Saturday, July 10, 2010

BKMU & EBTC/BOUGHT 200 CLF:TO AT 20.20 CAD/JNJ/Near the End of A Long Term Bull Market in Bonds Staring in the Early 1980s?

The Barrons cover story highlights the risks of bond funds. While acknowledging that the herd piling into bond funds had "gotten it right" so far this year, the author, Tom Sullivan, points out some of the risks in bond funds and recommends some alternatives for investors. Two of the alternatives mentioned by him are to buy individual bonds in a ladder and to shorten maturities. He also mentions the new Claymore Bulletshares Corporate Bond ETFs with liquidation dates in each year from 2011 to 2017. Item # 1 Claymore Introduces Term Corporate Bond ETFs

I am using some of those Claymore ETFs as part of my multi-prong strategy to manage interest rate risk in my retirement accounts, which are bond heavy. Managing Interest Rate Risk Investment grade corporate bonds with short maturities have low yields and consequently this type of an investment is not likely to provide much in the way of a real rate of return. In an IRA, I bought the Claymore corporate bond ETFs maturing in 2104 and 2105 respectively. Bought 100 BSCE Bought BSCF at 20.18 Hopefully, when those ETFs liquidate, interest rates will be higher then, and I will be able to reinvest the proceeds into higher yielding term bond ETFs at that time.

For those of us who started investing in the late 1960s or during the 1970s, we do not need to be told twice about the impact of inflation and rising interest rates on fixed coupon bonds. Ultimately, no one knows now the long term inflationary impact of the massive fiscal and monetary stimulus over the past two years and its likely continuation for months to come. One possible result is a repeat of the inflation experience which started in the late 1960s and gathered steam throughout the 1970s. Consumer Price Index, 1913- | The Federal Reserve Bank of Minneapolis

While the government's CPI number is currently running at around a 2% annual rate, the cash inflation number is higher at around 2.7%. An alternative measure of inflation published at Shadow Government Statistics is running closer to 6%.

I am seeing more stories in the financial press warning investors about the dangers of inflation on their bond fund investments. Besides the cover story this week in Barron's, there was a similar theme voiced in the most recent cover article in Having actually experienced the 1970s, and studied the long term bear market in bonds that culminated in the early 1980s, I am actually more wary of bonds now than stocks. I would argue that bonds have been in a long term secular bull market since 1982. Treasury yields are either at new all time lows or close to it depending on the maturity. Hitting historic lows in yields is not where a long term trend starts but it is likely to be where one ends. The only question is whether it is ending now, next month or next year. It will end, and it may end badly for those piling into bond funds after such a long bull cycle and when rates are paltry.

1. JNJ-A Colossal Failure in its Consumer Products Unit (own JNJ common): If there was ever a need for corporate layoffs, it is in in McNeil's consumer unit. This unit has demonstrated beyond any doubt a lack of attention to routine safety issues in the manufacture of OTC children's products. The proof of that statement can be found in the numerous recent recalls. For the eighth time, JNJ has had to recall some products including children's Tylenol. Reuters JNJ's less than stellar attention to good manufacturing practices has probably caused irreparable damage to several of its consumer brand name products including Tylenol. It is certainly understandable that many parents will no longer trust the safety of JNJ consumer products manufactured by McNeil. At a minimum, the entire top layer of management at the McNeil unit needs to be fired, along with the entire management structure in charge of safety issues at this unit, a total house cleaning. If JNJ is unwilling to do what is necessary with its personnel, then the alternative is to sell the McNeil consumer unit to a company who will pay close attention to the minute details of safe manufacturing practices.

Notwithstanding these problems at McNeil, I still view JNJ as undervalued at the current price. Given the problems at the McNeil consumer unit, however, I am not inclined to add to my position.

2. Deadbeat Millionaires: The NYT reported that more than 1 in 7 home loans in excess of one million dollars are seriously delinquent, referencing a Corelogic study.

3. BankMutual (BKMU) & Enterprise Bancorp (EBTC) (own): I recently purchased 50 shares of BankMutual, based in Wisconsin, as part of my Regional Bank Stocks' basket strategy. An article in TheStreet lists BKMU among ten small cap banks that are potential takeover targets. The article starts with the discussion of Wainwright that recently received a cash offer at close to a 100% premium, and I was fortunate to own shares. Sold 50 Wain at $18.7-Being Acquired I would not buy shares in BKMU based on the premise that it may be a potential acquisition target. Instead, I was more focused on the bank's turnaround potential and its strong capital position. A 50 share buy of a stock at $5.5 does not indicate a great deal of confidence however.

The article in the Street also mentions Enterprise Bancorp (EBTC) as another small bank as a potential takeover candidate. I have already averaged down on EBTC and now own 100 shares as part of the regional bank basket strategy. Bought 50 EBTC at 11.75 Added 50 EBTC at 10.33 The author of this article refers to EBTC as "certainly undervalued", selling below tangible book and at 8.3 times trailing earnings.

I have two more of the banks mentioned on a monitor list and have no interest in the others mentioned in the article.

4. Bought 200 shares of the CLAYMORE 1-5 YR LADDER GOV Bond at 20.20 Canadian Last Friday (CLF:TO) (see Disclaimer): This brings my position up to 400 shares of this ETF. I previously discussed this Canadian bond ETF in two posts: Added 100 CLF:TO-Sold 100 CPD:TO Sold HSE:TO at 30.48 CAD/Bought 100 of ETF CLF:TO at 20.10 CAD

This is a link to the sponsor's web site: Claymore 1-5 Yr Laddered Government Bond ETF - CLF The expense ratio is .15%. The ETF owns Canadian government bonds, issued by the federal and provincial governments. The fund owns an equal amount of bonds, using a ladder approach, maturing in 1 to 5 years. The ladder starts with bonds maturing in 1 year to 1.99 years and end with bonds maturing between 5 years to 5.99 years. As the bonds mature in the 5 to 5.99 year portion of the ladder, the proceeds are then rolled back into the 1 to 1.99 year. The short duration of the bonds, plus the use of the ladder and the roll, reduces interest rate risk. I view the main risk to be currency risk. Since I am a long term holder of the Canadian currency, and just want to earn some kind of return on that currency position, I am willing to assume the currency risk. Distributions will be paid in Canadian dollars subject to a 15% withholding tax. I just received a quarterly distribution for CLF:TO and the Claymore 1-5 Yr Laddered Corporate Bond ETF - CBO. I also own Claymore S&P/TSX Canadian Dividend ETF ( CDZ ) which pays monthly.

I would only buy this kind of ETF where I have confidence in the overall responsibility of the foreign government and a favorable long term view of the foreign currency versus the USD. If a similar product was available for Australian government bonds, I would likely buy a similar amount. I believe that both the Canadian and Australian governments generally act more responsibility than the U.S. government under both Republican and Democrat administrations. I would agree with Mahamed El-Erian who likes the "credit" exposure in both the Canadian and Australian government bonds. Bill Gross also shares that opinion as discussed in a previous post, Bill Gross:The New Normal, and in his February 2010 newsletter, PIMCO - February 2010 Gross Ring of Fire. The U.S. is of course in the "Ring of Fire", whereas Australia is in the "green" circle. The U.S. investor faces currency risks with foreign bond, a factor that makes them undesirable to most U.S. citizens according to David Swenson. NYT I would agree with that assessment as a general rule of thumb. It is just not applicable to me under my circumstances and risk tolerance.

More private sector jobs are being created in Canada than in the U.S. at the present time. Canada reported on Friday an increase of 93,000 jobs in June with the unemployment rate falling to below 8% for the first time since January 2009: Latest release from the Labour Force Survey. Friday, July 9, 2010


  1. Hi,

    I have been reading your blog for a while now, and appreciate the time you spent sharing your thoughts and investment process. I have one question, which broker are you using to trade Canadian securities?

    Thank in advance,

  2. I use Fidelity. I can settle trades using USD or Canadian dollars. My purchase of 200 of the Claymore Canadian Bond ETF executed immediately after it was placed on Friday.

    I can buy from Fidelity Canadian dollars or seven other currencies including the Australian Dollar and the EURO. The commission is higher to trade on the Toronto exchange than in the U.S. I have to pay 19 CAD to trade on Toronto.

    The Canadian ETFs that I buy are available in the U.S. only on what is called the Grey Market where there is almost no volume and no transparency. And the bid and ask price are not provided. So generally I will wait for a slight fall in the price to compensate for the added commission. I find the Grey Market in the U.S. to be almost impossible to trade so that is why I am buying these Claymore ETFs on the Toronto exchange where the bid/ask is narrow and there is significant volume. Another reason that I will buy on the Toronto exchange is that the dividends are paid to me in Canadian dollars which is what I want. If I bought a Canadian security in ADR form, the Canadian dollars would be converted into USDs.