Wednesday, August 25, 2010

Medtronic/QE/Hedging Long Term Corporate Bonds/SOLD ABWPRA AT 25.15 & CBLPRC at 24.25/Sold IAE at 17.15/Bought 100 of the CEF HPF at 19.09 in Roth IRA

The Masters of Disaster apparently believe that continuing signs of U.S. economic weakness, accompanied by bloated trade and budget deficits, are reasons to buy the U.S. dollar and to sell currencies with none of those factors in play. The dollar fell against the Yen however, as the Japanese currency soared in value: FXY: Summary for CurrencyShares Japanese Yen. The Dollar Index is still above it 200 day moving average after crossing it to the upside on 8/11: DXY Index Chart

Existing homes sales plunged 27.2% to a fifteen year low in July and were 25.5% below the July 2009 number. July Existing-Home Sales Fall as Expected but Prices Rise This dismal report is in part the echo result of the temporary time distortion in demand caused by the housing tax credit which expired early in the year. Inventory of unsold homes rose 2.5% to 3.98 million which represents a 12.5 month supply.

One reason for the increased inventory is strategic defaults, where the homeowner is capable of paying the mortgage but chooses to walk away since the home is valued less than the mortgage. This practice has become so prevalent now that 1 out of 4 foreclosures originate from those strategic defaults. Mortgages: Just Walk Away? - (see Item # 4 Strategic Defaults) This is occurring particularly in those states which prohibit the lender from securing a deficiency judgment against the borrower's other assets. There are also 21 states that require a foreclosure to go through a judicial process, frequently in an overloaded judicial docket, where the mere filing a motion by the borrower's attorney can end up delaying foreclosure for months, sometimes over a year, while the homeowner continues to live in the home rent free. This fact is generally known and encourages defaults. For Some Homeowners in Foreclosure, a Rent-Free Approach -

The only way to effectively deal with these problems which are aggravating the downturn in housing and making the recovery far more difficult is for Congress to override state legislation, making all mortgage loans recourse to the borrower's assets and to require borrowers to pay a fair market value rent for continuing to live in the home after defaulting on the loan. At a minimum, such a law would prevent most strategic defaults, help stabilize housing prices by reducing the inventory flooding the market, and ultimately help those who wish to walk away now. {This change in the law for some states would not have any impact on the large number of foreclosures where the borrower has no assets worth pursuing, where the lender deserves to take a loss since the frequently funky loan should have never been made in the first place.} This kind of legislation, which mandates some personal responsibility, is anathema to the politicians from both Tribes in Congress and contrary to the perceived constitutional right protecting all Americans from personal responsibility. After all, it is never their fault but someone else is always to blame for whatever pickle they created for themselves.

The OG has noted that the stock market has some major negative vibes and consequently it would not be surprising to see a big down day, maybe even a really big down day.

DKR, a trust certificate containing a senior Hertz bond maturing in 2012, became the latest TC redeemed by the owner of the call warrant. Structured Asset Trust Unit Repackagings (SATURNS) Series 2003-8 Trust Receipt of Notice of Intent to Exercise Warrants in Full | Business Wire I no longer own DKR but it was one of my more successful trades among TCs purchased during the Dark Period. SOLD 50 DKR AT 23.76 TRUST CERTIFICATE HERTZ BOND DKR Bought at $6.45 SOLD 1/2 POSITION DKR Hertz Bond Information in One Post

1. The Federal Reserve and Quantitative Easing Part II: Based on an article in the WSJ yesterday, there was significant dissent at the last meeting on whether or not to keep the Fed's balance sheet from shrinking. Several voting members were either opposed or expressed reservations about maintaining the Fed's balance sheet at 2.05 trillion dollars. This calls into question whether the Fed will be sufficiently united to embark on another round of quantitative easing.

Prior to the publication of this article, I had seen various estimates on how much the Fed balance sheet would shrink without purchasing additional securities.. The Fed was estimating that its mortgage portfolio would shrink by 350 billion by the end of 2011 as Americans took advantage of the low interest rates to refinance their existing mortgages. This is a far more significant drop off than any estimate that I had previously seen and does suggest that the Fed's action was more meaningful than originally thought by commentators.

This extended period of low rates will have some positive long term benefits. A large number of corporations will be able to improve their profitability over the long term by refinancing their existing debt, or by securing capital for future expansion, at abnormally low rates. The other primary benefit is that a large number of consumers will improve their balance sheets by refinancing mortgage loans at the current historically low rates. The primary detriment will be the diminution in buying power caused by the dwindling income on savings.

I would suggest that most of the benefits from low rates have already been realized and any further gains will be more than offset by the contraction caused by the negligible and practically non-existent earnings on savings.

And the dissension in the Fed on this point adds to investor angst and nervousness.

2. Hedging Long Term Corporate Bond Portfolio: So far, my gut has told me to refrain from buying a hedge on my long term corporate bond portfolio. Any slightly negative news about the economy now is viewed as a confirmation that the U.S. was entering into an extended period of deflation or very low rates of inflation, with that consensus view providing the milieu for the long treasury to continue its parabolic moon shot. I mentioned yesterday that Dodge and Cox had started to hedge its long corporate bond portfolio by shorting the futures for the 10 year treasury. While this is more of a gut feeling, I suspect that the treasuries have more room to run on the upside before their long term secular bull move comes to an end and crashes, the end game of all parabolic moves.

I am not set up to buy futures or options. I do not have a margin account. Possibly, I may apply for one at some point to enable me to short some ETFs. I can avoid the serious tracking problems of the double short ETFs, discussed by me in previous posts, by simply shorting an ETF that goes long. An example would be to short SPY for the S & P 500 or IWM for the Russell 2000. For treasuries, I could short IEF for the 7-10 treasury or TLT for the long treasury. Instead, I have used TBT and PST in the past to hedge my long corporate portfolio. Fortunately, I have not had a position in either of those double short ETFs for over a year now. I liquidated TBT at around $45 for a good profit back in April 2009, Sold TBT, and have so far resisted the temptation to buy it back. It is now trading close to $30. TLT continued its upward spiral yesterday, rising $1.7 to $107.76, a gain of 1.6%, while TBT fell 3.28% to close at $30.63.

3. Medtronic (own): I took a hit on my 200+ shares in Medtronic yesterday as the stock plummeted over 10% on a revenue miss and downside guidance for the current 2011 fiscal year. Medtronic reported adjusted earnings of 80 cents per share for its first fiscal quarter ending on 7/31/2010, in line with most reports of the consensus estimate, though some services claimed that the adjusted earnings estimate was 81 cents. The firm significantly missed the earning estimate, reporting a 4% decline in revenues and importantly reduced its revenue growth estimate for the FY to a range of 2 to 5%. The prior guidance for FY 2011 revenues was for an increase in the 5 to 8% range. MDT also made a slight downward adjustment in its adjusted E.P.S. forecast to $3.4 to $3.48 including five cents in dilution from the ATS Medical and Invatec acquisitions. The prior guidance was $3.50 to $3.6. A more thorough discussion of this report can be found at Reuters.

The revenues for MDT's first fiscal quarter were negatively impacted by having one less week in the 2011 FY 1st quarter compared to the 1st quarter of FY 2010. This had a 200 million dollar negative impact compared to the year ago quarter. Foreign currency exchange rates had a 21 million dollar negative impact.

A negative assessment of MDT stock, even after yesterday's plunge, can be found at Barrons. MDT closed at $31.81, down 10.8% yesterday. I intend to hold my shares. I am not likely to buy more than 50 more shares, and I am inclined to wait for a price below $30 to do even that small add. I am going to continue to reinvest the dividend into additional shares. While I view the MDT report to be a disappointment, I also believe that the market overreacted to it, driving MDT shares further below 10 times estimated earnings on its 2011 FY.

4. SOLD Last 50 Shares of AMPPRA at $25.15 (see disclaimer): I have no interest in continuing to own this TP after the price crossed its $25 par value. I bought the shares sold yesterday at $19.42 in November 2009. I previously sold the other 100 owned at 22.2 . (on TPs see generally Trust Preferred Securities: Links in One Post)

5. Sold 50 CBLPRC at $24.25 (see Disclaimer): I recently bought this equity preferred security in June at 21.87. Par value is $25 and I did not want to press my luck on such a junior security. CBLPRC is an equity preferred stock from a heavily indebted mall REIT. I received one dividend payment on those shares. It was not that long ago that I nibbled on this security at $10. I still own the common shares as a LOTTERY TICKET.

6. Sold 100 of the CEF IAE at $17.15 (see Disclaimer): A comment by a reader caused me to look into the return of capital issue for the CEF IAE, even though the comment was about the new CEF IDE launched by ING. I am willing to cut IDE some slack on supporting the dividend with returns of capital since it is a new fund. The ING Asia Pacific High Dividend Equity Income Fund (IAE) is not a new fund. I noticed that it was also selling at a small premium to its NAV. I looked at the return of capital issue and found that my cost basis had been reduced by returns of capital. I had been taking the dividends in cash. My position was acquired in two fifty share lots. The first lot was purchased at $17.49 in July 2008 and my broker was showing the cost basis for those shares now at $15.37. The second lot was acquired at $15.28 on 7/30/2009 and the cost basis is shown now at $14.66. Bought 50 of the CEF IAE-Averaging Down The broker may have not made the cost basis adjustment yet for the dividends paid in 2010 since the return of capital issue for 2010 will not be finalized until next year. I have received two distributions in 2010, and the fund has been cutting the distributions slightly over the past year. ING Asia Pacific High Dividend Equity Income Fund - Distributions

While I do not pay income tax on that part of the dividend classified as a return of capital in the year paid, I do have to lower my cost basis by the amount of the dividends so classified. In effect, this cost basis tax adjustment created a capital gain on the first lot purchased when I actually had a small loss. I may buy these shares back again when market conditions are more conducive to the fund earning its dividend and the shares are selling at a greater than five per cent discount to NAV.

7. Bought 100 of the bond CEF HPF at 19.09 in the Roth IRA (see Disclaimer): HPF is the replacement for the lower yielding Rivus Bond Fund (BDF) that was recently sold in the ROTH. Sold BDF AT 18.22 I am in a trading mode on all bond CEFs acquired in 2010 due to my views on interest rate risk.

Unlike BDF, HPF pays dividends monthly and uses leverage. The current monthly dividend rate is $.124. Historical Distributions Assuming that rate continues for 1 year, the yield at a total cost of $19.09 would be about 7.79%.

The leverage is currently working in favor of HPF for two primary reasons. First, the cost of borrowing is low compared to the yield of securities bought with borrowed funds. Consequently there is a good spread between the cost of borrowing short term and the interest receive from long term bonds. Second, the value of those securities purchased with borrowed funds are rising in value, in what I anticipate to be a blow-off phase of the long term secular bull market in bonds that started in my opinion in 1982 with some bumps along the way. HPF has similar holdings to another bond fund from John Hancock that I recently purchased in a taxable account: Bought 100 of the CEF HPI at 17.76 The stock blow-off phase in 1999 lasted for over a year, so it is impossible to time the end of a parabolic move with any precision.

HPF is known as the John Hancock Funds - Preferred Income Fund II . As of Monday's close the NAV was $20.13 and the discount to NAV was -3.83 based on Monday's closing price of $19.36. When I placed the order on Tuesday, I believed that the price correction in the shares was likely expanding the discount, as the price of the shares had fallen 25 cents when I place my order and the value of the securities was probably rising some.

While the name "preferred income" is in the name of this fund, the fund owns very few traditional preferred stocks. In fact, most of the securities are properly classified as senior bonds, European hybrids and trust preferred (in effect junior bonds), and some first mortgage bonds. Readers of this blog will recognize many of the names in the portfolio since there are exchange traded bonds, a frequent topic of my posts.

The last quarterly report for the period ending in May can be accessed at The real estate investment trust securities listed in that report are equity preferred stocks.

This is a link to the Morningstar page on the fund. As shown at that page, this fund has occasionally sold at a premium to its net asset value ("monthly premium/discount" graph on the left hand side).

HPF closed yesterday at $19.19 and reported a net asset value at $20.10, which gave it a 4.53% discount as of the close on 8/24/2010. The NAV information can also be found at the CEFA - Closed-End Fund Association, which was not as current as the WSJ for this CEF.

And, just as a reminder, leverage can work both ways: Item # 5 Dangers & Benefits of Leveraged Bond CEFs/LTD; Item # 1 Bought 200 ACG at $8.12 in Roth; Item # 2 Bill Gross and Utility Funds.

I will discuss the remaining trades in tomorrow's post.

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