Sold PICO at 31.51 and Added 50 MWR at 22/CSCO/Interest on U.S. Government Debt/ BOUGHT 50 STIPRA at 19.85

The treasury is currently financing the exponentially growing federal debt at abnormally low rates by historical standards. Yet, in fiscal year 2010, the U.S. incurred $413,954,825,362.17 in interest expense servicing the national debt, up from 383 billion in F/Y 2009: Government - Interest Expense on the Debt Outstanding 

Two events are inevitable. 

The interest rates to finance the debt will increase as well as the amount that needs to be financed, with the later number growing at a trillion plus dollar rate per year now.   

I was asked by a reader whether I was predicting a U.S. government default in my post yesterday.  Financial Armageddon-Avoided or Just Delayed Yes, I am.  I do not believe that it will occur prior to 2020, though I plan to adjust the possible time frame based on subsequent events. 

The default will be manifested in a series of failed treasury auctions, where the U.S. is not able to sell all of the paper necessary to retire existing debt and to fund the government. 

That default will trigger the first worldwide depression since the Great Depression. 

And I do not view that as an outlandish prediction. Too much debt almost triggered a worldwide depression in the fall of 2008.   

I am not managing my money now based on that prediction, except to a limited degree. The most important financial planning goal for such a scenario will be to own everything outright. Staying out of debt is something that I would do anyway. Some of my existing investments might work in such a dire scenario such as gold and silver bullion tucked away in a safe deposit box at a bank, sovereign debt issued by Canada, Australia and Switzerland, and senior bonds from financially stable U.S. corporations. I will need to be much closer to the event to have a better feel for those asset classes likely to outperform when and if this scenario unfolds, which I view as inevitable.       

I did mail yesterday the necessary forms to move my Roth IRA from Fidelity to another firm. This is a direct response to the prohibitions being implemented by Fidelity on the purchase of a variety of exchange traded bonds that have been a staple of my IRA investments for two years now.  

I do not like being told that I can not buy what I deem to be appropriate for those accounts. Fidelity Brokerage Extends Denial of Trading Opportunities to Synthetic Floaters and Even an Exchange Traded Junior Bond DFP

I also mentioned yesterday that I do not regard a trust preferred security as part of a bank's equity capital. Really, who would? It is a bond after all. Why would anyone classify a bond as part of equity capital? That is just one indication that the world is just not straight in the head.

The following table contains my regional bank basket, as of yesterday's close. Michael Kahn, the Barrons' technical analyst, believes this sector is poised for a pullback after its recent outperformance, compared to the S & P 500, but he believes the uptrend will remain.

Regional Bank Basket as of 12/27/2010

I am keeping track of the realized gains in 2010 from this strategy in Item # 3 2010 Realized Gains Regional Bank Stock.  I am not keeping track of the dividends being generated, nor do I include in this table the shares purchased with reinvested dividends. I suspect that the dividend generation is somewhere in the $1,600 to $2,000 per year range.

1. Sold 30 PICO at 31.51 and Added 50 MWR at $22 (see Disclaimer): With the OG in charge, the emphasis is on the purchase of income producing securities. The  reasons for selling 30 shares of PICO was to realize a $100 or so profit and to redeploy the proceeds into an income producing security. PICO does not pay a dividend. RB Buys 30 PICO at 27.89  Besides, PICO was a RB buy anyway. 

I noticed that MWR was falling some yesterday morning so I added 50 shares at $22 in a taxable account. MWR was discussed in yesterday's blog after I purchased 50 shares at $22.25 in a the regular IRA. I have nothing to add to that discussion. Bought 50 MWR in regular IRA at 22.25  

I am hoping that MS will redeem this TP at some point before 2016, when it can no longer be included in Tier 1 equity capital. 

The purchase is not based on that premise however. I bought it for diversification purposes, as well as the yield, which is over 7%, and the quarterly interest payment schedule.  

2. Bought 50 STIPRA at 19.85 on Monday (see Disclaimer): STIPRA is a non-cumulative equity preferred stock issued by SunTrust Banks (STI) that pays the greater of a 4% guarantee or .53% above 3 month LIBOR. Par value is $25. Final Prospectus Supplement 

Buying this security at a discount to par value will increase the value of the guarantee and the LIBOR float when it becomes a greater rate than the guarantee. This is a thinly traded security. 

When I placed a limit order to buy 50 at $19.85, the bid was $19.8 and the ask was at my limit price of $19.85. No shares had been traded up to that time which was mid-day. 

I have bought and sold STIPRA. Sold: 50 STIPRA @ 21.24 (Dec. 2010); Bought 50 STIPRA @ 19.75 (Oct. 2010); Sold 50 STIPRA at $20.90 (March 2010); Bought 50 STIPRA at $17.2 (Sept. 2009)

The extension of the qualified dividend rate for all taxpayers makes this kind of security more attractive, since its distributions are taxed at the 15% qualified dividend rate.  

I also suspect that we are moving closer in time to a period of rising short term interest rates. Maybe that will not start until the second half of 2011. 

Eventually, the short term rates will start to rise to more normal levels. 

Based on history, a 4.5% average LIBOR rate over a long period of time would be a rational forecast. At times, it will likely be much higher, and then much lower as now.  During the low periods, the guarantee will provide a cushion.  

The LIBOR float would be activated after the 3 month rate increases above 3.47% during the relevant computation period. At a 6% Libor rate, the coupon becomes 6.53% which translates into a current yield of 8.25% at a total cost of $19.8.  

I give a more detailed discussion of this type of security in Advantages and Disadvantages of Equity Preferred Floating Rate Securities, a post that I view as important. 

Suntrust still has government preferred stock on its balance sheet. In fact, I believe that STI has the largest outstanding amount of government preferred shares among the banks at 4.5 billion.  

STIPRA stands at the same level of priority as that government preferred stock. For STI to eliminate the STIPRA dividend, it would first have to eliminate the common stock dividend, just a penny a quarter, and to defer the government's preferred stock dividend. 

While that is a possibility, particularly if the economy turns south, I doubt that the management of STI would do it unless it became absolutely necessary. The signal, that such actions send to the market and to its customers, could only be characterized as dire. 

STIPRA pays quarterly dividends and just went ex dividend in late November.

3. Cisco (owned):  Cisco fits into my large cap valuation strategy. Item # 1 Large Cap Valuations;  Item # 3 Large Cap Valuation Strategy-A New Long Term Strategy (May 2010); Item # 1 Explaining Low Valuations of Large Cap Tech Stocks The stock made no sense to me when it was selling at 130 times pro forma earnings, somewhere near a valuation where Cisco would have to grow so large that it would have to swallow the U.S. GDP within the confines of the company in order to justify the multiple. Maybe that is a  slight exaggeration but what does Cisco's price in 1999 say about the efficient market hypothesis?  Now, Cisco is trading near 12 times earnings and has 40 billion in cash, close to 1/3 rd of its market valuation. The foregoing points are made in the Barrons cover story this week, written by Michael Santoli. In response to that cover story, the stock popped yesterday, rising 47 cents or 2.47% to close at $20.16.

There is nothing new in Santoli's piece.  The article is filled with obvious observations.  

When I bought 50 shares of Cisco at 19.55 after the last earnings release, I mentioned the P/E and the cash per share. 

I knew the foregoing when I sold 50 shares @ 24.42 shortly before the last earnings report, having just bought those shares at 20.39. 

And I made the same point when I sold shares in August 2010, shortly before the prior earnings release. 

This trading activity shows a recognition of Cisco's low valuation and its cyclicality, which makes quarterly earnings projections unreliable, plus an awareness of Cisco's execution problems. 

I doubt that the recent story in Barron's will cause the stock to run much more, given the huge disappointment announced at the end of the last quarter. 

Instead, for Cisco to approach $25 again, which is likely to prompt another sale by me, there will need to be an earnings surprise and an upbeat future assessment. Then the stock will quickly recover back to $25. This may not occur until the middle of 2011. 

My last purchase at $19.55 was based on a belief that the stock was mostly washed out at that level, rather than a belief that it had much upside until it had a more positive story to tell.   

In short, I did not see much risk at $19.55 and I was willing to be patient to receive a 20% or so upside.

I will discuss the remaining trades from Monday in the next post. I am coasting to the end of 2010, satisfied with what I have accomplished already this year. Part of that coasting will be shorter blogs for the remainder of 2010.