter almost entirely limit orders. I am making an exception now for major stocks like GE, KO, JNJ where there are millions of shares being traded and few brokers would attempt to justify an odd lot fill 36 cents above the then existing ask price. I am also entering some limit orders at the ask price where I find that price to be acceptable. While the recent problem is not something that happens every day or week, it is not unusual either. I would say about 5 out of 100 fills are as bad or close to it. The convenience of the market order is simply not worth the mental aggravation caused when I am screwed.
4. Shiller Skeptical of a Housing Recovery: Possibly the introduction that Professor Shiller wrote to the second edition of his book "Irrational Exuberance" provided me with the most important information that I have received in the past decade. I did not fully realize at it at the time that I read it, but it played a profound role in what I did in 2007. I had read Professor's Shiller's book Irrational Exuberance when it was first published in early 2000 at the height of the craziness and bubble mania. This book did not change what I was doing then, but simply confirmed my opinion that investors had lost their marbles.
The introduction to the second edition was read at my local library, Barnes and Noble, soon after it was published in May 2005. I was not about to buy the book again. As discussed by Shiller in his column in the NYT on Sunday, this introduction related to historical data that he had gathered which showed the home prices in the U.S. were in a well defined bubble of epic proportions. This had a substantial impact on my processing and evaluation of future information. It played an important role in my awareness of the subprime mortgage meltdown, as it was developing, which started to garner major national attention as early as February 2007. In other words, I had a framework for analyzing that information that had been provided by Professor Shiller in that introduction to the second edition. Sometimes, it helps to read a lot and sometimes the information gathered proves to be actually important, provided the reader is receptive to receiving it and does not discard it because it is inconsistent with pre-existing beliefs and opinions. Prior to reading that introduction, I had not given the parabolic rise in home prices much if any thought.
In his article in the NYT, he expresses some skepticism that a housing prices have started a long term cycle of price increases starting in May 2009.
5. China Fund NAV Information: The China Fund (CHN), a CEF which was bought last week, still shows as of late Sunday, the net asset value for March 26, 2010. The NAV was $30.39. I am not sure why it has not been updated. The WSJ CEF page for World Equity funds shows the NAV at $32.66 as of 4/9/2010, a nice gain for the week. The closed end fund association has the same NAV information of $32.66: CEFA - Closed-End Fund Association So, anyone interested in this fund may want to monitor the NAV data from the WSJ web site or the CEF Association site. Bought 50 of the CEF CHN at 28.53
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