Thursday, November 19, 2009

Sold all of WIP ETF-View Risks Now Outweighing Potential Reward/Added To CEF ADX/ CPI and CPI Floaters OSM and PFK /PNW & CPB

1. CPI and the CPI Floaters OSM and PFK (both owned): The CPI rose .3% in October on a seasonally adjusted basis. The year over year number still shows a decrease of .2%. Importantly for the CPI floaters, like OSM and PFK, the October number replaces a negative number from October 2008 which was used in the CPI computation by those floaters. The seasonally adjusted CPI for October 2008 was a -.8%. Bureau of Labor Statistics Data The November 2008 was down a staggering 1.7%, and the December number was -.8%. By January, the year over year inflation numbers will not look so benign. Bureau of Labor Statistics Data

Before starting to write this post, I had been looking at the seasonally adjusted data for CPI furnished by the BLS which is actually the wrong data series to use in obtuse CPI calculations made to determine the monthly penny rates for OSM and PFK. (PFK will use NSA too: see general prospectus at pp S-25-26 Prospectus Supplement & prospectus for PFK Pricing Supplement No. 122 dated March 31, 2006) OSM uses the non-seasonally adjusted CPI which is slightly different by month. This is a link to the BLS chart showing month by month changes for non-seasonally adjusted CPI: Bureau of Labor Statistics Data And, at least to me, this is a somewhat scary chart from the St Louis Federal Reserve showing CPI NSA (non-seasonally adjusted since 1910) St. Louis Fed: Series: CPIAUCSL, Consumer Price Index For All Urban Consumers: All Items . The non-seasonal CPI data can be downloaded from this web site at the St Louis Fed: The BLS figures show NSA CPI for October through December at -1, -1.9 and -.1 respectively, more disinflation than shown by the adjusted numbers. So, when the last three months in 2008 are eliminated from the CPI calculation for OSM and PFK, the monthly interest rate will go up. (here is a link to a Bloomberg chart showing non-seasonal CPI). This will not occur until the May 2010 calculation as explained below.

I did note that OSM did not declare a monthly dividend for November, apparently due to the inflation calculation being so negative based on the 12 month period used in the formula that a 2% float over the number for that month yielded a negative number (see page 3: ).The October interest payment was almost nothing at $1.18 for 100 shares or about a 1/2% at an annualized rate. To determine the interest rate for the period ending starting October 15 through November 14, 2009, you would start with the CPI number three months earlier than October, i.e. July, subtract the July 2008 CPI number, then divide the result by the July 2008 number and then add .02%. So, the bottom line is that it will be another two or three months of nothing or near nothing. By May 2010, which will not use the last three readings from 2008 in the calculation, the penny rate will hopefully start to look better. Now remembering that I am a philosopher and an extremely math challenged person, I tried to do the OSM calculation for November:

CPI JULY 2009 215.231
CPI July 2008 219.964
Difference= -4.733
Divided -4.733 by 219.964= -.021517
Add Spread: +.02 and -.021517= a negative number -.001517 so the interest is zero for 11/09

Anyone who is a math whiz may want to leave a comment if you come up with a different result.

For my purposes in evaluating these investments, I would just say that a 12 month period is used with a three month lag. The lag will help for a few months when CPI starts to fall, and hurt for a few months when it starts to turn up. I am just not interested in that obtuse calculation on a month by month basis in making long term decisions about buying these CPI floaters. Instead, I just make an assumption of an average rate for CPI over the course of the next ten years to evaluate these investments, which smoothes out the lag. OSM matures in 2017 and PFK in 2018. I then make an assumption about the average CPI per year over that 10 year period and then apply that percentage (plus the 2% spread) to the par value to calculate an average penny rate. The last step for me is to figure the yield generated by that average penny rate at my cost. So as an example, I bought OSM at $12.5 and it has a $25 par value. Just to get a rough idea of what I might earn on average for the next 7 years and a few months until maturity, I assumed an average inflation rate of 2.5% per year. Some years might be more while others are less, but 2.5% seems reasonable to me as a prediction about events yet to occur. Add the 2% spread to that number and that gives me 4.5%, then multiply 4.5% by the par value of $25 to determine the average penny rate per share, and the penny rate under that inflation assumption becomes $1.125 per year. Divide that number by my cost of $12.5 and I arrive at a 9% average yield, plus the yield generated by capturing the spread between $12.5 and $25 at maturity, assuming Sallie Mae survives to pay me, which is roughly 100% divided by 7= 14.28% per year, actually a little less than that since the bond matures in 7 years and a few months. But that is close enough when making assumptions about the future, at least for me, when I recognize of course that my core assumption (i.e. average CPI per year) may be way off, up or down.

If anyone can explain it better or if you disagree, please leave a comment.

2. Home Construction: Housing starts, which includes multifamily dwellings, decreased 10.6% in October from September. Total construction was at an adjusted annual rate of 529,000 units with expectations at 590,000. Until I have further data, I will work under the assumption that the slowdown was due to the uncertainty about the extension of the tax credit for home purchases.

3. Sold all shares in WIP at $57.98 (see disclaimer): Sometimes, I just act on instinct and an assessment of risk/reward. The ETF WIP contains inflation protected bonds issued by foreign governments, and it has enjoyed a good run based primarily on the fall of the U.S. dollar. The price has moved from around $43 in early March to $58 yesterday. Chart I mentioned in a post a few days ago that currency fluctuations would overwhelm any benefit to the inflation protection of those bonds. I also viewed this ETF to be primarily a currency bet against the dollar, with negligible income generation through dividends. (see Item # 4: Foreign Bond ETFs). Given the low dividend yield, and the substantial appreciation based on the recent movement of the dollar, the risk/reward on this ETF tilted toward risk at its current price. At current levels against most major foreign currencies, I am not willing to bet on a continued decline in the dollar. Others may have a different opinion, but I suspect the dollar's weakness against the Euro and Yen is overdone.

When evaluating risk, I have to identify what my risks are. A substantial risk to owning foreign bond ETFs is the relative value of the dollar against foreign currencies. That risk becomes enhanced after a precipitous fall in the value of the dollar against the currencies of those foreign bonds. If I was earning a lot of interest on those bonds, I might be willing to assume some of that risk but that reward is not present in these foreign bond ETFs. The dividends paid by them are negligible. BWX and WIP ceased paying monthly dividends a few months ago. Foreign bond from developed nations have enjoyed a long secular bull market like U.S. treasuries and are consequently not yielding much now. Inflation protected foreign bonds are yielding less than fixed coupon bonds. If the dollar gained substantially against those currencies, and there was also a correction in the bond prices (yields up & prices down), the potential reward for a re-entry into those foreign bond ETFs may start to outweigh the risks which will have to be assessed when and if that occurs.

4. Pinnacle West (PNW)(owned): PNW is a non-core electric utility holding, bought primarily for its above average yield. The last purchase was at $31.9 based on my favorable view of its 3rd quarter earnings report: See Item# 3 Added to PNW at $31.9 Yesterday, PNW rose 93 cents to close at $34.4 based on news that an administrative law judge (ALJ) approved a retail rate settlement. Institutional investors must have look favorably on that development. Volume spiked to almost 3.9 million shares compared to the average of 775 thousand.

5. Added to CEF Adams Express at $9.98 (ADX) (see Disclaimer): I first bought shares in Adams Express in 1983. Today, this CEF went ex dividend with a 30 cent distribution, which I will use to buy additional shares. Before buying a CEF I will check the current discount to NAV which can be found daily at the WSJ market date page (just look on the right hand side for closed end funds), or by going to the sponsor's web site. The Adams Express Company web site showed the discount to NAV to be 15.81% based on Tuesday's closing price. This is sufficient for me to add shares. This is a link to the 3rd quarter report for ADX: .pdf

I noticed that IGD continued to decline after announcing its dividend cut. If it continues to decline, I may be interested in buying some shares, provided the discount to NAV widens to more than 10%. Otherwise, I am just a long term holder taking the dividends in cash. I might change the distribution option to reinvestment if the discount starts to hold for several months at over 10%. It is not there yet but is moving in that direction: ING Global Equity Dividend and Premium Opportunity Fund

6. Campbell Soup (owned): In a post from yesterday, I discussed the importance of calculating the rate of dividend growth and making a judgment on the reliability of the dividend, which would include an evaluation of a firm's historic rate of earnings growth and the payout ratio. This discussion related to a dividend increase by Sysco ( Item # 3 Sysco). At about the same as the buy of SYY, the RB bought Campbell Soup in two lots and sold the first lot already. Bought XLK-Pared Campbell Soup The second lot, 70 shares, which is what I currently own, was bought at $25.35 in April 2009, Bought CPB/ The reasoning was similar to the justification given for the Sysco buy. I had confidence in the dividend. Campbell has paid dividends to its shareholders in every year since it came public in 1954. And, the fall in the common price to $25 juiced the value of the dividend to me at that cost. Campbell announced a 10% rise in the dividend to 27.5 cents per quarter from 25 cents. This raises my yield at my fixed cost to 4.34% from 3.94% per annum. Unlike SYY, CPB has had an erratic history of dividends over the past 10 years. So I do not view it the same way as I would SYY or KO, or XOM. CPB's dividend was 90 cents in 1999 and $1 in 2009. It was reduced according to the Morningstar data to 63 cents in 2001, kept at that level for 3 years, when CPB started to increase it every year starting in 2004. So I will not draw the same kind of analysis as I did with SYY or KO earlier:Barrons Recommendations and My Trades in The Barron's Columnists' Recommendations in 2009 The bottom line is that CPB is on a shorter leash than SYY.

7. The Baltic Index: This index has started to move up significantly over the past 6 weeks after bottoming in September. Bloomberg. The improvement in prices for transporting dry cargo is a positive. This index tracks international shipping prices of various dry bulk cargos.

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