1. OSM-SLM: I do not fully understand the latest legislative and parliamentary legerdemain in our House of Representatives. Somehow the student loan legislation, advocated by Obama, became mixed up with the health care bill passed by the House last night, so it appears the subsidies to private lenders like Sallie Mae will likely soon end. NYT Student Loan Overhaul Tied To Health Care Bill CBS News This may have a negative impact on SLM shares today. I did note that those shares took a hit last Friday, apparently based on this development. I have no interest in owing SLM common shares. I currently own just 150 shares of OSM, a senior bond issued by SLM and maturing in 2017. I have kept the position small, and traded it some to book profits, due primarily to my credit concerns which have been the key consideration since my original purchase in 2008. {Item # 3 Sold 50 of the 200 OSM} SLM did sell last week 1.5 billion in 10 year senior notes at a price to yield 8.25, a hefty 462 basis points higher than comparable treasuries. The OSM bond matures on March 15, 2017. Par value is $25: www.sec.gov The best account that I found on the web this morning about this issue is at money.cnn.com.
2. Indian Central Bank Increase: India's central bank increased its benchmark rates by 1/4% last Friday for the first time in close to two years. Several other central banks have started to raise rates, with Australia's central bank being the most noteworthy so far. Hopefully, the worldwide Jihad by central banks around the world against savers will end soon, and these rate increases are a "sign of things to come" in the words of a BNP Paribas employee quoted in this BusinessWeek article. India's industrial production increased 16.7% in January and 17.6% in December, the fastest pace since 1994. Inflation in India was up 8.56% for the month of January. India Bloomberg WSJ.com
3. Treasury Inflation Protected Securities: In this article from Kiplinger, the manager of Vanguard's Inflation-Protected Securities fund (VIPSX) is quoted as saying he believes inflation will average 1% over the next three to five years. This fund has been favoring non-inflation protected treasuries over TIPs recently according to this article. If that prodiction proves to be accurate, my long term bonds will hold their value much longer than I currently anticipate. I would agree with the manager of this fund that TIP are not attractively priced now, and I have sold out of my TIP ETF position. Bill Tedford's Inflation Prediction & His Sell of TIPs /Sold All Shares TIP ETF/Started Hedge for Corporate Bonds
My reasoning is different however. The manager of the Vanguard fund apparently believes inflation will be less than the breakeven point, and consequently the TIP will end up paying less than a non-inflation protected security. I suspect that the breakeven of the 10 year TIP may be close now to the average rate of inflation for the next decade. However, I suspect the real yield or coupon rate of the treasury inflation protected securities will be revised by the market to a much higher rate, causing those securities issued now to fall in value as investor's demand both a higher real yield to compensate for inflation and a higher nominal yield on the non-inflation protected 10 year notes.
The Federal Reserve issues daily the estimated real rates for treasury securities, and the 10 year real rate was just 1.5% last Friday. U.S. Treasury - Daily Treasury Yield Curve This would be what I would expect to receive in a 10 year treasury TIP coupon. And that number is close to the 1.47% shown by Bloomberg last Friday for the current coupon yield of the 10 year TIP: Bloomberg.com: Government Bonds The non-inflation protected 10 had a current yield of 3.69 last Friday, so the breakeven is around 2.22% using the Bloomberg data, and that may be close to the average inflation rate over the next ten years. For an investor to beat that 3.69% nominal yield, the average inflation rate would have to increase by more than the breakeven of 2.22% in this example.
I would guess that the actual inflation number will be between 2.5 and 3% and that the danger is to the upside not the downside. If I am in right, investors will start to demand more of a real yield and possibly factor in a larger breakeven spread than now. Still, based on my prediction, it would be better now to buy the 10 year TIP directly at the auction, hold until maturity, rather than the 10 year non-inflation protected bond. My problem is that I do not like either the inflation or non-inflation protected securities at current prices.
I will hold 10 year TIPs bought at auction in the Roth. I also have a small position in the VIPSX. . Maybe the Vanguard manager is right and I am wrong about the likely course of inflation in the years to come. As a general rule, I do not swing entirely one way or the other, more like weighted toward my prediction rather than his.
4. Morningstar's Economist: Bob Johnson has been more optimistic and correct about the recovery in the U.S. economy than other economists that I regularly follow. He upped his prediction of U.S. GDP growth to 4.5% from 4 % in 2010. If he is correct in that forecast, the stock market may very well hit the targets forecasted by Goldman Sachs earlier in the year of around 1300 on the S & P 500 sometime before June 30. Hitting that level in two or three months from now would likely cause more anxiety in me than pleasure.
5. Texas School Board: For reasons that are hard to fathom, the reactionary forces in America have a fervent and never ending desire to turn the public school system into Americanized versions of the Pakistani madrassas. The news media, acting as a branding agent for the reactionaries, calls them conservatives.
Some in our society may recognize the name of Thomas Jefferson, possibly due to his visage being present on the ubiquitous nickel. Jefferson committed an unpardonable sin, maybe two if you count his liaison with Sally Hemings. It was Jefferson who coined the truly conservative doctrine of "separation of church and state". For that cardinal sin, the TBs who now control the Texas school board has stricken his name from the children's school books as one of the thinkers who inspired the American Revolution. History Network Texas No, it was not Jefferson's handwriting on the Declaration of Independence but that of Rush Limbaugh. NYT Yes, George Washington is still deserving of a place in the textbook, right behind Rush, Newt, and John Wayne.
6. Common Stock Yield vs. Bond Yields/Common Stock Dividend Growth Strategy: I have commented in several recent posts that several common stocks were providing investors more yield than the bonds issued by those companies, even after the huge rally in stocks since March 9, 2009. There were far more examples in March 2009 of common stocks providing better yields.Most of the financial articles on this particular subject will often focus on the comparing stock and bond yields for AT & T and Verizon without taking into account all of the variables that need to be considered in making a decision, many of those factors as they relate to AT & T and VZ are discussed in Dividend Paying Stocks & Bonds.
I would look at the issue in much broader terms which would require an examination of stocks that currently pay less than a long term fixed coupon bond from the same company but who have a long history of growing their dividends. I have previously discussed in this context several that I own including KO & SYY { Item # 4 for Sysco; Item # 1 KO My Trades) For my own edification, I wanted to examine one that I do not currently own, Johnson & Johnson, which I have owned in the past.
First, I will check the FINRA site on the bonds to see how much I would pick up in current yield and yield to maturity by buying a fixed coupon long term bond issued by JNJ:
JNJ:GJ matures on 9/1/2029 and has a 6.95% coupon. The last trade was at $120.192. FINRA The current yield on that one would be around 5.78% and a lower yield to maturity of around 5.27% due to the premium to its par value.
JNJ:GH matures on 11/15/2023 and has a 6.73% coupon. The last trade was at $123.566. (YTM only 4.41%). The current yield at that last trade price would be around 5.45%. The YTM would be lower than the other one due to the premium and the shorter period to maturity.
So, what can you say? I am not the least bit interested in those bonds.
The stock is currently yielding around 3% at Friday's closing price of $65.11. JNJ The current dividend rate is 49 cents per quarter which will most likely be raised soon. Traditionally, the dividend is raised for the 2nd quarter payment each year. The annual dividend per share in 2009 was $1.93. In 2003 the dividend was 93 cents. (in 1998 49 cents per share) So, I will call that trend a double in 6 years. It is also important that the dividend payout ratio hovers around 40% to net profits which indicates that dividend growth is well supported by earnings growth.
The dividend growth strategy works better when the stock is bought during a major correction or bear market. Ideally, assuming the investor has capital, such a period would be the most opportune time to implement the strategy. By buying the dividend grower at a reduced price, the initial starting point will have a higher yield. Since this is a long term strategy, the lower cost will generate a high yield more quickly. For example, even after the bull run in stocks was well underway, JNJ closed on 6/23/2009 at $53.73: JNJ: Historical. The company had just raised its quarterly payment to the current 49 cent per quarter or $1.96 for that upcoming dividend year. At a total cost of $53.75, the starting yield would have been 3.65%. If the dividend doubled in six years, taking into account my cost is constant, the yield would then be 7.3% based on that cost constant. {Before tax, it will take about 9.84 years for money to double at a 7.4%.}
If one assumes that this dividend growing company will continue to double the dividend in 6 years, I will have a dividend yield at a total cost of say $65 of more than a JNJ bond maturing in 2029 sometime in 2016 or 2017. Before that bond matures, I would have a yield twice as much. I would add of course that the common dividend can be reduced or eliminated but the senior bond owner has to be paid the fixed coupon amount assuming the firm wants to remain in business outside of bankruptcy court.
Recent experience has taught that the dividend growth strategy may not be appropriate with financial institutions or with companies like GE and Pfizer. I primarily follow it with companies in the consumer stable sector who are more reliable. There is no guarantee that the future will be similar to the past even with these more dependable companies.
It is helpful to me to write the foregoing as a form of investor therapy. I have a tendency to become impatient. Some would even say that patience is not one of my few virtues. I become bored easily with these companies who grow slowly and whose stock prices rarely soar. To illustrate the need for therapy, I would just refer to some posts where I correctly implemented this dividend growth strategy almost to perfection with Pepsico and Proctor & Gamble, buying shares in March 2009 at less than $50. I then went into the tunnel vision of the LB, selling shares on pops and buying them back on dips until there were no further dips to be had. Pepsico Buy BOUGHT 100 PG AT $52.85 Sold PG at $59.45 Bought PG at 47.59 Sold PG at 56.89
These are the main areas that I look at in implementing this strategy:
1. I want the current yield to exceed 3% as a starting point. My preference would be over 3 1/2%. Many candidates for this category will not increase to over 3 1/2% except during a bear market, so the opportunity has to be seized even when the investor is nervous and everyone else appears to be selling, easier said than done.
2. There must be a long history of dividend growth, but it does not have to be an uninterrupted one. However, there can be no dividend cuts within say 20 years, which is the data series that I normally examine, so most banks are now eliminated as candidates for this strategy. I will simply give more weight to those companies with a long history of raising the dividend every year over those that have increased the dividend every year most of the time, occasionally just maintaining an existing dividend during a recession.
3. I pay a great deal of attention to the historic rate of dividend growth. How quickly does the company double the dividend. I would prefer a company who historically doubles the dividend in 6 or 7 years compared to one on a ten or 12 year schedule. So even if the company is raising the dividend every year, I want to know the rate of growth.
4. I would look for a relatively constant payout ratio to net income, preferably 50% or lower. This would establish that the dividend is not in danger of being cut and is supported generally by earnings growth.
5. Then there would be a potpourri of other factors, such as profit margins, debt to equity, etc. Some may think too much about too many things, a problem that Old Geezers no longer have. (see e.g. Dividend Growth Investor analysis of KO dividend growth).
The most obvious candidates for this category would be well known consumer staple companies, and I already own a number of them. Some industrial companies such as Emerson Electric and Untied Technologies would qualify as potential selections. I own EMR in that category and have for several years. Emerson had a 78 cent dividend in 2002 and $1.32 in 2009. UTX just raised its dividend 10.4% to $.425 per quarter, and UTX has a good recent history of dividend growth. The dividend yield on UTX at the Friday closing price of $73.24 is, however, only 2.32%, which is too low as a starting point for me, at least for this particular strategy. If the price fell some to take the dividend over 3%, I would consider adding it. EMR has rallied a lot since March 2009 and closed last Friday at $48.62 to yield 2.76%. I am reinvesting the dividend but would not buy additional shares on the exchange at this price. Some electric utilities would also qualify.
7. VIX Pattern Before Onset of 2003 to October 2007 Bull Cycle: To see how the market formed a stable VIX pattern coming out of an Unstable VIX Pattern for the last bull cycle, it is helpful just to scroll through the the historical numbers at YF: ^VIX: Historical Prices for VOLATILITY S&P 500 If that link works, it should direct you to the daily numbers for the VIX between 1/1/2000 and 1/1/2004. If not, just enter those dates in the search box and follow along in a separate window on the computer. This post assumes familiarity with the contours and terminology of the Vix Asset Allocation Model: Vix Asset Allocation Model Explained Simply With as Few Words as Possible
I would start at the "Last" number in this sequence, which shows an Unstable VIX Pattern in force as of 1/3/2000. In my view, the VIX was not confirming the validity of the market's move at that time towards the sky. I have previously referred to 1999 as a non-confirmation event in the VIX Asset Allocation Model. The Model was saying sell that sucker.
The VIX was mostly moving in what I call the Phase 1 of the Unstable VIX pattern in 2000, a whipsaw movement mostly between 20 to 30 with some short durational moves above 30 and below 20. Hitting the "PREV" link, I move forward in time and see a continuation of that pattern which is a dangerous one for the individual investor. Personally, I enjoy it. I am now in the summer of 2003 and I start to see spikes in the VIX well over 30, briefly entering the Phase 2 Unstable VIX Pattern on August 2, 2002 and then remaining elevated in the 30 to 40 range for several weeks. So the VIX is building into a crescendo of fear similar to what happened in October 2008 except that it was much worse in the recent bear cycle. The ugliness continues into mid-November, when the pattern reverts from 30 to 40 readings to the typical phase 1 pattern of the Unstable VIX. More movement to the mid 30s is noted February and March 2003. Without consulting the S & P 500 chart, I know that the market is experiencing a really serious bear market during this period.
Then, I see movement back down into the 20s in April and May 2003. Then, on May 3, 2003, there is movement below 20 again. In retrospect, I know now that the market is beginning a bull move. But, I have just seen how the VIX can fall to below 20 during bull rallies in a bear cycle for short periods of a few days or weeks before bursting back out to the 20 to 30 range. So, I do not want to draw a conclusion yet about whether this is just another short lived counter-move in a bear market or the start of a new bull cycle. I see now several weeks of the market struggling to stay below 20 but the movement over 20 is into the low 20s. That is very important. The market is finding stability.
By mid July 2003 I would be encouraged by the duration of the moves below 20 and the brief movement into the low 20s and no higher. I will start my three month count, not knowing what is about to happen, on August 8 2003. I will disregard the closes in the low 20s in late September/early October numbers as meaningless noise in the overall pattern developing which is clearly a dominant Stable VIX Pattern of continuous movement below 20. So I will start the Stable VIX Pattern Start Date as of 11/10/ 2003. A few weeks sooner would be okay given the steady movement below 20 most of the time in June and July.
At the start of this period the S & P 500 was at 1496.25 as of 12/31/1999. ^GSPC On November 10,2003, the S & P 500 was at 1047.11. So, what exactly have I missed during the Unstable VIX Pattern?
As readers know, the Trigger Event in the VIX Model, which ended the Stable VIX Pattern which formed in the Fall of 2003, occurred in August 2007. As the counter-move took the VIX back below 20, this was the signal to sell into strength. The S & P 500 hit 1565 in early October 2007. The Trigger Event ending this multi-year Stable Vix cycle occurred clearly in August 2007: ^VIX: Historical Prices for VOLATILITY S&P 500 It is shown as a very prominent break in the stable vix cycle on a five year chart: VOLATILITY S&P 500 Index Chart - Yahoo! Finance
So when I look at this data and the charts, and overlay what was happening in the market, it is apparent that the VIX has some predictive ability for long term cycles once it is place in proper context, which no one apparently does. The contrary conclusions reached by many indicate a failure to grasp the obvious which is quite common among the denizens of Wall Street and all financial journalists. I view this entire model as just obvious. Just open the long term interactive VIX chart, scrolled over the line, and it is apparent. Of course, the person doing that has to know now what was going on in the market during those years since 1990, and maybe that is what trips up all of the journalists.
The problem in 2007 was to design a model that avoids false signals of a start of a long term bull market. As seen in the previous period from 2000-2004, there can be brief periods when the VIX falls below 20 and continues below 20 for a few days. If I did not know what was happening in the market, I would just say the market was in a short term bull move within the context of a long term bear market. The same kind of movement happened in mid 2008 after the series of Trigger Events in August and November 2007. The duration was short lived however, and was not a signal to get back into the market. This is why I have from the start required a 3 month period of continuous movement, making exceptions here and there for very brief excursions into the low 20s, as long as the pattern developing is clearly a Stable Vix Pattern. When I developed this model, I could see how the market and the VIX moved in the 2000-2003 period, so I was not sucked into the market with brief movement below 20 in May and August 2008: ^VIX: Historical Prices for VOLATILITY S&P 500
This same bear to bull VIX pattern formed out of the 1990-1991 bear market, giving a green light in 1991. The next trigger event was in October 1997, with a get out of jail card in February & March 1998. If I had gotten entirely out of the market on March 12, 1998 when the VIX fell to 18.25 after the October 1997 Trigger Event (invested in 10 year treasuries!), the S & P 500 was then at 1016. On 11/10/2003, it was at 1047. So, what did I exactly miss other than a lot of excitement, the thrills and agony of rapid up and down moves going nowhere after almost 6 years.
I do not move completely in and out of the stock market, being primarily a Stock Jock, but would view it as irresponsible and irrational not to move allocations up and down based on the signals being given by the market. I always have money invested in stocks. I was helped a great deal by moving money out of stocks in 2007 and into cash and bonds, which enabled me to recover more quickly and move ahead from where I was in October 2007 much sooner. I certainly did not anticipate the severity of what happened after the Lehman failure when looking at the August 2007 Trigger Event. And, I felt comfortable investing in March 2009 with some of that stash set aside, so I was in a position to take advantage of buying oppportunities in a bear market which I could not have done so easily with a larger amount in stocks as of 1/1/2008.
And in my numerous posts discussing the Unstable VIX pattern, that dangerous pattern can be a productive and profitable trading opportunity for sophisticated investors due to the heightened volatility. The most basic strategy would be to lighten up on moves below 20 and to initiate positions on spikes above 30, and to look for long term opportunities that may develop in certain niche markets, such as Trust Certificates, floating rate equity preferred, REIT cumulative preferred and closed end funds. Those markets might become extremely inefficient during heightened period of stress.
Another strategy is to overlay a short strategy timing part of the moves to the VIX, laying on shorts when there is a counter-move below 20 and taking them off on spikes into the 30s, possibly with some insurance in place to hedge against a repeat of a catastrophic Phase 2 Unstable VIX pattern, the period when most of the wealth destruction can occur for a long investor.
One problem that I noted in 2008, contemporaneous with its occurrence, is that putting on long positions on spike above 30 could backfire if and when there is a formation of the Phase 2 catastrophic Vix Pattern, meaning the VIX spikes into the 40s and beyond. So, there is a need to be flexible for those brave souls trying to profit from volatility in the Unstable Vix Pattern.
If and when a stable vix pattern forms, I would not refer to the stock market as safe, in the sense that many individual investors understand by that term, as in I want 20% compounded per year in a safe investment without taking any risks. No, I would just use the word "safer" than trying to navigate the roller coaster ride of an Unstable Vix Pattern. Historically, since the start of the VIX data in 1990, an investor would be just fine staying out during the Unstable VIX Pattern, and moving in after the formation of a Stable VIX Pattern, and buying 10 year treasuries during the unstable period. The future may be different. While it has not happened yet, there could be a Trigger Event within a relatively short time after the formation of a stable pattern. In that case, I will have to adjust. The model does not preclude that from happening. It simply says that in the past several years of a bull move will transpire before the Trigger Event. And the Model does not say that the investor will be given a better opportunity to sell after the Trigger Event, only that this has been the case in the past.
The basic premise is that human beings need to feel confident and comfortable to invest. When there is rational fear and and uncertainty, the market will compensate with lower prices. Once that subsides, the market has a basis for starting a bull cycle. There will be actual events in the real world that are being portrayed in the VIX. For example, just looking at the chart, I know something important happened in February and August 2007, and something really dreadful in September 2008. It is not an irrational fear that drove the VIX into the 60s and 70s after the Lehman failure. The world was indeed at the precipice of a financial disaster engineered by the Masters of Disaster who profited greatly from it, a point made by Frank Rich in his column on Sunday (NYT) and repeadedly highlighted in real time in this blog since I started it in October 2008.
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