Friday, June 18, 2010

Sh-- Happens/CPI/Swiss Franc & Roche ADR/Sold COP EWS & EXAR-De-Risking Process/Philly Fed Manufacturing Survey and Initial Unemployment Claims

Yesterday was not an auspicious day and started out with me losing a cell phone that my 87 year old mother had entrusted to me for safekeeping. She has never lost a cell phone. I have now lost two and washed one in my pants. By the way, in case you were wondering, water and cell phones do not go well together.

But, there is an investing lesson to be learned from this event, sometimes sh-- happens. LB wants everyone to know that it was the Old Geezer who lost the phone. LB has never lost anything since everything is kept in its proper place, inventoried and stored in multiple back up systems. And LB wants everyone to know that it has never made a mistake, all mistakes made here at HQ are the result of the Old Geezer and the Lame Brain RB combining in some kind of unholy mind meld to interfere with the LB's best laid and supremely rational plans.

An individual who bought BP stock a few months ago for the dividend probably thought the dividend was safe, as did a retiree who bought Bank of America or GE stock before the Near Depression. Knowing that bad things happen out of the blue is one reason why I stay ridiculously diversified in my income generating securities. Sh-- happens. This is a point made by Ron Lieber in his NYT column yesterday.

Joe Barton, a Republican congressman from Texas, offered a heart felt apology to Tony Hayward and BP yesterday, saying he was outraged by Obama's request of a 20 billion dollar escrow fund from BP, referring to it as a White House shakedown.

1. CPI: TIPs and Corporate Bonds Floating at a Spread over CPI: Both CPI floaters that I own, OSM and PFK, use the non-seasonally adjusted consumer price index for all urban consumers. Data for this index since 1947 can be found at The Labor Department released this number for May 2010 yesterday which showed a slight increase to 218.178 from the 218.009 reading in April. The index has increased 2% since the 213.856 number in May 2009.

The market's estimate for future inflation can be derived by the break-even point in the treasury inflation protected securities. This number represents the annual rate of inflation that would generate the same return from both the inflation protected security and the comparable non-inflation protected security. To illustrate, Bloomberg was showing yesterday morning a coupon on the 10 year TIP at 1.22%. The nominal yield on the non-inflation protected 10 year treasury was 3.25%. The breakeven point was therefore 2.03%. If I bought the 10 year inflation protected note with a current coupon yield of 1.22%, I would need an average rate of inflation greater than 2.03% over the next ten years to be better off with that security compared to the non-inflation protected security paying me at the higher coupon rate of 3.25%. The TIP does provide an investor with some protection against greater than anticipated inflation over the bond's life. A good introductory explanation of the treasury inflation protected securities can be found at Fidelity Investments.

I also have a more extensive discussion in two posts:

The two CPI floaters that I own, PFK and OSM, pay monthly interest tied to a somewhat complex calculation using CPI data. OSM pays a 2% spread whereas PFK has a 2.4% spread. Both issues are intermediate term senior bonds, with OSM maturing in March 2017 and PFK in 2018. PFK is issued by Prudential, a much better credit in my view than Sallie Mae (SLM), the issuer of both OSM and ISM. This credit issue is reflected in the current prices of these securities, with PFK trading near its par value of $25 whereas OSM is hovering about $9 below its $25 par value. Obviously, if SLM survives to pay par value, and the market has a question about that, then OSM would provide both a higher current yield and a significantly higher yield to maturity, both based on the greater discount to par value for OSM compared to PFK.

For my nerd readers, I generally perform a calculation to show how the recently released CPI number will impact the penny rate for OSM in the relevant month. The penny rate will change from month to month. The calculation uses CPI for a one year period for a three month lag. So the recently released data for May will be used to calculate the penny rate for OSM's September 2010 payment only:

May 2010 CPI 218.178
May 2009 CPI 213.856
Difference: 4.322
Divide Difference by 213.856=.02021
Add the Spread of .02 for OSM=.04021
Multiply .04021 x $25 par value=$1.00525
Multiply $1.00525 x 31/365 (31 days in payment period)= $.0854 rounded

PFK calculation uses the same methodology except the spread is .024%.

Based on a $16 price for OSM, a monthly penny rate of .0854 would result in an approximate current yield of 6.4% on an annualized basis. As I mentioned, the penny rate changes monthly. I prefer to use my guess about the average rate of inflation over the remaining life of this security to perform the calculation. The market might use 2% whereas I am more pessimistic (or optimistic depending on your investments) at 2.5%.

My last purchase was 50 shares of OSM at 15.74. I currently own 250 shares which is immaterial. My purchases of PFK were at prices below $19, sufficiently advantageous that I will hold PFK to maturity in 2018. Bought 100 PFK/ Bought PFK in IRA/ /Added 50 PFK at $17.83 The 100 shares of OSM in the regular IRA are on a hair trigger.

The seasonally adjusted CPI number for May was down .2%, while the core index increased .1%. Consumer Price Index Summary Cash inflation is running hotter than the government's CPI number which includes "owners equivalent rents", a hypothetical calculation attempting to estimate what a homeowner would charge himself to rent the house owned by him. First Trust Economics Blog As you would expect this hypothetical cost item is lowering the government's CPI number.

2. MKZ and MKN: I own 100 shares in two Citigroup Funding "principal protected notes" that pay the greater of 3% or an annual percentage return in the DJ-UBS Commodity Index. I sold the 100 of my 200 shares of MKZ when I went over my exposure to Citigroup Funding notes by the purchase of another one of its securities. Both MKN and MKZ are senior notes that pay a guarantee of 3% and mature in 2014. I mention these securities now since the first annual period for MKZ is nearing an end. The closing date for the first annual period is 6/23/2010, with the distribution payable on 6/30. See Details in Item # 3 Bought 100 MKZ at 9.91 in the Roth IRA

For MKZ, the closing value of the DJ Commodity Index on 6/23 will determine both the ending value for the first annual period and the starting value for the second annual period. The index has corrected since hitting 135.76 on 4/26, which marked the recent high in the stock market, and has retreated to the 128-129 level in trading yesterday. The starting value for the first annual period is 123.338 so I do not expect much now from the first annual payment. If the index closed at 129 on 6/23, this would be only a 4.59% increase over the starting value. Since that number would exceed the 3% guarantee, then Citigroup would pay the higher number. It would not take much of a decline, however, from the current number in the coming days to trigger the 3% guarantee.

I was lucky on the first distribution for MKN which was 18%. MKN & MKZ I bought the security at below par value shortly before the annual distribution. Bought 100 MKN at 9.85 I believe that the starting value for MKN's second annual payment period is 132.67 with the next closing date on 3/30/2011. MKN has a better percentage at 33% than MKZ at 31%, but I like having both of the securities due to the time difference. As long as there is not a close above 176.45 in the commodity index on or before 3/30/2011, I will receive the greater of 3% or the percentage increase in the index up to 33% for MKN. If there is one day where the index closes above the maximum limit of 176.45 (33% over the starting value), then I will receive the 3% guarantee, no matter where the index ends at the closing date. I call that nuance the reversion clause. So each of these securities has an annual reset button and MKN is already in its second annual period whereas MKZ is near to closing out its first.

MKZ Prospectus: Pricing Supplement

The buyer of these securities is subject to the credit risk of the issuer (Citigroup does guarantee the obligations of Citigroup Funding as provided in the prospectus). Without question, if Citigroup goes into bankruptcy before these notes are paid off in 2014, I AM SCREWED, as in most of my investment finding its way to money heaven. Still, notwithstanding that issue, which can never be relegated to out of sight, out of mind, I prefer MKZ and MKN to buying a commodity ETN tied to the same index, DJP, given their principal protection and the distribution possibilities.

I would add that DJP is in effect a senior note too, as are all ETNs. So DJP has issuer credit risk too. That security is an unsecured senior obligation of Barclays. djp.pdf Who really knows whether Barclays is a better credit risk than Citigroup? While I am not perfect in predicting a firm's demise in sufficient time to exit a position in one of its securities, I have managed to avoid losses connected with Lehman, Fannie, Freddie, Enron, Worldcom, Wachovia, & Bear Stearns. { I never owned the common stocks in any of those firms. I had a position in 100 shares of a Lehman preferred stock, which I sold for a profit in late 2007, after reading something that caused me to become queasy and to exit that position)

After purchasing 100 IFO, I am now close to $1000 over my self imposed exposure to Citigroup Funding notes, and will eventually decide to sell one currently owned. I will allow myself to go as much as $2000 over the limit for a few months but I have to comply with the rule sooner rather than later. These type of limits are part of my capital preservation plans. I will keep both MKZ and MKN however, so the sell will probably by MHC before the end of the year.

3. Rise In Jobless Claims and the Philly Fed Manufacturing Survey: There are a number of indicators that are pointing to a slowing in manufacturing activity. The release from the Philadelphia Federal Reserve Bank yesterday of its manufacturing survey is the latest example. June 2010 Business Outlook Survey - Philadelphia Fed While any number over zero indicates expansion, the Philly Fed manufacturing index fell from a reading of 21.4 in May to 8 in June, the lowest reading in 8 months. The employment component was slightly negative. These kind of reports are not going to cause me to jump of a cliff and launch into a hysterical rant against owing stocks. I expect an economic recovery from the Near Depression to be uneven and erratic. It is not surprising to see a burst of manufacturing activity during the early stages of a recovery, as firms replace depleted inventory levels, and then to taper off.

A more upbeat view of the Philly Fed report is provided by Doug Kass, summarized in this CNBC article. Among the positives is the increase in new orders.

The Labor Department reported yesterday that initial jobless claims rose a seasonally adjusted 12,000 for the week ending 6/12. ETA Press Release: Unemployment Insurance Weekly Claims Report This kind of data is consistent with the jobless recovery scenario. I am not counting the temporary jobs for census workers that juiced the last monthly jobs number. The reluctance of employers to hire is one of the main reasons why I have shifted into a slightly more conservative posture since the last unemployment report on 6/4: Employment Situation Summary

4. ADJUSTMENT Based on Recent Economic Reports-Sold 50 COP at $54.71, Sold 100 EWS at 11.55 and Sold 100 EXAR at 7.30 (see Disclaimer): While the recent economic reports do not warrant-- yet-- a significant massive shift in allocations, some nip and tuck is probably in order, representing a slightly more cautious stance on equities which is the direction that I have been going for several months now. The sells yesterday of my remaining shares in COP and 100 shares of EXAR and EWS are almost entirely a reaction to the economic reports summarized in Item # 3 above, rather than having anything to do with COP or EXAR.

I had bought Conoco in two fifty share lots. I sold the first lot at 56.63 which has been purchased at at $51.22. I held those shares for about 3 weeks. The second lot, sold yesterday, was purchased at 51.35. I may buy the shares back at some point, particularly if the share price for COP fell below $50.

Exar was sold near break-even, and was sold solely due to the de-risking described above. That security pays no dividend and I have been increasingly selling those type of positions in this de-risking process. Yesterday's adjustment in allocation was a minor one, though it does reflect a continuing cautious stance toward stocks.

EWS is another one that I will buy back when I become more comfortable with equities. Those shares were bought earlier in the year at $10.9.

The only buy order, which was for a senior bond, was not filled yesterday.

5. Cramer-In Need of a Bottle of Chill Pills and a Barrel of Scotch: Cramer continued his diatribe against the market moving up some at the start of his show yesterday. Some might characterize his remarks as less hysterical (not in a comical sense) than the ones made last Tuesday. (see CNBC) Fortunately, he has managed to scare the Old Geezer here at HQ, who is unlikely to return anytime soon from his sabbatical. RB interrupted the writing of these minutes with the inflammatory statement that "LB was a Mama's Boy and a bigger scaredy-cat than the Old Geezer-go all in". LB just shot off another memo to Headknocker about buying that mental shredding machine to be used on the RB, to quiet the noise problem once and for all. HK replied that he was studying the RB's latest plan to acquire Canada, all of it.

Cramer believes that the market should have been going down this week a lot, based on what he perceives as awful economic news. Instead, the market had a very good gain on Tuesday and managed to close yesterday slightly positive. The S & P 500 is trading above its 200 day moving average. Cramer believes that mindless traders of double and triple shorts are taking the market up, in spite of the increasingly negative fundamentals in both the U.S. and Europe, based on incorrect criteria. He identifies the incorrect data point for a stock market rally as the recent rise in the Euro against the USD. He believes the EURO is going up now because the U.S. economy is starting to slow down which should be negative for stocks in his view.

I suspect that the Euro's recent rise has nothing to do with the market's perception of relative economic strength. Instead, given the steps recently taken by several EU members to cut spending, and the approval of the 1 trillion dollar bailout package, certain market participants may have decided to buy the EURO, as Jim Rogers said that he just did, which may have caused some shorts to cover. The Euro was also helped yesterday by Spain selling 3.5 billion Euros in long term debt. The ten year debt went for 4.864%, less than where the bonds were trading before the sale. Spain also sold some 30 year debt at 5.908%. Again, I would ask why are people hyper-ventilating about Spain? Spain's central bank also announced that it was going to publish results of its stress test on Spanish banks. BusinessWeek WSJ

The recent data does suggest to me the need to de-risk some, and I have been moving in that direction for about two months now. It is too early to draw any definitive conclusions about whether or not the slowing of economic activity is a precursor to a double dip. I am more worried over the near and intermediate term about the jobs situation in the U.S. than the sovereign debt issue in Europe, which appears to me to be less important now after the recently announced austerity plans and the 1 trillion dollar EU fund.

6. Swiss Franc and the Roche ADR/the CEF Swiss Helvetia (SWZ) : When I discussed purchasing Roche, part of the rationale was the decline in the Swiss Franc against the U.S. dollar. ( Item # 7 Added 70 RHHBY at 34.07-Completing Round Lot; Item # 3 Bought 30 RHHBY at $35.48 Using the currency ETF for the Swiss Franc as a surrogate, this Chart shows a decline in FXF from over $94 in mid-April to $85.4 on June 7th. Switzerland is not part of the EU and the Euro is not its currency. Yet, the Swiss Franc started to decline with the EURO against the USD on 11/25/2009.

Yesterday, FXF rose $1.47 to $89.42. There was news. The Swiss National Bank announced yesterday that it was going to cease selling Swiss Francs in their effort to stop the Francs rise against the Euro. I mentioned in my posts about the Roche purchase that I viewed the Swiss Franc as a strong currency, and it was clear that its decline was due to massive selling of francs by the Swiss National Bank. Since the start of this year, the SNB has bought an incredible 90 billion Euros. Obviously, given the size of this Switzerland's central bank, it could not keep on buying Euros by the ton and selling the franc.

Yesterday, Roche ordinary shares closed at 158.9 CHF, up from the 157.17 CHF price on the day of my purchase of the Roche ADR at $34.07 (4 RHHBY ADR shares equals 1 ordinary) The ordinary shares have risen about 1%. The ADR closed yesterday at $35.87, or an increase of 5.28%. The ADRs have increased by 4.28% more since my last purchase a few days ago. The difference is the Swiss Franc gains against the USD since my purchase. There is a limit to an increase due to currency exchange, possibly another five per cent in favor of RHHBY on the outside over the short term.

I also own shares in the CEF Swiss Helvetia Fund: - Swiss Helvetia Fund As of yesterday, this CEF was reporting that 18.39% of its assets were invested in Nestle, 13.61% in Novartis, 8.4% in Roche, and 4.55% in Credit Suisse. (see also: CEFA page on SWZ). The latest SEC filing of its holdings can be found at Swiss Helvetia Fund, Inc.. This is a link to the filing of its last shareholder report with the SEC: Swiss Helvetia Fund, Inc.

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