Monday, December 27, 2010

Financial Armageddon-Avoided or Just Delayed/Bought 50 WMT at 53.52/Bought 50 MWR in regular IRA at 22.25

I have started to think about what I can do to lessen the impact on my family, when Financial Armageddon returns with a vengeance. I believe that it will before 2025, most likely between 2018 to 2025. While governments in the developed world averted a financial collapse in the Fall of 2008, they will be powerless to stop the next one from occurring for a simple reason.

They will be the cause of it, with the U.S. government leading the way. The U.S. is proving that a majority of its citizens will not support the measures necessary to avert a financial catastrophe.

Politicians from both tribes lack the courage to deny anyone most of whatever they want, without paying for it of course. There is a total unwillingness to live within our means or anywhere close to it.

And that is true for both governments at all levels and the nation's citizens.  The U.S. and its citizens are addicted to spending borrowed money, with no regard to the inevitable consequences. And there is no indication yet that even hints at a willingness to deal with the looming crisis in an intelligent manner. It is not helpful that ideology trumps facts for members of one political tribe whose tendency toward reality creation is constant source of amusement. 

For the past two years, and for many years to come, the U.S. will be adding over a trillion dollars a year to its national debt. Municipal and state governments have also been unwilling to address their own fiscal problems, much preferring to postpone their day of reckoning with accounting gimmicks and legerdemains.   There seems to be a belief that the remainder of the world will finance U.S. irresponsibility and  profligacy indefinitely.

One day, in the not too distant future, there will be an unwillingness to buy U.S. debt, at least in the quantities necessary to feed the beast, and there will be insufficient funds to retire maturing debt and to pay the bills.

The rest of the world will sense correctly that the U.S. has no means to pay back any lender except by borrowing more money from those same lenders seeking to be repaid, in effect paying them back with their own money.

Before that day arrives, the interest rates necessary to attract capital will start to accelerate, eventually rising after five years or so into the double digits, which will simply hasten the inevitable, and then there will be no takers for our paper at any price.

This will be due mostly to the market's downgrade of U.S. sovereign debt which will occur before the rating agencies lower it one notch.  Inflation and a growing loss of confidence in the USD will accelerate that rise in rates.  

How will the deficit start to look when the financing costs of that debt averages 10% and the baby boomers are drawing their social security and relying on medicare?  

I view the outcome as inevitable. But economists believe that the U.S., which can print money and issue debt in its own currency, can not default. I suspect that common belief will be proven wrong,  possibly before 2025. 

The nation is like some crack cocaine addict driving a vehicle at 100+ miles per hour headed directly for a steel wall. The wall is seen and not seen. If I am generally right about the future course of events, and nothing is certain about the future, then what could be done to protect our family which is all that I can do?

My first answer is that hopefully I will see events unfold in a proper perspective and consequently be able to recognize the asset classes that may hold their value. I do not know now what those assets will be, but I suspect that  government debt at all levels in the U.S. would more likely be a source of the problems rather than a refuge for those seeking safety.  

My first approach will be to avoid debt for the remainder of my life. Most asset classes will fall in value or even lose all or most of their value in my dire long term forecast. I have started to invest in government bonds issued by sovereign states that I view as far more responsible than the U.S. government. It is possible that gold and silver may hold their values.

I view the bull market in precious metals to be a vote of no confidence in the long term value of the USD or the Euro, and assets valued in those currencies.   The Swiss Franc may be another option. I am just starting to think about it more, as in everyday now, after the two tribes came to an agreement to add another trillion dollars to the deficits over the next two years. Based on what I now see, it is impossible to envision a favorable outcome when so many are so delusional.

The foregoing long term forecast is intended by me to provide a framework for evaluating future events and to plan accordingly.    

1. Bought 50 shares of Wal-Mart on Thursday at $53.52 (see disclaimer):  Near the end of a long term bull market, valuations will become absurd even for companies likely to survive and to prosper for many decades to come. This is part of the euphoric phase of a long term secular bull market. By the late 1990s, blue chip companies like GE and Wal-Mart were selling at 30 to 50 times earnings. The long term secular bear market, which naturally follows, will compress those P/E ratios, even for the long term survivors, to the single digits. 

In 2000, WMT shares hit $69. The company earned $1.4 per share in 2000, giving it a P/E of over 49 based on the peak share price for that year.  Since 2000, WMT has been increasing earnings every single year. The company earned $3.70 per share in 2009 (using Morningstar's data) and is estimated to earn $4.05 in its F/Y 2010 ending in 1/2011. The consensus for F/Y 2012 is currently $4.45 per share. The forward P/E has been compressed to just 12 times earnings. I view that compression to be a normal evolution in a long term bear market.

The stock is viewed negatively now because it has gone nowhere for a purchaser in 1999.  

However, that is not an indictment against WMT but against the purchaser who paid over 40 times (or even over 20 or 30 times) earnings for this company.   WMT has done just fine as a company over the past decade even as the stock has stagnated. (See Item # 3. Multiple Compression for Many Large Cap Stocks/Long Term-Large Cap Valuation Strategy at  Large Cap Valuation Strategy-A New Long Term Strategy)

I discussed the multiple compression issue as it relates to WMT in a post from July 2010, when I decided to pass on buying WMT shares:  Item # 1 Consumer Debt Levels-Still Way too High (see also  Large Cap Valuations)

At the present time, I do not see much downside and a decent chance for the shares to hit $60 within a year. 

Since 2000, WMT has been increasing its dividend every year, starting with an annual rate of 24 cents in 2000 which more than doubled to 54 cents annually in 2004.  The dividend doubled again to $1.09 in 2009.  The current quarterly rate is $.303 per share or $1.212 annually. The payout ratio is less than 30%.  That dividend was an 11% increase over the dividend paid in the prior year. (Form 10-Q at page 24). 

WMT's future growth prospects are probably being under estimated in its current valuation. International sales make up about 26.6% of revenues for the Q/E 10/2010, and are growing at a rapid clip. (Form 10-Q at page 16)

Operating income for WMT International rose 13.5% in the last quarter. The recently announced acquisition of the South African based Massmart Holdings, if consummated, will likely give WMT a good foothold for expansion on the African continent.  

Since starting this blog in October 2008, I owned 100 shares of WMT briefly, buying at $49.55 in July 2009 and selling those shares at $51.2 in November 2009. 

2.  Bought 50 MWR at $22.25 on Thursday in the regular IRA (see Disclaimer):   Fidelity allowed me to buy this exchange traded bond after I was denied the opportunity to buy a synthetic floater due to its most recently announced prohibition.  Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP  MWR was my fall back option for some of the cash received as a result of the DFY redemption by Delphi Financial.  I am far from enthusiastic about this purchase.  

MWR is a typical trust preferred security. The issuer is Morgan Stanley Capital Trust III, a Delaware Trust formed by MS to issue trust preferred securities to the public and then to use the proceeds to purchase a junior bond issued by Morgan Stanley. The TPs represent a beneficial interest in the bonds owned by the trust.

Distributions will be taxable as interest and are paid quarterly.  The coupon is just 6.25% on a $25 par value, giving me about a 7% current yield at a total cost of $22.25.  The TP matures on 3/1/2033.

MWR Prospectus: 

By typical TP, I mean that the interest payments may be deferred for up to five years provided no payments are made on a junior security such as common stock or an equity preferred stock.  

In order words, the common share dividend and the dividend on MSPRA would have to be eliminated before MS could defer the interest payments on MWR or its other TP securities. If the interest payments are legally deferred, then those distributions accumulate and earn interest at the coupon rate. 

The TP can be included in the TIER 1 equity capital of a bank holding company, but that treatment is being phased out for those institutions with over 15 billion in assets, as of year-end 2009, under the recently enacted financial reform legislation.  

While I did not research the issue in any depth, I believe that MS converted to a bank holding company in 2008 and would be required to exclude its TPs from equity capital by 1/1/2016 after a three year phase-in period. I have no idea what MS intends to do with the large amount of TPs it has outstanding. One option would be to redeem them. TruPS Moving From Tier 1 to 2nd Rate

MS can redeem MWR now at par value plus accrued interest. (page S-7).

As discussed in this recent FDIC publication, TPs are in reality junior debt. .pdf (pages 2 - 16). I do not regard debt to be a component of equity capital.    

 Trust Preferred Securities: Links in One Post


  1. I was only able to find this (old now)on TPs phase-outs

  2. This video is interesting, to take your worst case scenario to the EXTREME.
    (Porter Stansberry/End Of America)
    Trouble is, in this outcome, assets in overseas banks will be frozen most likely by the US authorities. I have a friend in Costa Rica, the US froze his account to pay taxes, not too safe anywhere.I tend to think we slip into inflation/hyperinflation rather than an official USD default or devaluation. Comments appreciated.

  3. You may want to read this decision by the U.S. Court of Appeals for the 4th Circuit, in a case involving Mr. Stansberry.

    I am predicting a depression triggered by sovereign defaults. The most serious default will occur when there is a failed U.S. treasury auction.
    viewarticle/articleid/3861666 Then followed by several more. The problem will ultimately be the sheer amount of debt that has to be financed.

    If that came to pass, there will be asset classes that may hold their value. Those asset classes would not be state or municipal bonds, where the rot is already extensive, or U.S. treasury bonds.

    Possibly, senior notes from large financially viable U.S. corporations would be an alternative. Interest on those notes have to be paid to avoid bankruptcy and those corporations will do whatever necessary to continue their business. This would include companies like Coca Cola or JNJ, but would not include any financial company or any company with a large financial business like GE. Bonds from emerging market nations may also be an option. Also, many banks will survive this kind of catastrophe and cash at financially sound institutions may be safe.

    When I refer to foreign government bonds, I do not mean Costa Rica. I am referring now to Australia, Canada, & Switzerland. Part of my planning for this possibility includes the ownership of the Permanent Portfolio mutual fund that is heavy into gold and silver and Swiss government bonds.

    I am not predicting an imminent debacle. We may very well have a long term bull market in stocks take hold first. The long term forecast, meaning ten to fifteen years from now, is that the budget problems in the U.S. will become increasingly more dire in the coming years, made worse by a rise in interest rates.

    At the abnormally low rates prevailing now, the treasury incurred 413 billion in interest expense in FY 2010 to service the national debt.

    I am predicting that this amount will exceed 1 trillion within ten years.

    The need for refinancing maturing debt and issuing new debt to fund future deficits will eventually swamp the capacity and willingness of lenders to feed the beast which will lead to a U.S. default. That series of defaults will be the trigger for the depression in this scenario.

    The recent recession has just exposed the rot in finances among many state and local governments. Their problems will just become worse too. It is just amazing to me that Illinois has not been paying its vendors for months now.