1. Interest Rate Risk in the Retirement Accounts: I did sell Tuesday the only remaining stock ETF in a retirement account to raise funds to buy senior bonds, thereby increasing my cash flow and diversifying my individual bond holdings further.
I am dealing with interest rate risk in the retirement accounts by a variety of tactics. I of course realize that the price of a bond will go down in value as interest rate rise. I have discussed this particular topic in multiple prior posts and will just summarize some of these tactics to deal with interest rate risk.
First, if I own individual bonds with maturity dates, I have the option of recovering any loss value due to a rise in interest rates by holding the bond until maturity. I also have sufficient funds to diversify my holdings of investment grade bonds to lessen the credit risk issue associated with buying individual bonds versus a well-diversified bond fund.
Second, I have bought the 10 year TIP at auction. When rates start to rise due to inflation, and ultimately this will happen, the TIP provides me some protection against unanticipated increases in the inflation rate. However, given the low coupon prevalent now, I do not intend to add to my current position until the coupon on the 10 year TIP exceeds 2%. (see e.g. purchase at TIP auction in Item # 4: 10 Year TIP Auction, and generally: Advantages and Disadvantages of Treasury Inflation Protected Securities and Treasury Inflation Protected Securities as a Non-Correlated Asset)
Third, during the Near Depression period, I purchased several securities that pay the greater of a guarantee (typically in the 3 to 4% range) or some percentage above a short term rate (frequently 3 month Libor). These securities provide both a measure of inflation and deflation protection in the same security. (December 2008 Post: Inflation or Deflation: Bond Alternatives/) The deflation protection is the guarantee while the float component provides some protection in a rising rate environment. These securities can be dividend into two general classifications: (1) synthetic floaters and (2) floating rate equity preferred stocks. The synthetics are tied to bonds.
I have sold the Synthetic Floaters bought in the retirement accounts except for GYC, GYB, PYT and GJN (GYB pared). The sales were based on profit taking and the desire to increase my yield. GYB was recently pared to lessen my overall exposure to Goldman Sachs bonds in the retirement accounts. Sold 100 GYB at 18.09 All of the floaters are paying their minimum guarantees in the current low rate environment. So, I have sold GJS,GJP, GJR, GJK, PYV, GJL, GJT, and GJO. However, since I have a constant stream of cash flow into the retirement accounts from interest and dividend distributions, I will add one or more of those back when I start to become concerned more about interest rate risk than now. I always have some concerns about the inflation bogeyman since inflation is the primary enemy of my bond portfolio.
The only pure equity preferred floating rate stock owned in the retirement account is METPRA which I do not intend to sell given my favorable purchase price. I also own AEB, a hybrid floater from Aegon. Advantages and Disadvantages of Equity Preferred Floating Rate Securities I will generally lump AEB with the equity preferred stocks due to the U.S. tax treatment of its dividends, but it is in reality a bond. Aegon Hybrids: Gateway Post
The fourth way that I am attempting to cope with interest rate risk is the purchase of corporate bonds that pay monthly interest tied to CPI. I own PFK and OSM in both the retirement and taxable accounts. {Most recent discussion of OSM is in Item # 1 CPI; see also /Bought 100 OSM at 15.75-Regular IRA; /Added 50 PFK at $17.83; Bought PFK in IRA/ Bought 100 PFK/; Item # 3 CPI & CPI Floaters;CPI FLoaters PFK AND OSM/; CPI and CPI Floaters-OSM; Item # 1: CPI and CPI Floaters OSM and PFK/Added 50 PFK at $17.83} I have been discussing these securities since starting this blog in 2008.
Fifth, while I have a few bond funds that do not have a term date currently in the ROTH (200 ACG & 100 BDF), most of my bond fund allocation is currently devoted to term bond funds. They come in two general flavors: (1) ETFs with term liquidation dates and (2) Closed End Funds with term dates. I recently added two investment grade corporate bond funds in the IRA that liquidate in 2014 and 2015 respectively. Bought 100 BSCE/ Bought BSCF at 20.18. I also have 245 shares of the CEF GDO in the retirement accounts which liquidates in 2024. While the term date does not insulate me completely from interest rate risk, it does serve to mitigate the impact of a rising rate environment in that the term date is as close as a bond fund can come to the option of holding an individual bond to maturity. Discussions of term CEFs can be found at the following posts: Bought 70 of the CEF GDO in Regular IRA at 18.61 Bought 100 GDO Bought 100 of the CEF GDO at 18.6 Bought 100 CEF IGI at $19.89 Added 100 of the CEF IGI at 19.78 Bought 200 of the CEF GDO. I have since sold the 200 shares of IGI but I may at some point buy some or all of those shares back.
And, lastly, I am dealing with interest rate risk by maximizing my cash flow. As I increase my cash flow with bonds, I will be in a position to buy higher yielding bonds when interest rates start to rise causing a fall in bond prices and a rise in yields.
While I am still subject to interest rate risk in my fixed coupon preferred stocks and bonds, I am not that concerned about it for several reasons. The most important reason is that I have already taken measures outlined above to deal with that risk. And, secondly, many of the fixed coupon securities were bought during the Near Depression period and have very high yields at my cost. I am more concerned about credit risk than interest rate risk as a result. If I become queasy about credit risk, I am more likely to dump the security compared to a heightened concern about a developing and imminent interest rate risk issue.
2. Laszlo Birinyi on 1974 or 1982: In this interview in Barrons.com, Birinyi argues history may be repeating itself, but the appropriate parallel is not to the short cyclical bull move between 1974 to 1976 which occurred within a long term secular bear market. Instead, he believes the appropriate historical analogy is to 1982, the start of a long term secular bull market. I would disagree on that point.
However, it is true that many of the problems that existed in 1982 were as bad or worse than the ones now. Both unemployment and inflation were still high in 1982. The sovereign debt problems in Latin America, where there were actual defaults, were arguably far more serious than anything that has happened this year. In August 1982, the starting month of the long term secular bull market, Mexico declared that it could not pay its debts. www.fdic.gov/bank.pdf Mexico nationalized its entire banking industry (page 3 www.minneapolisfed..pdf) These kind of problems may help to place Greece's non-default into some kind of historical perspective.
My difference with Birinyi starts with identifying where we are in addressing the underlying cause of the current long term secular bear market. Inflation was the source cause of the bear market which started in 1965 and ended in August 1982. Due to the efforts of the Federal Reserve, it was clear by the summer of 1982 that the inflation problem had been solved. Although it was not known or appreciated at that time, the second main driver of the bull market, increasing productivity due to technological innovation, was also well underway with advances made by Intel in micro processors to be rapidly followed by other innovations that improved productivity and help to keep inflation at bay.
The underlying source cause of the current long term secular bear market is excessive debt and leverage by individuals, financial institutions and governments, primarily in developed nations (the U.S., Western Europe and Japan). While it is open to some dispute, the lingering effects of the de-leveraging process- which has only just begun- will lead to a prolonged slowdown in economic activity when the benefit of massive economic government stimulus is withdrawn, a different result than the burst of economic activity occurring with the taming of inflation and the productivity revolution. So, I would be surprised if today was like October 1982. I believe the worst is over but another two or three year workout period is in order before the world can sustain the kind of burst in economic activity experienced after 1982. (posts from September 2009: 1974 or 1982: Start of Cyclical Bull in a Long Term Secular Bear Market or the Start of Secular Bull Market? more on 1982 or 1974) Thus, I anticipate a grinding market moving in a sideways pattern mostly between 950 to 1250 on the S & P 500 for the next two or three years.
These big picture topics, which I frequently explore in this blog, are viewed as the most important undertaking in my hopefully continued successful management of my money. I start from the top and then move down. Individual security selection is important but the overall driver of successful money management is appropriate asset allocation under the prevailing circumstances. I will turn to a few more trades that I made on Monday and today in a post later on Wednesday.
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