Friday was a most troubling day in an awful week. The fact that the market could not mount a sustainable rally after the jobs report and the shellacking on Thursday was more than disconcerting. But the most worrisome aspect of Friday's action was the VIX moving over 40. This is a potentially serious development, unless the VIX moves back down quickly from Friday's close next week. If there is another spurt up, this would suggest the formation of a Phase 2 of the Unstable Vix Pattern, referred to here as the catastrophic phase of the Unstable Vix Pattern. The prior Phase 2 formation happened in late September 2008 as the VIX accelerated from the mid 20s to a burst on September 29, 2008 to a close of 46.72 from 34.74 the day before. There was then two closes in the high 30s before the VIX was upward and onward: ^VIX: Historical Prices for VOLATILITY S&P 500
Late Friday, I was keying off this pattern to buy some double short ETFs for high beta, foreign stock indexes which had fallen in price late in the day. Basically, what I am looking for in a hedge is a stock index that has moved with U.S. stocks since March 2009 but with a much higher beta. The purpose is not to make money on those buys. In fact, I hope the market simmers down, finds its footing soon, and starts to recover again, in which case those buys will certainly lose me money. But, if the bottom falls out next week, I will have something to sell which is increasing in price in order to raise additional funds for bond buys. Both of those buys were adds to existing positions, and are currently at or close to break-even.
The ^VIX closed on Friday at 40.95, up 24.85%. The VIX hit 42.15 intra-day.
I am not yet ready to characterize what happened today as the formation of a Phase 2 Unstable Vix Pattern. I would just say that today marks the beginning of what may end up being one. I will know for certain one way or the other soon. It is like a pressure cooker, letting off some steam at first, before it blows or the stove is turned down in time. Personally, I do not understand why this is happening now after the EU came to terms with Greece on the bailout. What happened on Thursday undoubtedly shook individual investors up, and had to be a blow to their confidence in the market. The Europe sovereign debt problem is blown out of proportion in my opinion, but not in the only opinion which counts-the one offered by Mr. Market.
Possibly, the market is looking into the future and sees a cascading of sovereign debt problems. And, how long with the Greeks put up with a little less gravy on their government gravy train. I mentioned in a comment to the last post that 51% of the Greeks oppose any austerity whatsoever. They are not going to change, and maybe the market senses that too. And, what is more, the same type of issues, though now less severe, are present in Spain which has a 20% unemployment rate and the government has yet to cut spending in any meaningful way. Portugal appears to be in between Greece and Spain. And remember that Italy almost had a failed auction for one of its treasury bills. WSJ.com
This past week is sufficient to change my strategy for several weeks and possibly months. A lot will depend on my income investments continuing to throw off cash flow from dividends and interest. This is one reason why I focused on buying consumer staples and drug stocks recently. The cash flow will be used to buy more income generating securities, with preference given to investment grade bonds. I will attempt to trade some positions in an effort to upgrade the priority of my securities. This would include selling an equity preferred stock and buying a senior bond, as an example. Or, it could mean something like I did today, selling my 50 shares of ORHPRB and buying 50 shares of RNRPRD, as explained below. In that switch, I picked up considerably more yield, realized a profit on the ORHPRB shares, improved the credit rating, and added a small amount of cash due to the price difference.
I recently sold two stocks in the regional bank strategy, East West and Wilshire (both with negligible dividends), and I will stick to my plan of using the proceeds from those sells to buy other bank stocks that pay decent dividends. I added 50 share of FNB on Friday which used up $430 with the commission of the available funds for reinvestment ($2145 available minus $430 for FNB=$1715 remaining). When I go into the capital preservation mode, as now, I will stick very closely to specific dollar amounts. This means that the cash stash will remain in cash. This is still a very dangerous market. I am allowed under LB's strict trading rules in this mode to sell one security and use the proceeds to buy another.
1. Jobs: The Labor Department reported on Friday that the U.S. economy produced 290,000 jobs in April, more than the consensus estimate of 180,000. The March number was revised t0 a 230,000 increase from the previously reported 162,000. Temporary jobs for the Census accounted for 66,000, and those jobs will last just for a few months. The unemployment rate, which is based on a household survey, increased to 9.9%, as more workers entered the job force looking for work. The average workweek increased by .1 hour to 34.1 hours. Employment Situation Summary The U-6 number, contained in Table A-15, rose from 16.9% in March to 17.1% in April. This is the number which includes the total unemployed plus persons marginally attached to the workforce or working part time involuntarily. Table A-15. Alternative measures of labor underutilization
2. Enerplus (ERF)(owned): In its earning release on Friday, Enerplus confirmed that it will be converting to a regular corporation effective 1/1/2011. I owned Advantage Oil at the time of its conversion, and this triggered a "tax sale" of the shares at that time. Warnings on Canadian Trusts Converting to Corporations I do not plan to own ERF at the time of its conversion to avoid an additional headache about how to report the matter to the IRS. Moreover, while ERF maintains that its dividend will not be impacted at least initially by the conversion, it is clear to me that this is due to a tax pool of 3 billion that will shelter the company from paying income taxes for 3 to 5 years depending on the amounts future profits of course. When that tax pool is exhausted, the payment of income taxes will act to reduce the amount of dividends payable to shareholders below what would otherwise be payable now and in the past when ERF was a trust exempt from income taxation by the Canadian government, for obvious reasons. The government would be taking a large chunk of money that formerly went to the shareholders as dividends. All of the foregoing makes ERF an unattractive investment for me now, compared to my alternatives, both in Canada and elsewhere. I am no hurry to sell my shares, but will most likely sell the 210 that I own before the end of this year. I am still receiving a good dividend paid in Canadian dollars and not converted to the U.S. currency. (Shares held: ERF-UN.TO)
The market did respond favorably to the ERF's earnings report, with the stock rising 50 cents in trading today.
3. Bought 50 RNRPRD at $19.58 & Sold 50 ORHPRB (see Disclaimer): I previously bought 50 shares of another equity preferred issue from RenaissanceRe, RNRPRB. Based on the prices prevalent at the time I entered an order on Friday, RNRPRD gave me the best yield of the three RNR preferred stocks.
RNRPRD has a 6.6% coupon and a $25 par value. This translates into a 8.43% yield at a total cost of $19.58.
According to QuantumOnline, the current rating for this security is investment grade, and I did not attempt to verify it. This is a link to the prospectus: Final Prospectus Supplement The prospectus states that RNR believes that the dividends will be classified as "qualified dividends". Quantum does list RNRPRD with those preferred stocks paying qualified dividends.
I view the RNRPRD buy to be an upgrade from the sell of 50 ORHPRB at $24. I bought those shares at at $20.93 in October. I believe that I received two quarterly dividends. ORHPRB is non-cumulative equity preferred stock issued by OdysseyRe which pays a spread of 3.25% over the 3 month Libor rate. This rate is currently very low, around .4%. The RNRPRD improves my current yield by about 4.85%. And according to the Quantum site, the ODysseyRe preferred is rated Ba2 by Moody's whereas the RNRPRD is rated Baa3. That information is on the same page at the QuantumOnline site (free site, registration required).
In the capital preservation mode, which is what I was in after the Lehman failure, I will be looking for ways to increase my current cash flow in as many ways as possible. That cash flow is then used to fund additional purchases of income generating securities hopefully at more favorable prices than now. I am still holding a number of those purchased in the October 2008 to March 2009 time frame. While in the capital preservation mode, I will not dip into the cash allocation to buy anything. If stocks become attractively priced, as they were in March/April 2009, then I will sell another asset class to raise funds to buy them. Back then, I just about sold all of my individual short term bonds to feed the RB's stock buying frenzy. I am down to just one of those, so something else will have to be used in the event the same opportunity arises in the future. Hopefully, the panic will subside, and all will be well. I doubt it.
4. Added 50 FNB at $8.42 (See Disclaimer): This purchase is the first purchase using the proceeds of the EWBC and Wilshire sells. Assuming FNB does not cut the dividend, its current rate is 48 cents per year, which translates into a 5.7% yield at a total cost of $8.42. This is an average down from my recent purchase at 9.36. I discussed this bank in that foregoing linked post, and I have nothing to add to that discussion other than the stock is cheaper now than on April 27th.
5. Sold 100 MKZ at 10.49 (see Disclaimer): I recently purchased shares at 9.91 in the Roth IRA. I still own 100 MKZ in the taxable account. I discussed previously my desire to sell one of my Citigroup Funding principal protected notes to cut down on my credit exposure to Citi. I chose this one for several reasons: (1) I own another 100 MKZ bought at 9.96; and (2) I want to raise more funds to buy bonds in the event of further precipitous declines and this give me a total of over 3 grand to make opportunistic bond buys . I personally like MKZ, and may buy it back in the taxable account sometime before the end of the year, but that would require the liquidation of another one of the Citi principal protected notes (e.g. MKN, MOU, MHC, MYP or MBC) If the carnage continues, I would anticipate that the first buying opportunity for cash in the retirement accounts will be an investment grade senior bonds in Trust Certificate form. Some fell a good bit in trading today.
I corrected on the date of this post the reference to receiving a cash dividend of $180 for MKZ, that was received on MKN, a similar security. MKZ has not yet paid its first annual dividend.
Interesting times to follow your analysis of the VIX Asset Allocation Model with what occured this week following that sustained period of <20. Talk about going from calm to squall.
ReplyDeleteI suppose times like this illustrate why those double-short ETF's aren't always bad, but man, they're hard to stomach when the market is running up.
Luther: The double shorts have tracking problems and require good timing to work. If I had a margin account, I would just short some regular ETFs. But the double shorts do give me more bang for the buck. I made a quick $400 or so on 100 shares of EPV. I am not trying to hedge an entire portfolio or even a small part of it. The best way to hedge for a conservative investor is to sell securities, and to buy higher grade bonds as the opportunities arise (assuming inflation is not the problem causing the stock downdraft, which is not the case now). I am just trying to position myself so that I have something going up if the market has another post Lehman failure type nervous breakdown. I currently own TWM too, double short ETFs on two foreign indexes and two double shorts ETFs on sectors that have led the bull charge, though this does not yet include SKF which gave me the willies when I bought it in November 2007, jumping around in $10+ a day clips.
ReplyDeleteThe capital preservation mode, as I describe it, is far more important than the limited role played by the double shorts. The VIX did give a warning when it burst out of the steady movement below 20 to 22.81 on 4/27. That was a warning shot, the second warning was on the spurt to 22.05 on 4/30 after just one day below 20, and then there was one more burst on 5/4. During these bursts, there probably needs to be some lightening up on speculative positions, like my lottery tickets which I have steadily sold, and some taking of profits in non-dividend paying securities that have had good gains. It remains to be seen whether the next move with be a burst higher into the 40s, which would be most unfavorable, or a settling down back into the Phase 1 Unstable Vix Pattern, mostly of movement between 20 to 30 with some spurts in into the 30s and below 20. A movement back to 20 after these recent events will cause me to sell one stock mutual fund.