Wednesday, August 19, 2009

Sold 100 MJT at $24.43/Uncle Warren Warns on the Deficits/Hanover Insurance/Hewlett Packard/Technical Analyst of Chinese Market/hn

1. Sold 100 MJT at $24.43 (see Disclaimer): This TC just went ex interest for its semi annual payment and had risen to within 50 cents of its par value. This TC was bought in June at $22.57. Afternoon Comments 6 11 2009/GS on Electric Utilities/Bought 30 TIP-Sold Am Gen Bonds/Sold 50 FJA & SE & Bought 100 MJT I sold my 100 shares yesterday at $24.43.

My purchase of MJT falls into the category of bonds purchased at less than 20% of par value, which are in a trading category-held for sale so to speak. (item # 2: I Never Buy Bonds at More than Par Value or CEFs at Premiums to Net Asset Value) Three others, PJL, GJF and EHL, are in the same category but I still own those.

MJT is functionally equivalent to MJV and MJY. I have no interest in keeping one of these securities bought at over $20 when the price approaches par value, particularly when the security rises to recoup the ex interest payment quickly.


All of the above TCs contain the same DPL bond, a TP issue maturing in 2031. I will continue to monitor all three for a subsequent re-entry point. Hopefully, if I decide to buy again, I will choose the one that provides the greatest yield at the time of purchase, recognizing that the yield at my cost is the important factor, not the differences in coupons among these three TCs.

There is another reason to start lightening up on corporate bonds. They have experienced a powerful rally this year. While bond portfolio managers argue that the rally has further to go,, I will always turn more cautious after a huge rally in an asset class. As with stocks over the past two weeks, I am inclined to sell some bonds too. I do not see any urgency to sell down my bond holdings, given the current Fed policy and the practically non-existent rates paid by money market funds now, but I do feel the need to at least go into a trading mode as a response to the current rally, at least for those bonds bought at less than 20% discounts to par value.

What do I mean by trading mode? I would use the proceeds from the sell of MJT to buy another bond that yields more and is closer to its ex interest date. An example would be to buy IGK, the ING junior bond/equity preferred, but I already bought that one a few days ago. Bought 100 IGK So, I need to find another one. Then, if that new purchase moves a couple of points, I will sell it, and so on. This requires a good deal of knowledge about potential alternatives. One alternative might be to buy one of the TCs containing the DPL bond back at some point after a 10% or greater fall in price.

2. Junk Bonds: An article in Forbes notes that junk bonds have rallied almost 38% this year. The price of DKR, a TC with a Hertz bond that I own (TRUST CERTIFICATE HERTZ BOND DKR), has just about tripled this year, and I passed up an opportunity to buy more when it fell to $5 in March. I am critical of my decision to keep $250 in my pocket and not even buy back the 50 shares of DKR at $5 that I had sold at around $14. DKR is now over $20. I I think that I can classify the purchase of DKR as a home run, provided I sell it soon. If I continue to hold onto it, it may turn into something other than a home run. My current yield based on my cost is around 27%, with two interest payments received to date, but most of the return was always predicated on capturing most or all of the the spread between my purchase at $6.45 and the $25 par value sometime on or before maturity in 2012. That objective would be mostly realized by a sell now. Most likely I will wait until the holding period passes the year mark and then decide. The factors militating against a sell include the fact that I have already sold 1/2 of my position (50 shares) at a profit, the financial position of Hertz is better now than it was back in December, and the proceeds from the sale would be parked in a money market fund yielding about zero now. So, even though the amount of money is small, it is a difficult decision.

I would not even call my buying of junk bonds a tiptoe into that market, though my purchases are up far more than 38% this year, including DKR, FCZ and PFX. An accurate description of my limited forays into junk bonds would be Lottery Tickets, a bond version of my stock lottery tickets. I am more comfortable holding some of the junk bonds than others. For example, I am far more comfortable holding the junk rated Hanover junior bond, discussed below, than the senior bond from Phoenix Insurance. Inertia may be the only sensible explanation for continuing to hold PFX. I am not sure why I haven't declared victory on the Ford Motor Credit long bond either. FCZ has run from around $7 to $18 in the last nine months. PFX has gone from as low as $3 to $16. Phoenix Senior Bond: To Wild for LB/ I see from reading that post why the 100 shares was being kept:

"When I last mentioned it, it was trading at around 3 bucks and yielding about 50% at that price..... The Phoenix bond closed today at $8.46. RB likes that kind of movement, but LB is just unnerved by it. The sheer velocity and magnitude of that kind of movement is symptomatic of extreme risk and an inability to price risk with any degree of confidence. Having disposed of the shares in my retirement account, LB will keep the remaining position in PFX to humor RB, keep it distracted and occupied-like giving a toy to a tot so that serious adult business can be transacted by LB."

That post was written on 3/26/2009. PFX closed yesterday at $15.3. Moody's lowered Phoenix into junk territory back in March: And S & P has cut the ratings: Investment News

3. Hanover Insurance (own bonds only) I recently added two TCs that contain the same junior bond issued by AFC Capital and guaranteed by Hanover. Bought 150 TC PKM Bought 50 KRH in IRA/ The underlying bond is a typical Trust Preferred issue. I will review the earnings reports even if my sole connection is ownership of the bond. However, I am only concerned about making an ongoing assessment of the firm's ability to pay its debt obligations. Hanover Insurance earned $1.25 per share and increased its book value by 13% from 3/31/09. Operating earnings were 86 cents, lower than expected due to weather related losses and pension expenses. S & P kept its 4 star rating, and Barclay's maintained its overweight recommendation on the common after the report. There is nothing in this latest report that would cause concern to me as a bondholder. Both PKM and KRH just paid their semi-annual interest payment.

4. Hewlett Packard (no position): The most interesting take away from HP's call was Hurd saying that Windows 7 was not "different enough to drive a refresh cycle". Admittedly, I am not much of a tech investor which was a good thing after 1999, but I have been pondering what to do with my 50 shares of Microsoft. Being an Apple guy, I am not exactly sure why I own shares in Mr. Softie anyway. I am also convinced that elephants can not be taught to tap dance. I did note that the AmTech analyst, Yun Kim, raised Microsoft to a buy yesterday with a $29 target.

5. Barron's Technical Analyst on the Chinese Market: My interest in the Chinese market is mainly via mutual funds and a CEF. I did note Michael Kahn's claim that the Chinese market has just suffered a "significant breakdown" with a treadline break. The Chinese market is volatile and appears to be in a correction. When discussing today's fall of over 4% in the Shanghai index, The AP writer, Jeremiah Marquez, is hyperventilating by referring to this correction as an unraveling.

6. Uncle Warren Gives a Warning: Buffett has an opinion column in today's NYTimes warning about the potential damaging effects of flooding the world with greenbacks to finance our soaring deficits. Warren is concerned that we are evolving into a banana republic, where politicians are unwilling to control spending or to raise taxes, preferring to finance a growing deficit with higher rates of inflation which can not be "attributed to a specific action that any elected official takes". For politicians of both Tribes, it is far preferable to be irresponsible and to avoid the repercussions of responsible actions in the nation's best interests. Keynes observed and Buffett quotes him with approval, that creating the conditions for inflation to flourish results in a hidden tax that confiscates the wealth of the government's citizens, which does not have the blowback effect of voting on specific pieces of responsible legislation to reign in the burgeoning deficits.

7. Is there a distinction between information and the formation of rational judgments based on information-the efficient market hokum? It is almost impossible to fathom why anyone would view access to information and decisions based on that information to be equivalent. As Jim Jubak discusses in a recent column, efficient market theory assumes that there is a rational market because human being will form a collective rational judgment based on available information and then, acting with good judgment, will pursue a course of action in their best interest. Only those divorced from the real world could come up with such a hypothesis. Access to information, and forming rational judgments based on that information, are just not the same. A great deal is lost, warped, transformed, forgotten, and ignored in the way human beings process information. To say that humans, who often act in an irrational manner, exercise bad judgment, draw the wrong conclusions, acquire rationality as a collective pretty much ignores the history of mankind to create an economic theory divorced from the real world.

One argument for the efficient market is that money managers are unable to outperform dumb indexes on any consistent basis. From that fact, the professors who foisted the efficient market theory on mankind conclude that the reason for that under performance is that the market has already reflected all available information by the time a human can react to it. On a superficial level, that argument makes sense, but is the efficient market theory the explanation. With the evidence building to a crescendo that markets do not price rationally available information, as shown in the stock market and real estate bubbles of recent origins and other countless examples from the past, you would think that there would be a search for an alternative explanation for poor performance by money managers other than an efficient market theory. I would propose such an alternative. The reason is that the so called professionals are professional in name only, and are subject to the same errors in the processing of information as the non-professional investor.

8. Pimco Claims that it Active Management will Beat the TIP ETF: In this document, Pimco claims that it can beat a passive TIP's index fund by active management. The WSJ pointed out that the TIP ETF, which I own, has had an average annual return of 4.28% over the past five years whereas PIMCO's Real Return fund sold to individual investors (the Class "D" shares-PRRDX) has underperformed the TIP ETF with a 4.14%. The institutional Real Return Fund did outperform the dumb index due to lower fees (PRRIX) according to the WSJ article. The WSJ observations were based on Morningstar data available at the time of the article.

When you look at a 10 year comparisons, year by year, of the index and PIMCO's institutional TIP fund, there are years of both significant outperformance and underperformance of PIMCO's institutional fund. PRRIX - Fund returns - MSN Money This would indicate to me that the PIMCO managers are acting overall as rational processors of information in this area, capable of beating the index, but not in every year. Even with the institutional low cost fund, another year of underperformance could easily cause the managers to fall below the indexes ten year average return, making the dumb index a better bet than active management over a ten year period even for a low cost actively managed fund. The MSN data shows a 11.7% underperformance for 2008.

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