Thursday, December 16, 2010

CPI/Bought 50 PJI at 23.11/Eaton Vance CEF Dividend Cuts-EIO and ETW/Added to UZV at 25.01/

Yesterday, I had to work on another matter for the entire trading day, except for the first hour, without interruption, so this post will only discuss two very minor trades.

At the moment, I am just trying to find replacements for my bonds that are being called by either the issuer or the owner of the call warrant for trust certificates.   I mentioned in the post yesterday that the owner of the call warrant has called the trust certificate KRH for redemption.  Before the end of the year, I will also have the senior bond, DFY and RNRPRB, called by their respective issuers.  I will lose also about 1/2 of my senior bond, TDA, due to a partial call by its issuer Telephone & Data Systems.    

The Labor Department reported that CPI rose just .1% in November on a seasonally adjusted basis and has increased 1.1% over the past 12 months before seasonal adjustments.  The core number remains low, rising just .8% over the past year and .1% during November after being flat for the prior three months.   Consumer Price Index Summary The recent correction in bond prices has more to do with the fear of future inflation rather than the current CPI numbers which would lend more support to those concerned about deflation.  After all, the current inflation numbers are after the 700+ billion fiscal stimulus plan passed at the start of Obama's term and QE1 launched in March 2009 which was more than twice the size of the planned QE2.

Industrial production rose .4% in November.

IPB, a TC containing 15 corporate bonds and treasury strips, went ex interest yesterday for its semi-annual payment. Bought 100 of the TC IPB at $16.99 Bought 50 of the TC IPB at 21.3 Bought: 50 of the TC IPB at 23.11 in IRA  When rates go back up to something like normal levels, I would be interested in seeing more TCs packaged with multiple bonds like IPB. (prospectus:

The market rekindled its concern about European sovereign debt when Moody's stated that it may downgrade Spain's credit rating, having lowered the rating just three months ago.  The current Spanish budget shows the need for 192 billion Euros in financing needs for 2011.     

1. U.S. Public and Private Debt-A Bug in Search of a Windshield:  By a vote of 81 to 19, the Senate passed yesterday the tax stimulus bill which, along with QE 2, has caused what now can be called panic selling in bonds, with the ETF for the long treasury (TLT) falling 1.2% yesterday to close at $90.94.    The bill extends the Bush tax cuts for all taxpayers for an additional two years, and creates a new tax cut by reducing the social security tax from 6.2% to 4.2% for one year.    NYT  Since the social security tax is levied on incomes up to $106,800, that particular tax cut will have the most beneficial impact on the working poor and the middle class.  

Many still believe the Bush tax cuts ushered in an era of prosperity in the U.S. and believe their continuation is the magic elixir for economic nirvana.  Growth in the developed countries for the past fifty years has been fueled by both the public and private sectors incurring more debt and then spending it. The chart at this link, which I have seen reproduced in other publications (e.g. Seeking Alpha), shows the U.S. public and private debt as a percentage of GDP since 1870.  The parabolic move in both private and public debt starting with the Reagan presidency, when both private and public fiscal responsibility were thrown out the window (Age of Leverage), is just startling, though some have criticized this kind of Debt-To-GDP Chart for several reasons, including the inclusion of private hedge fund and investment bank leverage before the Near Depression.    (growth in private debt as a percent of GDP is shown in figure 7 at p. 22 of this unpublished paper by Reinhart & Rogoff titled "Growth in a Time of Debt".) 

I can understand why U.S. debt would go down in value, at least in part due to a fear of inflation as the end product of too much fiscal and monetary stimulus.  I suspect, however, that most of the recent decline is  due to a growing recognition that the U.S. will continue to flood the world with ever increasing amounts of its debt and will become more fiscally responsible at some future date.    Sooner or later, the yield on U.S. paper will rise solely due to the lack of demand for it, as everyone will already be brimming with the stuff and not overly anxious to add more. Apparently, politicians believe there is a limitless supply of money in the world to fund U.S. profligacy.   A rise in inflation would only compound the rise in yield and decline in price.   

1. Bought 50 PJI at 23.11 (see Disclaimer):  PJI is a trust certificate that represents an undivided beneficial interest in a senior bond issued by Goldman Sachs and maturing in 2033  (the "2033 GS bond").  I have had one TC redeemed by the owner of the call warrant that contains this same bond.     Alert on TC DKW-Exercise of Call Warrant/SOLD 50 OF 150 @ 25.20  Bought 100 DKW at 22.86 While the call warrant is an option, whose completed exercise requires its owner to pay the owners of the TC par value plus accrued interest to the redemption date, there is no obligation to ever exercise the option.  It would only make economic sense when it would be profitable to do so.  Over the past several months, a number of options have been exercised by the owners of call warrants attached to trust certificates where the bonds owned by the trust are selling at more than their par value, in circumstances where it would be profitable to redeem the TCs, pay the TC owners par value and accrued interest, take possession of the bonds, and then sell them for a guaranteed profit in the bond market.  I have lost a number of trust certificates due to call warrant exercises so far in 2010. Call Warrant Exercised on JZE and JZJ Alert on Verizon TC XFL: Call by Owner of the Call Warrant  DKK-Called by Owner of Call Warrant 

The 2033 GS Bond is currently selling at a small premium to its par value but has been declining in price some during the bond sell-off.  FINRA  The FINRA site shows that the credit ratings for this senior bond are A1 for Moody's and A for S & P.  Trade data information can be scrutinized by date, using the screen at the bottom of the foregoing linked page.  

The underlying bond has a coupon of 6.125%.  The TC has a lower coupon of 6%.   If I bought that bond in the bond market, which I could do, the par value for 1 bond would be $1000.  An order to buy 1 bond at 100 would cost $1000 before commissions.   The TC, on the other hand, has a $25 par value, and is traded on the stock market, thereby making it more accessible to the average individual investor. 

At a total cost of $23.11, PJI's current yield would be about 6.49% and the yield to maturity would be a little higher given the purchase of this security at a discount to its $25 par value.     It may say something about my age, since there is no other good explanation, but I am almost satisfied with 6.5% per year until the bond matures on 2/15/2033.  

PJI Prospectus:
Prospectus for the Underlying Bond:

For those who read this blog frequently, TCs containing the 2033 GS bond have been a frequent topic of discussion in 2010.  I have bought and sold several of them, including PJI. Added 50 PJI at 20.17  Bought 50 PJI at 20.85  Sold 50 PJI at 23.52 Bought 50 JZS at 22.95 Sold 50 JZS @ 24.15 Bought 50 JZS at 23.37 Bought 50 PYB at 22.83 Bought 100 PYB @ 23.81 Bought 50 PYB @ 23.69

I am comfortable with increasing my exposure to the 2033 GS bond since I have pared my ownership of the Synthetic Floaters tied to GS bonds to just 50 shares of GYB.  I noted in a prior blog that my realized gains from trading those synthetic floaters was $2411.49, plus interest payments, in 2009-2010: Item # 8   Sold  50 GJS @ 16.20, 100 GYB @ 19.9  The realized profits on fixed coupon GS bond TCs such as JBK and DKW (mentioned above) would take the share gain close to $4000.    Bought 100 JBK @$16.15 Sold 100 JBK at 21.59   Bought  50 JBK @ 19.63 in Roth IRA Sold 50 JBK @ 21.59 The general goal is to arrive at a point where I am playing with the house's money on this grouping of securities.  

2. Added 19 shares UZV at 25.01 (see disclaimer):  I received a partial fill of an odd lot limit order for 50 shares, one of the hazards of trading odd lots.  I could have avoided that outcome by placing a limit order to buy 50 at the ask price of $25.08 but the Old Geezer is at the trading desk.   In an effort to save a couple of bucks the OG will often manage to lose ten times that much or more. A penny saved is a penny earned the OG just noted.  This brings me up to 169 shares of UZV. Bought 100 UZV at $24.42 Added 50 shares to UZV at 25.16

 UZV is an  Exchange Traded  senior bond issued by United States Cellular (common stock symbol USM) that just went ex interest for its quarterly interest payment.  By exchange traded, I am referring to a stock exchange rather than the bond market.   The majority owner of UZV is Telephone & Data Systems (TDS) which owns 83% of USM's stock.  When the OG manages to fill the remainder of the order, which will now have to be done at a lower price according to OG's reasoning for him to actually save that two bucks, I view the addition of another 50 UZV simply to be a partial replacement of my TDA shares about to be redeemed in a few days by TDS.  I currently own 200 shares of TDA and expect that close to 100 of those are about to be called by TDS. 

U S Cellular is a relatively small wireless carrier in the U.S. with  6.103 million customers as of 9/30/2010.  For the Q/E 9/2010, the company earned 43 cents per diluted share, up from 40 cents in the year earlier quarter.   usm10q 

This bond is rated investment grade.  The coupon is 7.5% on a $25 par value.  The bond matures in 2034, making it very susceptible in price due to changes in actual and/or perceived interest rate risk. 

It will take 9.58 years for money to double at 7.5%, Estimate Compound Interest, before taxes and the effects of inflation.   The OG is fine with all of that, much preferable to the 138.98 years it would take for money to double at .5%.  RB thinks the OG needs to be sent to the OLD FOLKS home to work on his checkers game.      


3. Eaton Vance Cuts Dividend Rates on Several Stock CEFs:  I own two of the CEFs that received a dividend haircut yesterday,  EOI and ETW.  Both of those CEFs, along with others, were originally purchased prior to the onset of the Near Depression for  the reasons discussed in more detail in earlier posts:   CLOSED END INVESTMENT COMPANIES: Hopefully Lessons Learned and To be Applied  (May 2009)  Buy High & Sell Low /Retrospective on the Good & Bad (October 2008).  

The market reacted badly to the dividend cuts, which normally happens with CEF funds, as their individual owners dump the shares.

ETW declined -4.24% to close at $12.2 yesterday.  It reduced its quarterly payout from $.39 to $.3024.   That $.39 penny rate was reduced from the prevailing $.45 in the 1st quarter in 2010.  Tax-Managed Global Buy-Write Opportunities Fund  I own 352.456 shares of ETW which lost $218.52 in value yesterday.  The annual "loss" in "dividend income" resulting from this most recent cut will be $123.5.  Of course, that $123.5 would have most likely been just a return of my capital and would not be viewed as income here at HQ anyway.  I have never maintained that individuals who invest in CEFs are rational.  I may add to my position when the discount to net asset value exceeds 10%.  I checked last night and the net asset value fell 11 cents to $13.41 per share and the market price decline was 62 cents.  This expanded the discount to net asset value to -9.02.

EOI declined -4.27% to close at $12.57 yesterday.  It reduced its monthly dividend from $.1164  to $.0922.  During the Dark Period, the fund was paying $.137 per month which was reduced to the $.1164 in January 2010. (See Distribution  History at Enhanced Equity Income Fund)  I did recently average down on my small position in EOI by buying 100  at $12.78. In that post I made the following comment about this fund:

"EOI was one of the CEFs bought in 2007 after I sold a number of mutual funds and pared my stock portfolio in response to the signal given by my Vix Asset Allocation Model. VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern EOI and a few other CEFs with similar strategies and large dividends were bought as a counter-weight in case my new model was giving a false signal. It was believed, erroneously as it turned out, that those CEFs would provide some decent protection on the downside due to the call writing strategy as well as the steady stream of dividends. . . . The strategy seemed to be working okay until September 2008 when it started to fail as the market cascaded downward. The strategy may have been a modest success with a shorter and shallower bear market, as the reinvestment of dividends at lower prices could have produced better returns upon the return of the next cyclical bull market. I quit reinvesting the dividends in 2008 and started to take the monthly distributions in cash"

I mentioned in a post from March 2010 that ETW had classified an unacceptable amount of its 2009 dividend as a return of capital.   I made the following comment at that time:

 "I see no benefit in creating a tax event for me for returning part of my investment in the form of a non-taxable return of capital dividend which has the effect of increasing my profit, or reducing my loss as the case may be, when the security is sold. Two of the main offenders in 2009 were the Eaton Vance Tax Managed Global Buy-Write (ETW) and Old Mutual Long-Short (OLA). My general policy is to give the fund a pass for one year of a significant return of capital, due to the kind of market disruptive event that was experienced in 2008. But, I am likely to sell one that does it for two years".  

I did subsequently eliminate OLA but kept ETW.   I have not added to ETW for over a couple of years, nor have I reinvested the "dividend".  I have noted that a stock CEF requires a bull market to support a large dividend distribution, and the devastation in 2008 wiped out the unrealized profits of many of these funds which were being harvested to support the dividend payments.   And it does not help a buy-write fund if the call writing is so poorly done that it detracts from portfolio gains most of the time.   

Most likely, I will sell ETW sometime between now and no later than the end of 2011, as I have been disappointed in its overall performance and particularly its continuing dependence on  return of investor's capital to support the dividend.  I would note, however, that Morningstar rates this fund with 4 stars.  Morningstar rates EOI two stars which is about right given its performance since I made a purchase in 2007.   I own only 214.411 shares of EOI and do not intend to add to it. 

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