Sunday, October 11, 2009

Balancing Risk and Reward for Recent Bond Buys/ Abelson and Rosenberg Again and Again/Shiller on Improving Psychology/ Stock Hedge

1. Recent Bond Buys: I have had a small change of heart on individual bond buys recently. For example, I bought back a Trust Certificate containing a DPL Trust Preferred near its $25 par value, having sold a functionally equivalent TC a few weeks earlier at $24.43: Bought 100 MJV at $24.8 Sold 100 MJT at $24.43 I also recently bought some more bonds recently at or near par value yielding anywhere from 7 to 8%: Bought 100 AMPPRA at $24.75 Bought 50 Shares of FPCPRA I prefer buying bonds at a much larger discount to par value, and to sell some when that discount narrows.

In deciding what to sell or to keep as that spread narrows, I will focus on my yield at the original price and the overall quality of the credit. So, as an example, I have kept DKF, a TC containing a senior Goodrich bond purchased at $20, even though it was recently trading at over $26. At my cost the yield is 10% annually until early redemption or maturity in 2038. Buys of DKF Another example is the purchase of JZE at $12.5 (JZE: MORE DETAIL), which gives me a minimum yield at my cost of 12% annually from this TC containing a senior AT & T bond, more in the event of debt downgrades, so I am not interested in selling it even though it is currently priced near its $25 par value. Other examples include purchases of a Trust Certificates containing a senior Prudential at $9.5 for a current yield of 15.8% to a 2033 maturity (playing with house's money TRUST CERTIFICATE JZH: PRUDENTIAL SENIOR BOND); a TC containing a senior CNA bond at $9.93 for a current yield of 18% annually until maturity in 2023 (playing with the house's money Buy of 50 JZV at 9.93 ); a senior bond from First American with a current yield of over 26% to maturity in 2028 ( PJS); and a junior bond from AON contained in the TC bought at $14 or less to yield almost 15% to its 2028 maturity (GRTPRF: A WALK ON THE WILD SIDE/ KTN add TRUST CERTIFICATE AON BOND KTN ORDER FILLED).

I am also more likely to continue holding those bonds even when inflation starts to cause a rise in interest rates and a fall in long bond prices. This will happen, only the timing remains uncertain.

So why buy some long bonds again near par value and yielding only 7 to 8%. Some of my reasoning is explained in this prior post: Temptation of Long Bonds in a Low Interest Rate Environment First, I understand the risk. I lived through the 1970s when bonds were crushed. I know what can happen when the long term secular bull market ends. And it will end. I am just trying to balance that risk with a desire to boost income now. The money used to buy these bonds recently is coming out of a money market account that yields .01%. One of those bonds, purchased with less than $2500, will pay me twice the amount in annual interest paid by that money fund on a million dollars. When I do that kind of computation, I will take some more risks, though I am not exactly going nuts with the risks that have taken and all of these recent buys near par value are on a short leash.

2. Obama's Nobel Peace Prize: As far as I can tell, the Nobel Committee awarded the Beanpole the Nobel Peace Prize because he is not George Bush. The language in the Committee's press release indicates that the award was more of a slap against W than a recognition of any tangible achievement by the Beanpole. The award was for Obama's "extraordinary efforts to strengthen international diplomacy and cooperation between peoples". The Nobel Peace Prize 2009

3. Abelson & Rosenberg: On the weekend before the market commenced its epic 60% run, Abelson was quoting Rosenberg in his March 9th column about how the market was not yet pricing in the bad news, as the S & P 500 hovered around 670. Rosenberg would later predict that the S & P 500 would hit 600 this October. Barrons's & David Rosenberg Now, with this average close to 1070, a mere smidgen the wrong way - just 60% or so from Rosenberg's forecast, Abelson's puppy love for Rosenberg's negative opinions about the market continues undiminished, though I have to wonder whether that reverence is simply due to both of them sharing a dour outlook rather than anything remotely resembling affectation for meritorious arguments. I would suggest that Barron's just go ahead and hire Rosenberg to write the last half of Abelson's column since that is where his opinions routinely find a home. When you are in a perpetual negative state, heaven and earth will be moved to discover any fact that supports a negative outlook, while ignoring or diminishing any inconsistent material information.

In Abelson's column this weekend, the new factual source of his negative opinion is the valuation of the S & P 500 after the 60% spurt that he missed of course. Their argument now is based on the high P/E valuation using the current top down estimates for S & P 500 operating earnings: $53 in 2010, $63 in 2011, and $81 in 2012. (I do not know whether those figures are accurate). Rosenberg's argument about valuation hinges on those numbers. If you accept a $53 estimate for 2010, then the S & P 500 is selling at 20 times next year's earnings, which is a number that brings out the caution police for me. On the other hand, the bottoms up estimate, which only goes through 2010, is much higher, at around $74. I mentioned in a prior post from July that Zachs had the consensus number at $74.09 for 2010, much higher than the $53 used by Abelson: Goldman Sachs Upgrades Forecast for S & P 500 Earnings/Earnings from KO and DD/CIT Bonds This article from October has the forecast for 2010 at $73.81 Still Positive Rosenberg has to dismiss that higher 2010 number in order to maintain his negativity. Based on a $73 to $75 forecast for the 2010, the S & P 500 is selling for a modest 15 times next year's earnings, and that would undercut Rosenberg's thesis.

I also read Rosenberg's most recent analysis that can be found in his report dated October 9, 2009, which can be found at Scribd: Gluskin Sheff Just because Rosenberg's prior predictions this year were foolish, this does not mean that his current analysis can be dismissed, and it has to be evaluated on its merits independent of any prior opinion that I have about him and Abelson.

I would agree that the market has probably come too far based on what is known now. Earnings for a number of companies in the S & P will have to be beyond current expectations to justify the expectations built into their current share prices. I am not inclined, like Abelson, to forecast the earnings during the recession as the new normal, cherry pick only the data that supports a perpetual dour forecast, and look for any reason to dish positive information or inconsistent data. But, looking at the current situation without any built in personality biases, I am not inclined to price securities now based on the hope of a rapid recovery from the train wreck and most significant financial crisis since the Great Depression. What I am inclined to do now is to be cautious, and to buy a few short term hedges for my stocks periodically. On Friday near the close, I re-established a hedge that I sold a few days ago. Sold Hedge for Stocks My second approach has been to buy some higher dividend paying stocks recently that have not participated in the rally, such as Verizon, BCE, Progress Energy, and Wal-Mart, along with the recent re-purchase of Proctor & Gamble after it retreated back to the $52 and change level.
Bought 100 WMT at $49.55/ Bought VZ Another example would be buying 100 of AOR, an ETF with some bond ETF exposure including the TIP, and selling 100 of XLI: Sold 100 XLI at $26.65/ Temptation of Long Bonds in a Low Interest Rate Environment Bought 50 ORHPRB at $20.93/Bought 100 AOR at $28.27

And, I sold some winners.

Jim Grant may be right when he opined recently that GDP growth will end up being greater than currently anticipated. I am inclined to agree with him. The market may be anticipating the same. I do not view that as an unreasonable hope, given the massive amounts of fiscal and monetary stimulus that could render Rosenberg's excessive reliance on past history and recoveries unreliable. With the run up in prices, however, the risk now is that those expectations are not met as quickly as hoped or anticipated, with that risk weighing more heavily than the potential benefits from further significant market gains after a 60% spurt. A similar concern is expressed by Conrad De Aenlle in a NYT column.

4. Shiller: In Professor Shiller's column in today's NYT that his survey of home buyers showed a "dramatic" change in expectations for price increases over the next 12 months, with the average answer now expecting a 2.3% rise in prices from the June-July 2009 survey from an expectation of a negative .4% increase in the year earlier survey. This indicates to Shiller, as it does to me, that buyers are increasingly expecting to see an end to the price declines and see no benefit by continuing to sit on the sidelines. The Professor notes that this kind of information dovetails with the 3.6% increase in home prices for the Case Shiller index for 10 metropolitan cities during the April to July period.

I have noticed a profound change in new home construction near my home. I mentioned previously an example of a new subdivision, where the developer had completed all of the infrastructure, new roads, underground utilities, water and sewer lines, street lamps and an expensive new entrance, and then nothing happened for about a year. A few months ago, a new home was started and over the past couple of weeks construction of five new homes commenced at the same time. A continued recovery in home prices can certainly be one factor that will propel the economy to stronger than expected growth next year, and improve the balance sheets of financial institutions holding the exotic mortgages created by the Wall Street wunderkind.

One last note is that my stock hedging now is not based on any model which was the case back in 2008. I am timing the buy and sells more on hunches and to some extent on the movement of the VIX. The duration of the hedge will be short, and the amount will be so small that the only significance is psychological. Though with a continue rally next week, and a fall in the VIX closer to 20, I may expand the the dollar amount of the hedge by another meaningless amount to relieve my growing anxiety more than anything else.

No comments:

Post a Comment