Saturday, August 17, 2013

GDP-Profit Margins/GMAC Bond Redemptions/SUNCOR/CISCO & Jobs/Added 50 BDGE at $20.76/Bought 50 EAA at $23.6-Roth IRA/Added 100 NPBC at $10.68/Added 100 CSQ at $10.18/Bought Back 100 EWM at $15.28

Big Picture Synopsis

Stocks:
Stable Vix Pattern (bullish)
Short Term: Expecting a 10%+ Correction
Intermediate and Long Term: Bullish

According to FactSet, the 12 month forward P/E ratio was 14.5 for the S & P 500 as of 8/8/13, based on a closing price of 1697.48 and a 12 month forward E.P.S. of $117.25. factset.com-earnings insight (8/9/13-PDF) The blended growth rate in the 2nd quarter was 2.1%. Excluding financials, the growth rate was a negative 3.1%, led by a -9.5% decease in the materials sector;  a -9.2% decline in the energy sector and a -8.2% decline in information technology (both Apple and Microsoft reported Y-O-Y declines of almost 20%)

The recent closing high for the S & P 500 was 1,709.67 on 8/2/13. A 10% decline from that close would take the index to 1538.7, about where the index was in early March 2013.

Over the past several weeks, I have been a net seller of stock funds and stocks, and I have raised my overall cash allocation to over 25%. I am not pleased with the near zero percent yield of those cash investments.  I am working under the assumption that the Fed's Jihad Against the Saving Class will last seven years from its start date late in 2008.


Bonds 
Short to Long Term: Slightly Bearish (Based on Interest Rate Normalization: The Difficult Path to Interest Rate Normalization)

Treasuries led the bond market lower last Tuesday after the government reported decent retail sales for July and the Federal Reserve drained $2.32B in reserves through reverse repurchase agreements. Recently, a decline in treasury prices has also precipitated a decline in other securities, such as REITs and MLPs, that are bought in part for their yields. That happened last Tuesday with the major market averages closing in positive territory:

Closing Prices Tuesday 8/13/13:

TLT: $104.99 -1.54 (-1.45%) : iShares 20+ Year Treasury Bond ETF
LQD: 113.10 -0.81 (-0.71%) : iShares Investment Grade Corporate Bond ETF 
DJIA: 15,451.01 +31.33 (+0.20%)

Equity REITs hit another air pocket yesterday, as shown in the price of the Vanguard REIT ETF: VNQ: $64.35 -1.62 (-2.46%) That ETF closed at $72.55 on 7/22.

The 10 year treasury broke out of its recent trading range between 2.5%-2.6% last week. Daily Treasury Yield Curve Rates The closing yield was 2.84%. The 30 year closed last Friday at a 3.86% yield, up from the previous Friday's close of 3.63%. TLT went down 3.63% last week.

The 10 year TIP closed at a .68% yield last Friday, Daily Treasury Real Yield Curve Rates, compared to the nominal 10 year yield at 2.84%. The break-even spread was consequently 2.16%. The move up in interest rates last week was due to the ongoing interest rate normalization process, rather than to a change in inflation expectations. Inflation expectations embodied in the 10 year TIP pricing declined last week from the prior week. The break-even spread as of 8/9/13 was 2.24% (2.57% minus .33%=2.24%)

As previously noted, I expect that the 10 year will reach 4%-4.25% within 12-18 months due to the interest rate normalization process, provided there is no increase in inflation expectations to over 2.25% per year. For each .25% increase in inflation expectations, I would increase that range by .25%.

David Kelly, the chief global strategist for JP Morgan funds, noted that the ten year treasury yields have averaged "2.6% higher than than the year-over-year core CPI inflation" over the past 50 years. Barrons.com For the year ending in July 2013, core CPI rose 1.7%, Consumer Price Index Summary, and that formula would result in a normalized ten year rate of 4.3%.

I did not buy a bond CEF last week, as the carnage continued in that sector. Although the yields are enticing, particularly with cash yielding near zero,  the decline in share prices is showing no signs of a let up. I may postpone further nibbles until the 10 year treasury goes above 3.25%. The best thing to do now may be to just wait and see. I have changed my distribution option for virtually all bond CEFs to reinvestment.

Equity preferred stocks have also hit an air pocket over the past several weeks. Those securities have no maturity date, worse than a long dated bond in that respect, while being junior in the capital structure to all bonds. Consequently, that type of security will be very sensitive to a rise in rates, likely to demonstrate enhanced volatility with a downside bias during a period of rising rates. I have recently bought 50 share lots in HBAPRF, HBAPRG and SANPRB, and all of those buys are in the red. I have resisted the temptation of averaging down.

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Recent Economic Reports:

The Federal Reserve Bank of New York reported that household debt declined by $78B from the previous quarter due mostly to a 91B decline in mortgage debt. Total household debt fell .7% from the first quarter to $11.15T, which is 12% below the peak of $12.68T in the Q3 2008.

CPI increased .2% in July on a seasonally adjusted basis. Consumer Price Index Summary Over the past twelve months ending in July, CPI increased 2% and core CPI rose 1.7%, both before seasonal adjustment. The Cleveland Fed's median CPI increased .2% or 2% annualized in July. Current Median CPI :: Federal Reserve Bank of Cleveland

The Fed's index for industrial production was unchanged in July: Industrial Production and Capacity Utilization Capacity utilization edged down .1% to 77.6 in July, which is 2.6% below its long run average.

The government reported that seasonally adjusted U.S. retail sales for July were $424.5B, up .2% from June and 5.4% from July 2012. census.gov/retail/pdf The May to June 2013 percent change was revised up to .6% from .4%. Excluding autos, sales rose .5% from June to July. Sales at department stores rose .6%, the largest gain since March 2012.

GDP rose .3% in the 2013 second quarter compared to the first quarter in both the euro area (EU 17) and the EU 27. ( led by Germany +.7%; UK +.6%; France +.5%) GDP declined .7% in the EU 17 compared to the 2012 second quarter on a seasonally adjusted basis. eurostat.PDF Industrial production was up .7% in the EU 17 in June compared to May. eurostat.PDF

The N.Y. Fed's manufacturing report for the "Empire" state fell to 8.24 in August from 9.46 in July. The new orders component fell to .27 from 3.77, while the employment index rose to 10.84 from 3.26. newyorkfed.org.pdf

I would consider WMT's earnings report to be an economic report, so I am discussing it in this section. WMT reported a 2.4% increase in revenues to $116.2B, below the consensus forecast of $118.5B, and lowered its guidance for current quarter and year. Comp sales for U.S. WMT stores declined .3% between 4/27 to 7/26. The company expects flat sales for its U.S. Wal-Mart stores during the current quarter. For the full year, WMT lowered its guidance to $5.1 to $5.3 from $5.2 to $5.4. SEC Filed Earnings Release Prior to that guidance, the consensus estimate was for an E.P.S. of $5.3: WMT Analyst Estimates

Privately owned housing starts rose 5.9% in July above the revised June estimate and 20.9% above the July 2012 annual rate of 741,000. census.gov.pdf New housing starts are still at historically anemic levels: Housing Starts: Total: New Privately Owned Housing Units Started - St. Louis Fed

The most recent charts from the Richmond Federal Reserve can be found in its 8/5/13 National Economic Indicators: richmondfed.org/nationaleconomicindicators/pdf 
  
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GMAC BOND REDEMPTIONS:

GMAC redeemed its 10/15/2017 and 4/15/2018 bonds at their $1,000 par values. Both paid monthly interest on the 15th of each month. I owned one of each:



Rather than take two snapshots, I just included the interest paid by two other bonds in the preceding snapshot. I made a nominal profit on both bonds.  Bought 1 GMAC 7.25% Bond Maturing 4/15/2018 at 98.396 (April 2011); Bought 1 GMAC 7.125% Bond Maturing 10/15/2017 at 98.072 (April 2011).

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Santander (own common-SAN and equity preferred-SANPRB):

I thought that this reinvestment price for a recent common dividend was noteworthy:



On 8/9/11, the date of the reinvestment, the shares traded in a range between $7.58 to $7.66 before closing at $7.59. SAN Historical Prices My reinvestment price is shown at $6.8601, last seen on 7/23/13.

Banco Santander, S.A. (SAN) Dividend History - Nasdaq.com

This is what I know about the SAN reinvestment.

I avoid the Spanish withholding tax by reinvesting the dividend.

In a family member's account at Vanguard, there is an account entry that the shares were submitted someplace for the dividend reinvestment. Fidelity does not have that notation. I am receiving a dated price on the reinvestment which worked to my benefit this time, as the shares rose in value from the reinvestment date to the payment date.

I calculated the Vanguard reinvestment price at $6.465, almost $.4 per share lower than the Fidelity reinvestment price. So, whatever Vanguard is doing, it is beneficial to me.

Normally, with a few exceptions for commons stocks owned at Fidelity, the brokerage will use the dividend to buy shares in the market when payment is received from the company, but will do so at different times during that day resulting in wide variations in the reinvestment price. Continuation of Discussions Re: Broker Price Differences For Reinvested Dividends (July 2012)

Last Friday's Close:  SAN: $7.78 +0.17 (+2.23%) 

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GDP & Profit Margins:

Added: In this week's BarronsJack Hough has a good discussion on this topic.

Investors who are prone to bearishness will rely on whatever statistic supports, or appears to support, their natural tendencies at any given moment in time. (Tests for Confirmation and Anchoring Bias -Morningstar)

John Hussman is one of those investors. Hussman manages a mutual fund, Hussman Strategic Total Return (HSTRX) that is undeservedly rated two starts by Morningstar.

In my opinion, his performance merits a one star rating. I would give it a 1/2 star except that this perpetual bear will shine in a year like 2008 that elevates his performance to a 1 star rating.

In 2013, this fund has lost so far 7.28% as of 8/20/13 according to MSN Money. Fund returns Pathetic may be a too generous description.

Since Hussman is in perpetual bear mode, he will shine only in a year like 2008 and will inevitably post dismal numbers whenever stocks post decent gains.

For example, the total returns for the S & P 500 were 26.46% and 16% in 2009 and 2012 respectively, while HSTRX gained 5.84% and 1.14%.

I was up 42% in 2009, with a large cash allocation, as noted in a January 2010 post: Stocks, Bonds & Politics I am not a professional investor but simply an individual investor working with no staff support.

Perpetual bulls and bears lack any semblance of balance. A investor lacking balance might be better off flipping a coin.

Balance is manifested by focusing on both the positive and negative data points which is an obvious point, making a concerted effort to weigh the materiality of the evidence, and discussing the weaknesses and strengths of each data point.

A balanced investor is not an advocate for any particular position but is simply trying to amass material data in order to make the best possible judgments.

This is a link to Hussman's historical commentary: Weekly Market Comment Many perpetual bearish investors follow his every word, just another example of confirmation bias, and accept his analysis without question.

If anyone can find any evidence of Hussman's balance, please leave a comment.

For several years now, Hussman has justified his bearishness, in part, by the historically high corporate profit margins to GDP.

He noted in a commentary earlier this year that "profit margins are more than 70% above their historical norms" (see chart at Weekly Market Comment:  April 8, 2013).

The same argument was being made in his 2005-2006 commentary: Weekly Market Comment: August 8, 2005 Weekly Market Comment: June 5, 2006Weekly Market Comment: August 7, 2006 ("corporate profit margins are currently at the widest levels in history" at close to 9% vs. a historical norm of 6% and corporate profits to GDP are over 13%, "the highest in history")

He has been making this same argument for as long as I can remember, but stocks continue to go up.

His argument is that profit margins will revert to the mean causing a powerful down move in stock averages.

What is wrong with his approach? I will just highlight two obvious problems with his use of data:

(1) He is relying on historical data going back over 50 years to arrive at the average profit margin number. Are U.S. corporations the same now as in the 1950s, when companies like General Motors, U.S. Steel, and other capital and labor intensive businesses were the typical large companies that dominated the S & P 500 and the DJIA. The answer to that question, without any doubt, is no.

A Google, Oracle, Apple, Pfizer, Cisco, Amgen or Microsoft have far higher profit margins than a General Motors or U.S. Steel.

Company/Profit Margins:
GOOG Key Statistics: 20.85%
MSFT Key Statistics: 28.08%
PFE Key Statistics: 46.62%
ORCL Key Statistics: 29.38%
AMGN Key Statistics: 25.98%
AAPL Key Statistics: 22.28%
CSCO Key Statistics: 20.11%
JNJ Key Statistics: 18.38%
MCD Key Statistics: 19.85%

GM Key Statistics: 3.67%
X Key Statistics | United States Steel: -.86%

In 1976, some of the components of the DJIA included Bethlehem Steel, Allied Chemical, Chrysler, Eastman Kodak, International Harvester, Johns Mansville, U.S. Steel, Westinghouse, Union Carbide, International Paper, Goodyear, Inco and American Can. Historical components DJIA

Hussman is aware that the landscape has changed dramatically over the last several decades, so why does he insist on using profit margin data for the past 50+ years rather than say the past ten or twenty? A contemporary and relevant depiction of average profit margins would not favor his reliance on this data point to justify a decade of bearishness. Corporate profit margins are going to be higher now than the historical norm.

(2) The second major problem with his data is that the U.S. corporations are selling more products and services overseas where profit margins are higher, due in large part to lower costs and taxes, a fact noted by Liz Ann Sonders.

One has to make allowances for obvious changes rather than to project historical data mindlessly into the present and future.

For many businesses, particularly those with relatively high fixed costs, profit margins will go up with increases in revenue, so there is room for profit margin expansion based on an improving worldwide economy.

I was able to find one chart at the St. Louis FED that showed the historical relationship between corporate profits after tax and GDP:

Corporate Profits After Tax (without IVA & CC adj./GDP
Graph: Corporate Profits After Tax (without IVA and CCAdj) (CP)/Gross Domestic Product (GDP)

There are several charts at this site that show historical profit margins, adjusted for inventory valuation and capital consumption which restate the historical cost basis to reflect current accounting for inventory withdrawals and depreciation. www.yardeni.com.pdf As shown at the chart on page 11, the after tax profit margin from current production fell to about 10% during the depths of the last recession, higher than most periods of expansion during the 1950s, 1970s and 1980s.

There is a negative associated with the currently high profit margin level. It is becoming increasingly difficult for corporations to squeeze out more profit by increasing profit margins through cost cutting including employee reductions. Increases in revenues will need to become a more significant component of profit growth than increases in profit margins.

In the next section, I mention a chart that shows the historical contributions to profit growth for revenues and profit margins. 

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JPM Quarterly "Guide to the Markets":

This quarterly publication has a number of helpful charts and can be downloaded at J.P. Morgan Funds - Guide to the Markets

One chart shows the adjusted after-tax corporate profits as a a percent of GDP which stood a 9.7% as of the 2013 first quarter, compared to the 50 year historical average of 6.2%.

A table at page 11 shows the S & P 500 year-over-year E.P.S. growth that is further broken down into the profit margin and revenue share of E.P.S. growth or decline.

A chart at page 14 shows that corporate cash as a percentage of current assets has been rising since 2000.

The chart at page 31 shows the gap between the 10 year real and nominal yields since 1960.

The table at page 32 shows the percentage impact on various bond types from a 1% rise or fall in rates. The 30 year treasury would go down about 20% with a +1% rise.

The chart at page 33 shows the correlations between a 10 year treasury and other types of bonds. The correlation with high yield and emerging market debt has been negative at times.

The chart at page 46 shows the average manufacturing wage for several countries. The U.S. average is $3,885 per month, with Indonesia at $148, Vietnam at $193 and China at $348.

The charts at page 41 compares real GDP growth for emerging market countries and developed ones.

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Cisco and Jobs:

I own Cisco shares, with an average cost at $19.5 per share.

John Chambers is one of those American executives who constantly whine about U.S. tax rates. The constant refrain is that Cisco would hire more Americans with a lower tax rate. I view his argument as just rubbish.

Cisco is already sitting on $50.61 billion in cash, cash equivalents and investments. SEC Filed Press Release Would Chambers really hire more people with another billion in cash after just announcing that it will shed another 4,000 jobs, with another  6,500 souls given the pink slip in 2011, and after reporting that it earned $10B in profit over the past year? "We're Swimming In Profits, You're Fired" - Forbes

U.S. corporations are already sitting on a record amount of cash, almost $5 trillion as of 2011. (St. Louis FED: "Why Are Corporations Holding So Much Cash?')

Increasing that unproductive cash pile is not going to create jobs. As noted in an earlier post, Warren Buffett identified the basic problem as an unwillingness of CEO's to invest their cash due to their constant handwringing about an uncertain future:


Page 5 Berkshire 2012 Annual Report.pdf

The future has always been filled with uncertainties.

It is also worth remembering that large U.S. corporations promised that they would create jobs in exchange for a repatriation tax holiday on foreign cash. Congress accepted that promise in passing the "2004 American Jobs Creation Act". The law prohibited using the funds for stock repurchases or to increase executive pay.

A Senate report found that the fifteen largest beneficiaries of that tax break reduced their payrolls by 21,000 jobs after repatriating $155B, increased executive pay by 27% in 2004-2005 and another 30% in 2005-2006 and vastly increased the amount of stock buybacks. Senate report (link to report in article)

I am not making a statement about all companies, but I would direct the foregoing criticisms at most large, publicly traded American corporations including Cisco.

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SUNCOR-BERKSHIRE HATHAWAY

Speaking of Buffett, I noticed in Berkshire's SEC Form 13F that BRK had acquired new position in the Canadian energy company Suncor. SEC FORM 13-F Information Table Over 17.7M shares were reportedly owned as of 6/30/13. This disclosure caused a mild pop in SU's share price last week, but Buffet's acquisition of a new position in Suncor had far less impact on the market price than Icahn's tweet about Apple.

I had planned to sell my 50 shares when and if the price crossed over $34 again, but I decided to go with Warren at least for another couple of points.

SU Position as of 8/16/13
Bought 50 SU at $28.67 (12/12/11 Post)

Last Friday's Closing Price: SU: $34.18 +0.24 (+0.71%)

SU is also a major holding in the ETF ENY, with a 5.36% weighting as of 8/16: Guggenheim Canadian Energy Income. That ETF has been a slight disappointment since I bought back a small position, though I have traded it profitably in this past as noted in Item # 2 Bought 50 ENY at $16.83 (October 2012)Added 50 ENY at $15.6/ (12/12/12 Post) I also own 100 shares of Husky which has a 5.05% weighting. Bought 100 HUSKF at $26.42 (7/6/13 Post)

Last Friday's Closing Price: ENY: $14.45 +0.08 (+0.56%)(I am reinvesting the quarterly dividend)

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1. Bought 50 EAA at $23.6 Roth IRA (see Disclaimer). This was another contrarian purchase in the ROTH IRA, and hopefully my last one.

Snapshot of Trade:

2013 Roth IRA Bought 50 EAA at $23.6
Security Description: The Entergy Arkansas Inc. 5.75% Series First Mortgage Bonds 2040 (EAA) is a First Mortgage bond issued by Entergy Arkansas, a wholly owned subsidiary of Entergy Corp. (ETR). The coupon is 5.75% on a $25 par value. The bond may be called at par, plus accrued interest, on or after 11/1/2015. Otherwise, the bond is scheduled to mature on 11/1/2040. Prospectus This is a first lien bond. The security is described at page 5 of the prospectus.

According to Quantumonline, this bond is currently rated A3 by Moodys and A- by S & P.

Profile Page of Entergy Corp (ETR) at Reuters

SEC Form 10-Q for Entergy and Its Subsidiaries: 10-Q

Entergy Arkansas (EA) had net income of $38.765M for the Q/E 6/30/13 (page 95). As noted at page 93, EA recently issued $125M of 4.75% First Mortgage bonds maturing in 2063, using the proceeds to redeem a portion of a 5.4% First Mortgage bond that matured this August.

2012 Annual Report 10-k (see pages 14-15 on a proposed disposition of transmission lines and the use of the proceeds to retire outstanding preferred stock and some debt securities)

Prior Trades: None

Rationale: I am playing with this kind of security a less likely interest rate scenario. I view the most probable scenario to be a gradual rise in rates over the next 12 to 18 months due to interest rate normalization, with the rise being capped by the current relatively benign inflation forecasts embodied in the pricing of the TIPs maturing between 10 to 30 years.

I may be wrong about that future forecast or any other that I routinely make when managing my portfolio.

A less likely scenario is a prolonged period of abnormally low rates, similar to the experience in Japan.

In that type of future scenario, a high quality and long term bond would be a good investment option.

I will play the less likely scenario but only with limited amounts.

I would only buy this kind of long term, relatively low yielding bond in the Roth IRA, where I in effect convert it into a high quality tax free bond. Unless Congress changes the rules about the non-taxation of Roth IRA withdrawals, the interest payments made by this bond will remain tax free in the event of their withdrawal which is viewed as highly unlikely. I would have to pay tax on any amounts withdrawn from the regular IRA which would negate the yield after tax argument,

Risks: The most significant risk is of course interest rate risk which is just an in your face kind of risk right now. This bond will lose value in a period of rising rates.

Duration—What an Interest Rate Hike Could Do to Your Bond Portfolio - FINRA

EAA was trading at over $28 in November 2012 and hit $26.92 in May 2013 before sliding as interest rates started to rise: EAA Interactive Chart 

Future Buys: Not likely unless the price falls below $18.

Closing Price Last Friday: EAA: $23.40 -0.10 (-0.43%)

2. Added 100 NPBC at $10.68 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer):

Snapshot of Trade:

Added 100 NPBC at $10.68-Satellite Taxable Account
Security Description: National Penn Bancshares (NPBC) is a regional bank headquartered in Boyertown, PA. National Penn Bancshares, Inc. - Investor Relations

NPBC is currently paying a quarterly dividend of 10 cents per share.

Profile Page at Reuters

As of 6/30/13, the bank had 120 retail branches, with 119 of those located in Pennsylvania.

SEC Filed Earnings' Webcast Exhibits 7-25-13

Prior Trades: I originally bought NPBC as part of my Lottery Ticket Basket Strategy and still own those shares. Item # 1 RB Bought as LT 30 NPBC @ $7.83 (April 2011). When and if the price crosses $12 per share, I will sell that 30 share odd lot.

Recent Earnings Report:  

SEC Filed Earnings Release 7-25-13

2013 2nd Quarter vs. 2012 2nd Quarter

Net Income: $25M / $22.448M
E.P.S.: $.17 /  $.15
Net Interest Margin: 3.53%/ 3.48%
Efficiency Ratio: 57.43% / 58.42%
NPL Ratio: 1.05% / 1.13%
Coverage Ratio: 188.5% / 197.6%
Charge Offs: .32% / .53%
ROA: 1.21% / 1.09%
ROE: 8.82% / 7.5%
Return on Tangible Equity: 11.53% / 10.4%

The capital ratios are good:


NPBC 10Q 6-30-2013 (p. 46)

Q2 2013 Results - Earnings Call Transcript - Seeking Alpha

The bank reported a loss during the 2013 due to retiring a high cost trust preferred security and repaying and refinancing FHLB advances. The adjusted net income was $.16, with the GAAP at ($.12).  SEC Filed Press Release Some financial websites use the GAAP number for that quarter when calculating the P/E. I would use the non-GAAP.

Rationale: For this basket strategy, my general goal is to keep my out-of-pocket monetary exposure between $40,000 to $50,000, excluding unrealized gains. While the total value of this basket exceeded the lower limit, I had fallen more than $3,000 below the lower band in the total purchased amount prior to buying NPBC and adding to BDGE which is discussed in # 5 below. With those purchases, I am still almost a $1,000 below the minimum investment exposure.

Most regional bank stocks are not appetizing to me after their recent run up. NPBC was one of the few still within my reasonable valuation range, and it was at the top end of that range.

{There are two primary ETF alternatives to owning individual stocks in this sector. One is the iShares U.S. Regional Banks ETF (IAT) that owns 58 regional bank stocks (as of 6/30/13: 1 year annualized return 24.23%; 3 years at 12.08%). I currently own only 7 of those 58 in my regional bank basket: HBAN, NYCB, FNFG, FMER, VLY, FNB and now NPBC. Only HBAN is in IAT's top 10 holdings at #10. NPBC is next to the last in its weighting of .39%. I focus more on the smaller cap names that would not be included in this ETF. The other main ETF for this sector is SPDR S&P Regional Banking ETF (KRE). That ETF has a significantly different weightings compared to IAT by excluding some of the larger regionals (as of 6/30/13: 3 year annualized return of 15.7%, 1 year at 26.3%)}

At last Friday's closing price of $10.39, the forward P/E is 14.43 based on an estimated 2014 E.P.S. of $.72, and close to 14.75 based on my purchase price. The dividend yield is at the high end which compensates some for the forward P/E. At a total cost of $10.68 per share, and assuming a continuation of the current $.1 per share quarterly rate, the dividend yield is about 3.75%.

Other factors supporting the purchase include the capital ratios, the better than average ROA and NPL ratio, the efficiency ratio at less than 60%, and the high coverage ratio.

At the current market price, I do not expect much capital appreciation over the next year unless NPBC can beat the 2014 forecast by 3 cents per share or more.

This is more of a long term buy, hoping for a return to $18 to $20 within five to seven years. The stock was trading in that higher channel in 2005 to 2007: NPBC Interactive Chart If that optimal scenario comes to pass, and assuming further some dividend increases, the total return would be good.

I suspect that the net interest margin will improve gradually, as the FED continues ZIRP well into 2015, which will keep the cost of funds low. Banks will be able to lend at higher rates as intermediate and long term rates rise due to the FED first tapering and then ending QE before ending ZIRP.

I am also anticipating a far slower rise in the federal funds when the FED embarks on a tightening cycle, compared to June 2004-July 2006 period when the federal funds rate was raised from 1% to 5.25%.

As noted in the earnings call, the bank is keeping its duration low of owned MBS at about 3.5 years and "rising rates will benefit us because we are asset sensitive". The bank is not keeping the longer term fixed rate mortgages on their balance sheet.

Risks:

For me, a reasonable valuation range for a solid regional bank is between 12 to 15 times forward twelve months earnings. NPBC's current price is near the top of that range.

Needless to say, banks do not fare well during recessions. Loan losses will spike even for prudently managed banks.

Banks are also subject to a wide variety of regulations that increase their costs and crimp profits.

Future Buys/Sells: I may add to this position at below $10, provided there are no material adverse events, and will likely sell the 30 share LT position when and if the price rises above $12.

Closing Price Last Friday: NPBC: $10.39 -0.11 (-1.05%)

3. Added 100 CSQ at $10.18 (see Disclaimer):

Snapshot of Trade:

2013 Bought 100 CSQ at $10.18 
Snapshot of History:


CSQ Position as of 8/12/13/Average Cost Per Share $9.33
As shown in the foregoing snapshot, I have not reinvested the dividend since February 2012.

Security Description: The Calamos Strategic Total Return Fund (CSQ) is a leveraged balanced closed end fund that will invest in common stocks, bonds (mostly high yield bonds) and convertible securities.

Sponsor's website: Calamos Investments - Strategic Total Return Fund

Asset Allocation as of 4/30/13
Last SEC Filed Shareholder Report: N-CSRS (period ending 4/30/13)(average rate on the borrowings was .96% for the period ending 4/30/13, note 7 at page 25; the fund has loss operating carryforwards of $34M+ expiring in 2017 and $29+M expiring in 2018, note 4 at page 23)

The fund is paying a monthly dividend at the rate of $.07 per share.

As of 7/31/13, the fund has generated an annualized return of 14.23% for 3 years and 7.5% for five years based on net asset value, slightly higher based on the market price: Strategic Total Return Fund (performance tab)

In 2012, the fund paid $.84 per share in dividends, of which $.115569 was classified as a return of capital: Tax Center Information

Data as of Friday 8/9/13
Closing Net Asset Value Per Share: $11.26
Closing Market Price Per Share: $10.22
Discount: -9.24%
Average 3 Year Discount: -9.62%

Data on Date of Purchase Monday 8/12/13:
Closing Net Asset Value Per Share: $11.26
Closing Market Price: $10.17
Discount: -9.68%

CSQ Page at CEFConnect

CSQ Page at Morningstar (rated 2 stars)

Calamos Strategic Total Return Stock Chart | CSQ Interactive Chart (link may display dividends, if not, dividends will show up on chart by clicking "event" and then "dividends").

Prior Trades in Taxable Account: Bought 100 CSQ @ $8.94 (November 2010); Item # 2 Added 70 CSQ at $9.63 April 2011; Item # 4 Bought 100 of the CEF CSQ at $9.69 (June 2011); Item # 2 Added 50 CSQ at $9.2 (August 2011); Item # 2 Added 50 of the Balanced CEF CSQ at $8.28 (December 2011)

I have had at least one round trip in the Roth IRA: Item # 3 Bought 100 of the CEF CSQ in Roth at 8.49 (August 2010); Item # 9 Sold: 100 CSQ @ 9.13 (November 2010):

2010 Roth IRA CSQ 100 Shares +$47.88
Rationale: (1) Income Generation + Some Capital Appreciation Potential: At my current average cost per share of $9.33, the dividend yield is about 9%. The yield is 8.25% at a $10.18 per share total cost.

I am not a fan of this CEF. I own it for the total return potential. At a 9% dividend yield, I do not have to make much on the shares to generate a 10% annualized return. The total unrealized gain is currently over $400 and 9% of my total cost including the 100 shares purchased last week.

Risks: The fund can not support the current dividend without capital gains, and the fund is not likely to earn any long term capital gains until it utilizes its loss carryforwards. The past competency of the managers is called into question by both the significant unrealized losses and the loss carryforwards.

This fund would have the normal risks associated with junk bonds and stocks in addition to the usual risks inherent in leveraged CEFs including the possible expansion of the discount after purchase and the adverse effects of leverage when the asset bought with borrowed funds declines in price.

Future Buys and Sells:  I am not likely to buy more and may sell all shares when and if the discount narrows to less than 7% and the price is over $10.5. The 52 week high was $10.99 hit intra-day May 16-17, 2013. CSQ Historical Prices

I am not reinvesting the dividend. Although I have held some shares for several years, as noted in the preceding snapshot, I do not regard myself as a long term holder given the drawbacks identified in the risk section.

Closing Price Last Friday: CSQ: $10.05 -0.10 (-0.99%)

As of 8/16/13, the discount to the closing net asset value of $11.11 was -9.54%.

4. Bought Back 100 EWM  at $15.28 (See Disclaimer):

Snapshot of Trade:

2013 Bought 100 EWM at $15.28

Security Description: The iShares MSCI Malaysia ETF (EWM) is an ETF that owns stocks based in Malaysia.

Sponsor's website: iShares MSCI Malaysia Index Fund (EWM): Overview - iShares (42 holdings, expense ratio at .52%). As shown at that page, the average annualized total returns, thru 6/30/13, were 11.76% for five years and 14.28% for ten years. The fund was shellacked in 2008 with a -41.26% return.

iShares MSCI Malaysia ETF (EWM): Holdings - iShares (I am not familiar with any of those companies)

World Bank Data and Information on Malaysia: Malaysia | DataMalaysia Continues to Improve in Ease of Doing Business

EWM Page at Morningstar

This is a link to a positive article about the Malaysian stock market published 7/13/13 by Barrons. As noted in that article, the Malaysian stock market was under pressure based on concerns that the ruling party, the Barisan Nasional coalition, would lose the elections, but that coalition squeaked out a victory in May. NYTMalaysian general election: 2013

While that victory caused a temporary surge in the Malaysian stock market, emerging markets started to correct in May as interest rates started to rise in the US, causing widespread depreciation in emerging market currencies against the USD. EWM hit $16.8 on May 14, 2013 before starting a slide to $15 on 6/20/13. iShares MSCI Malaysia Index ETF Chart

The fund went ex dividend for a semi-annual payment ($.223 per share) on 6/27/13. EWM Historical Prices

See also, FTSE Bursa Malaysia KLCI Index Chart

Malaysia | Economic Forecasts | 2013-2015 Outlook

Total Population: About 25 million

Literacy: 89%

GDP Per Capita (adjusted by PPP-purchasing power parity)= $15,588.66 as of 12/2011

Geographic Area: 127,316 square miles, roughly the size of New Mexico.

Prior Trade:

2013 EWM 100 Shares +$115.57
Item # 1 Bought 100 of the ETF EWM at $15.23 (January 2013)Sold 100 EWM at $16.45 (May 2013)

Rationale: (1) Emerging Market Super Cycle: Malaysia combines many of the features of a developed nation while generating growth that is characteristic of an emerging one.

While GDP growth has slowed some, growth is still exceeding 4%.

Malaysia GDP Annual Growth Rate

Malaysia is mentioned in this Forbes articles as one of the positive emerging market stories, along with Indonesia and the Philippines.

Risks: (1) Currency Risk: The Malaysian Ringgit has been declining in value against the USD which has contributed to the recent decline in the USD priced EWM. USD/MYR Currency Conversion Chart

There is some debate whether the Ringgit will continue its decline, due in part to the rise in U.S. interest rates and the slowdown in the Malaysian economy, or will rise in the 2013 second half.

Malaysian ringgit slumps to 3-year low as exports, economy slow - WSJ.com

Ringgit Rebound Predicted as GDP Limits Outflow Concern - Bloomberg

Once I buy EWM, I want the Ringgit to rise against the USD or at least hold steady. The best case scenario would be a rise in the Ringgit against the USD and a rise in the Malaysian stocks owned by the fund. The worst case is that the Ringgit will continue its decline and the Malaysian stock market will also go down, the dreaded double whammy for U.S. investors buying foreign securities, either directly on their host exchanges or through U.S. ADRs or funds.

The BOJ's monetary policy is causing problems for companies that compete with Japanese firms.

(2) Country Risk: While there is less country risk in Malaysia than in say Venezuela or Argentina, this kind of risk in nonetheless significant. The Malaysian stock market could decline based just on future election results, or ethnic violence and turmoil.

And, there is of course risks associated with Malaysian stocks. The Malaysian stock market has had a good run already over the past five and ten years.

Future Buys and Sells: I am in a trading mode for this ETF. Most likely, I may sell the shares near the same price that I sold earlier this year. When and if the shares crossed $17, I would seriously consider selling them.

Closing Price Last Friday: EWM: $15.05 -0.11 (-0.73%)

5. Added 50 BDGE at $20.76 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer):


Snapshot of Trade:




Snapshot of Position Shortly After Last Purchase: As shown in this snapshot, this last 50 share purchase raised my average cost per share to $19.69:

Average Cost Per Share=$19.69 
I have acquired almost 14 shares with dividends. I am not tracking dividends in the regional bank table that is published on the last Monday of each month. This is a link to the last update:  Updated Tables for Regional Bank and Lottery Ticket Basket Strategies

Security Description: Bridge Bancorp (BDGE) is the holding company for the Bridgehampton National Bank. BDGE has a market capitalization slightly over $190M at last Friday's closing price of $20.96.

Website: Bridgehampton National Bank (BNB)

BNB has 22 branches located in eastern Long Island, and will soon open two more at Shelter Island and Rocky Point. The bank had 11 branches during most of 2005, so it has already doubled the number of branches in about 8 years. A lot of capital is being used to expand.

BDGE did not participate in TARP, always viewed as a positive here at HQ: SEC Filed Press Release

The bank is currently paying a quarterly dividend of $.23 per share. On the positive side, the bank did not cut the dividend during or after the recent Near Depression. On the negative side, the quarterly dividend has remained at 23 cents per share since the 2005 second quarter, when it was raised from $.22. Prior to 2005, the bank was regularly raising its dividend, starting with semiannual payments in 1991 that totaled $.074 per share, and an occasional special dividend with the last one paid in 2003: Dividends | Bridgehampton National Bank BDGE obviously does not qualify anymore as a dividend growth stock.

At my average total cost of $19.69 per share, the dividend yield is currently 4.67% which is just fine. I am receiving a 5% discount for shares purchased with the dividends, as noted in a prior post: Item # 1 Continuation of Discussions Re: Broker Price Differences For Reinvested Dividends

2012 Annual Report SEC Form 10-K (BNB owns its main office and five its branches, page 11; E.P.S. held up relatively well in 2008-2009, page 14)

Prior Trades: I have sold at higher prices than the last purchase two 50 share lots: Sold 50 BDGE at $23.5Sold 50 BDGE at $23.01

Prior to this purchase, the preceding snapshot reflects two fifty share market purchases: Item # 1 BOUGHT 50 BDGE AT $18 (October 2011); Item # 4 Bought Back 50 BDGE at $19.65 (August 2012)

Recent Earnings Release:

2013 2nd Quarter / 2012 2nd Quarter:
SEC Filed Press Release

Net Income: $3.252M / $3.063M
E.P.S.: $.36 / $.36
Net Interest Margin: 3.23% / 3.63%
Efficiency Ratio: 63.24% / 60.1%
NPL Ratio: .39%/ .49%
NPA Ratio: .22% / .25%
Coverage Ratio: 429.22% / 405.99%
Operating Expense as a Percentage of Average Assets: 2.26% / 2.43%
ROA: .79% / .87%
ROE: 10.74% / 11.55%

Deposits grew 18% Y-O-Y.

BDGE acquired a one branch bank, formerly known as the Hampton's State Bank, for 273,479 shares in May 2011. SEC Filed Press Release An additional 1.377M shares were sold in a December 2011 private offering. The price was $17.5 per share: SEC Form 8-K

The NPL ratio for all U.S. banks is currently 3.16%: Nonperforming Loans (past due 90+ days plus nonaccrual) / Total Loans for all U.S. Banks Needless to say, BDGE's NPL ratio of .39% is substantially better than that average, while its net interest margin is about average.

The average net interest margin is currently 3.21%: Net Interest Margin for all U.S. Banks

The net interest margin will hopefully start going back up in the coming quarters. The CEO stated in the earnings release that the "increase in longer term rates should provide some relief to net interest rate margin compression as new loans are funded and securities are reinvested at higher rates".

However, the rise in rates also causes unrealized depreciation in securities available for sale that reduces shareholder equity. The bank is adjusting to rising rates by shortening the maturities of its investments, extending the maturities of certain borrowings, and focusing on shorter term adjustable rate loans.

The Capital Ratios are in between okay and good:

Capital Ratios for Holding Company and Operating Bank as of 6/30/13
10-Q for 2013 2nd Quarter at pp. 49-50

The bank has outstanding $16M in trust preferred securities with a 8.5% coupon that may be redeemed at par after 9/30/14. I would assume that the company will redeem that security on or soon after that call date. (page 32)

The stock declined after this earnings report, closing at $24.44 on 7/25/2013 and then skidding to $23.29 on 7/26: BDGE Interactive Chart The chart reveals an erratic trading pattern over the past year, with the stock bursting toward $24 and then declining back to $20 or slightly lower. A longer term chart, going back to 1999, reveals a move from $10.33 in 2000 to $32 in 2005.

Rationale: BDGE certainly appears to be a well run small bank strategically located on Long Island, NY. Due to its many strengths, I have chosen to ignore its unwillingness to raise its dividend since the 2005 second quarter, a very long drought, and instead to focus on its positive attributes including its geographic location and low NPL and NPA ratios. The costs associated with the banks expansion have probably restrained earnings growth which has in return kept the dividend in check.

I would also consider this small bank to be a potential buyout target.

The current consensus forecast is for an E.P.S. of $1.47 in 2013 and $1.68 in 2014. At a $20.76 price, the forward multiple of estimated 2014 earnings is about 12.36. If the 2013 and 2014 estimates prove to be precisely accurate, the growth rate would be about 14.29%. Only 2 analysts contributed to those forecasts: BDGE Analyst Estimates

Closing Price Last Friday: BDGE: $20.96 +0.10 (+0.48%) 

9 comments:

cathie said...

Regarding the equity preferreds, I still own an Aegon hybrid issue (AED) bought before and during the Dark Period. I'm still far from being in the red on those shares, but took a 2.5% hit yesterday, wondered what happened. Someone dumped a large lot around 1:30 pm....I whimsically picture some "market maker" getting back from lunch and realizing it's time to unload 47,000 shares. The yield at my cost is almost 8% and fortunately I don't anticipate needing to cash out any time in the next few years...knock wood! All this is just to confirm your observation that these are subject to volatility, but I have never regretted holding them. Anything that survived the 2008-2009 meltdown deserves respect in my book. Aegon never missed a payment.

TENNINDEPENDENT said...

Cathie: I classify both the Aegon and ING hybrids as "equity preferred" stocks since they pay qualified dividends for a U.S. taxpayer. Those securities are actually junior bonds. Unlike other bonds, they do not have a maturity date and that makes them very sensitive to rising rates.

If AED was going to mature at par value in three years, it would be selling at over its $25 par value now, rather than skidding down 81 cents last Friday to close at $23.1.

AEGON has the option to redeem, but does not have the obligation to ever do so. Aegon has had the right to redeem since 2010 and has not done so.

The right to redeem may restrain the downside price action until larger investors determine that AEG is simply not going to finance this security before rates rise to a level that makes it uneconomical. This may already be happening now. A 6.5% rate for a perpetual security is not that bad long term, particularly when it can be included in equity capital while the company deducts the interest payments like a U.S. trust preferred (TP) security in that respect. (note: I have not kept track of whether there has been any changes in European regulations that would alter the use of those hybrids as part of equity capital for regulatory purposes, similar to the Dodd-Frank law in the U.S. for TPs)

I would anticipate further downside pressure on the perpetual European hybrids as rates rise.

We had discussions about these securities during the Dark Period when the prices of both the AEGON and ING hybrids hit bottom in the low single digits. For the AEGON hybrids, I picked up AEH at $4.63 back in March 2009 and bought AEB as low as $5.5. I sold AEH at $23.09 back in June 2011.

I do not currently own any ING and AEG hybrids. I am monitoring their prices almost daily and may start nibbling again at lower prices. I am more inclined to just wait and see, preferring to nibble when the current yields exceed 8% and we are closer to normalized interest rates than now.

Aegon is in much better financial condition now. I am not currently concerned about credit risks. The downdraft in prices during the Near Depression was due to credit risk concerns.

I own Aegon common stock as part of my Flyer's Basket strategy and I am reinvesting the dividend. I gave that stock a promotion from my Lottery Ticket Basket to the Flyer's Basket when I added 70 shares at $5.28, discussed in a 10/5/12 post.

As for your AED, I would anticipate more volatile price action, with a downside bias, until interest rates normalize at higher levels than now.

TENNINDEPENDENT said...

Cathie: The price last Friday for AED was $23.22, down 60 cents for the day. I noted in my prior comment the price for AEH which was down .81 to close at $23.1. Both are functionally equivalent to one another.

Oregon said...

Sorry to see GMAC gone, old sentimental position of mine, it was kind of reassuring to be predictably paid fixed amount, month in, month out, especially at the effective clip of 11%+ since I bought it (14 of them however hesitantly) in the memorable 2008 at something like 67c on the dollar. Not bad for the first dip in the bond market for a newbie like me. Still sitting on a six figure bond portfolio that pays me, on par basis alone, close to 10% but wondering what the renormalization will do to it!

TENNINDEPENDENT said...

For the next two years, I would not anticipate any significant value change for corporate bonds maturing within four years due to rising intermediate and long term rates. Any material change would be sourced from credit risk changes. The shorter maturities will be primarily influenced by a continuation of ZIRP which will keep the short term rates anchored near zero. ZIRP is likely to continue for two more years.

Since May 2, 2013, the 10 year treasury has risen from 1.66% to 2.84%, while the 1 year treasury is still stuck at .13%. The 2 year treasury closed last Friday at .36%, up from .2% as of 5/2/13.

At least with individual bonds, the investor has the option to hold until maturity. The normalization process will hit intermediate and long term bonds. It is those maturities that have been manipulated to abnormally low levels through QE rather than ZIRP.

You can calculate the approximate impact by multiplying the percentage rise in rates by a bond's duration which is not the same as the time to maturity.

You can calculate the duration using a calculator available at SIFMA:

http://tipscalc.investinginbonds.com/tipscalcform.aspx

Anonymous said...

Hi South!

You had been praying for a correction. You've upped it to 10%+ expected. I'm missing in the article -- that's fueling that idea? Especially the + part.

Any sense of time frame for it?

Thank!
Curls

TENNINDEPENDENT said...

Curls: I am a value investor who is currently having difficulty finding stocks to buy. When I reach that point, I will generally become a net seller of stocks, which is the case now.

The trailing twelve months P/E for the S & P 500 is high at around 18.13, and the Shiller P/E is over 20. The recent earnings reports have been disappointing particularly the one from WMT discussed in this post.

The S & P 500 was up over 55% earlier this month, since closing near 1100 on 10/3/11. I mentioned in the prior post that this move was too far, too fast given the economic fundamentals.

A continued rise without more confirming economic data could precipitate an even larger decline than 10% to 20%.

The S & P 500 went down almost 20% between May-August 2011. I would view a similar downdraft positively now, followed by several weeks of consolidation. It is better to let the air out of the ballon slowly rather than to continue blowing it up until it explodes and crashes into itself.

Possibly and hopefully, the market has started a correction. The S & P 500 is down about 3.21% from its August closing high of 1709.67 printed on 8/2/13.

The market has started to anticipate the end of QE. Last week, interest rates rose for intermediate and longer term bonds even though inflation expectations came down.

The 10 year treasury has now risen about 69% in yield since 5/2/13, when the yield was 1.66%. I expect it to continue rising during the rate normalization process which could place short term downward pressure on stocks, similar to what happened last week.

Nothing is for certain however. I view my bond market views to have a much higher probability factor than my prediction about a stock market correction.

All that I can say for sure is that I will continue to be a net seller of stocks in the event the market continues its upward trajectory during August-September.

I am just not comfortable increasing my stock exposure at current prices, though I will buy some securities in small amounts that are not overpriced in my opinion.

I may also, for example, buy back some security, such as 100 shares of EWM discussed in the current post, where I sold the position at a higher price earlier in the year.

Anonymous said...

Thanks South!

Wow, a logical way to decide if it's time to sell:
"
value investor who is currently having difficulty finding stocks to buy. When I reach that point, I will generally become a net seller of stocks, "

That makes so much sense.

Great the details. You've answered my question very well.

I've seen P/E evaluated as too high, and just low enough... in the end, the idea that stocks seem expensive to buy, seems a solid way to get a gut read.

Happy investing!

TENNINDEPENDENT said...

I still own a lot of stocks and stock funds. I am mainly liquidating some stock funds, mostly CEFs, that have been disappointments as a means to temporarily lower my stock allocation. I am hoping for better prices after a 10%+ correction.

Since 1982, I have gone into a liquidation mode only once, and that was in 1999.

Since I own a large number of positions, I always have some positions that need to be jettisoned for one reason or another anyway.

I am not selling core individual stock or stock fund positions. I am selling some positions at profits as a means to reduce my stock allocation and to build up my cash allocation for later stock purchases.

I will use some of the proceeds to buy an individual stock where I have a comfort level about the current valuation and decent dividend support. It is hard to find that comfort level at current prices which is a signal to me to lighten up some.

Today, I bought 100 shares of Pfizer which I will discuss in the next post. I have stayed away for years due to patent expiration issues, particularly on Lipitor. I became somewhat comfortable after reviewing PFE's new FDA approved drugs and the drug pipeline, which allayed my concerns only sufficiently to justify a small purchase of 100 shares. The dividend is over 3% and the forward P/E on estimated 2014 earnings is 12.4. There is also a lack of enthusiasm for the shares which is fine with me, since I do not have to pay a high multiple for my entry purchase.