Reveille for Staff (RB and LB) sounded at 5 A.M. again this morning with Headknocker wanting to know more about "The Big Picture", saying Staff "can catch up on their beauty sleep over the Memorial Day holiday weekend." LB said to itself, in a barely audible whisper, that it would have been better to avoid the 5 o'clock bugle and just stay up all night, watch the entire South Carolina and Vanderbilt baseball game in the SEC tourney last night, which started at 10 P.M. and just forget about its "beauty" sleep altogether. Vandy won 5 to 4 with a tight finish in the 9th. VANDERBILT ATHLETIC SITEThe Dores are now 2 and 0 in the double elimination tournament.
1. Quantitative Easing ( New York Times) and the U.S. Dollar: With the usual caveats about having never read an economic textbook and avoiding coming within a hundred yards of a classroom where the dismal science was being taught, I decided to take up an important issue for me as a lone wolf individual investor, that is, whether the Fed's quantitative easing will have a negative impact on the value of the U.S. dollar. A related issue is whether the FED's quantitative easing is working to tamp down longer dated rates, particularly the ones impacting mortgage rates. I will take that issue up first with a simple observation.
The Fed announced on Wednesday March 18, 2009 its program to purchase massive amounts of treasury debt and mortgage securities in its latest campaign to revive the economy. NYTimes.com
That is what I understand quantitative easing to mean, in simple terms, the creation of more money out of thin air. Being an individual investor, I have to hunt for data. By going to the Fed's web site, I see that the 10 year treasury was at 2.75% on 3/20/2009federalreserve.gov
The WSJ Market Data page lists the 10 year yield as of yesterday at 3.351%. The WSJ has the 30 year currently at 4.291%. Markets Data WSJ.com On 3/19/2009, the 30 year was at 3.19% according to the FED. federalreserve.gov Yields are clearly moving up notwithstanding the FED's massive buying campaign with newly created money. In the Minutes of the Fed's last meeting, several participants discussed the potential need to increase the amount of FED purchases. Why? The only rational that I could fathom was that the current program was not working to lower the yields of longer dated treasury paper, so the thought was to do more buying. The reaction to that announcement was to drive yields up more and to knock the dollar down, or that is how I now interpret what subsequently happened after the release of the Minutes.
So it just occurred to me, being somewhat of a simpleton on matters within the purview of practitioners of the dismal "science", that what the Fed is doing is not working all that well, and doing more of it may make matters even worse.
Another impact of the quantitative easing appears to be the weakening of the U.S. dollar. I am not much of a currency trader, occasionally I venture into buying currency ETFs. On March 17, 2009, the currency ETF for the Euro (FXE) closed at 130.13. On the next day the Fed made its announcement about "creating money out of thin air" and the Euro ETF jumped to 134.9. FXE: Historical Prices for CURRENCYSHARES EURO - Yahoo! Finance It closed yesterday at over 139. The gold ETF has increased some from 90.04 on 3/17 to yesterday's close at $93.85. The currency ETF for the Japanese Yen has increased from 101.43 on 3/17 to 105.55 yesterday. The meaning seems clear to me, at least up to today. Money creation is bad for the U.S. dollar. The latest data that I have found says the dollar index has fallen about 10% since early March. More money creation by the Fed would even be worse for the dollar.
Having said all of that, it is not clear to me that the quantitative easing is causing the yields to rise on longer dated U.S. treasuries. That may be the case, possibly due to the risk premium to foreign buyers due to the decline in the dollar. But, and this is a fly in the ointment so to speak, the treasury is issuing a ton of new debt to finance the budget deficit and the Fed is only off-setting part of that new supply with its open market purchases. Conceivably, it could be a lot worse for the longer dated paper under those circumstances without the Fed's buying program. The only way to know that now, with a measure of confidence in the opinion, is for the FED to stop buying, which would be counter-intuitive from its viewpoint. Maybe the dollar would rise and rates would fall some, but who really knows the answer to that question.
LB may have been hasty yesterday in disposing of GSG. So, today, I may buy an equivalent amount of RJI with the proceeds from the GSG sale yesterday. While demand for commodities may be slow to pick up due to the worldwide recession, a continued fall in the dollar would be a countervailing force supporting the price for major commodities such as oil. Commodities Rise On Declining Dollar
I will also use the current weakness of the dollar to pare my position in BWX. This foreign government bond ETF is going to be very sensitive to currency movements, and that is why many experts do not want to use that asset as part of an asset allocation for a U.S. investor. You actually have to manage the currency risk in my opinion, not by hedging which just costs money and eats into the potential return, but by selling some on spikes in foreign currencies and buying the shares back when the dollar rallies. On 3/17/09, BWX closed at $49.91 and yesterday it ended the day at $54.04. This move may be entirely due to the currency move rather than an appreciation of the value of the securities contained in the ETF in local currencies. I am in a day to day mode on when and if to pare BWX. It would now lower my cost basis a good deal, to make a profitable sale now of the first shares bought, which are also the highest cost shares in my account. I use FIFO accounting, so ridding myself of those higher cost shares, will significantly reduce my cost basis in the position. I could then buy those shares back in the event BWX falls back closer to $50. That is how I manage the currency risk in BWX.
2. More on managing lost opportunity risk: Back in 2000, I was listening more to CNBC during the day. I heard some mutual fund manager talking about waiting until Cisco fell to $50 before she would buy it. This is a link to a long term chart of Cisco. Cisco Systems Yahoo! Finance
I am not going to say that Cisco will not return to $50 in my lifetime. Instead, I wish to use the "experts" opinion to illustrate a point about managing the risk of lost opportunity. My VIX Asset Allocation Model was not then in existence. If it had been, it would have been flashing a sell signal. Rather than buying a high beta stock selling at an outrageous price, the Model would be saying get rid of that sucker now. The VIX managed to fall below 20 again in August 2000 in an ongoing Unstable Vix Pattern, and that was a signal to lighten up rather than to buy. I would not have needed the model to know that most companies were selling at multiples to earnings consistent with pricing decisions made by humans suffering some form of mass delusion. Companies like Cisco were not even being valued on GAAP earnings but on some form of N0n-GAAP number that excluded a lot of expenses and costs, just a bunch of hooeyhooey definition
When managing risk for a particular security that I would like to own, I have to ask first "at what price". I can not manage risk by clearly overpaying for shares. If I had bought 100 shares of CSCO at $50 in 2000, I would not now have that $5,000 to buy CSCO at $18. I lost the opportunity of buying more shares at a lower price by buying shares at a price that was clearly out of line. So, the first issue that I have to resolve is whether the risk is worth the current price. Clearly, paying $50 for Cisco in 2000 was not worth the risk.
I could probably start a trade of Cisco at the current price, but I am not much of a tech investor. I just sold the few shares that I own after a pop. But, I could probably start a swing type of trade for CSCO now, hopefully using volatility to my advantage, selling higher cost shares first, buying back those shares on a fall below my lowest purchase price, and so on. I am not likely to do that.
I prefer buying a company like Unilever which was selling at a very low P/E when I started to buy shares at $18 and change. It also had a good dividend yield at my price, another important consideration for me. By waiting and choosing my spot at a lower price and very reasonable P/E, I reduced my risk and increased my dividend yield, two factors that were not present for Cisco at $50. Still, I decided to pare my position yesterday, keeping the second lot purchased at a slightly lower cost, and harvesting about a $6 gain on the first lot (33% annualized in 2 months) after the ex dividend date. This reduces my risk in the position further.
The problem now is that Unilever may continue to advance and I have now lost the potential opportunity to make more on the shares that I just sold. In the current market, I am not concerned about that risk. I am more concerned about losing the profit on shares that have popped in value. In a market clearly in a long term secular bull market, I would be concerned about selling too soon, and more willing to hold onto a position after a spike in price.
So, for Unilever, I may buy the shares sold yesterday back at less than $18. But, I am not limited in my trading model to using those proceeds to buy Unilever shares. I like Proctor & Gamble more than Unilever, and I may use those proceeds to buy more of PG on a downdraft. Or, I could use those proceeds from Unilever and the funds raised from the sell of Kroger shares and buy a new position in another consumer staple stock that I am monitoring on a downdraft in price. Or, I could buy 5 shares of Google with that money. The model is flexible in that regard.
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