Monday, January 3, 2011

Regional Bank and CEF Tables as of 12/31/2010/Municipal Bonds/ Bought 50 PYS at 22.6/Retirement Accounts-2010 Performance & 2011 Strategy

A recent Sandler O'Neill report, summarized in Barrons, offers a bleak assessment of municipal bonds for the foreseeable future.  The negatives are generally known:  the likely continued deterioration in state and local government finances caused by the recession (high unemployment, lower home values for property taxes); the expiration next spring of transfer payments from the federal government that were part of the stimulus package passed early in Obama's administration; the extension of the Bush tax cuts; rising costs including unfunded pension/health care plans; and continued headline risks.   I would agree with all of those points, but I would place them in a broader context of the looming sovereign debt crisis at the national level. Financial Armageddon-Avoided or Just Delayed  I would add that a large number of financial firms, particularly in the insurance industry, own significant amounts of municipal bonds.     Barrons had a recent article on the insurance companies most exposed to municipal bonds, as a percentage of their equity.  That article summarized a Credit Suisse report.    

The SUV Capital of the World, Brentwood, TN., has a AAA rating on its debt (City’s AAA Bond Ratings Reaffirmed), as does its neighbor Franklin, TN.   Moody’s and Standard and Poors Reaffirms City’s AAA Bond Rating  I would add that Tennessee has no state income tax on earned income, and my property taxes are a tad over $2000 per year on my house. 

1. CEF TABLE AS OF 12/31/2010: The following table is my CEF portfolio as of 12/31/2010.  I have updated some of the positions with recently acquired shares purchased with dividends.  The largest recently acquired position was 500 shares of the bond CEF FAX: Bought 500 FAX @ 6.71

CEF PORTFOLIO 12/31/2010

2. REGIONAL BANK BASKET AS OF 12/31/2010: This is my year end table for the regional bank basket:

Regional Bank Basket as of 12/31/2010

The realized gains in 2010 from this strategy was $3,133.37:  Item # 3  2010 Realized Gains Regional Bank Stock  Dividends would be in the $1500 to $2000 neighborhood for 2010.  As previously noted, I use FIFO accounting.  Where shares were bought on more than one occasion, the share price noted in the foregoing table is the average weighted cost, excluding commission, and the trade date for multiple purchases would be the date of my last purchase.  As shown in the table the unrealized gain is close to $7,500.  The realized gains and losses include commission costs.   The yield shown on this table is at the closing price from 12/31/2010, and not at my cost.  The dividend yield in virtually all cases would be higher, sometimes much higher based on my total cost.   All of the banks in category 1 of this strategy, except for WBS, have been sold.   I may start to add some of those back, not as part of the regional bank basket, but as lottery tickets.  Last Friday (12/31/2010), a number of the banks in this portfolio fell in the last fifteen minutes of trading, impacting the unrealized gain number by about $500.  

3. STATUS OF VIX ASSET ALLOCATION MODEL:  This is an update of the current status of the Vix Asset Allocation Model, last discussed in August 2010:  Current Status of The Vix Asset Allocation Model Signal (August 2010)

 The ^VIX has been continuously moving below 20 starting on 12/2/2010.  ^VIX Historical Prices  During the month of December, the DJIA rose 5.2%, almost 1/2 of the 11% increase for 2010.   The continuous movement in the VIX below 20 is bullish, but I will require three months of such movement before declaring the formation of a Stable VIX Pattern.   Some movement below 20 is also consistent with the  the Unstable VIX Pattern. In that pattern, a movement below 20 will soon be interrupted by another surge in the VIX, as it moves back into the mid or high twenties, possibly spiking into the low 30s.  That movement would be accompanied by a market sell-off which is what happened when the VIX spiked in April 2010 after moving below 20 for several weeks.   VOLATILITY S&P 500 Index Chart   During the Unstable VIX pattern, the movement below 20 would provide an opportunity to lighten up on stock positions and to establish hedges for a stock portfolio.    Then, when volatility spiked again, moving back to the high 20s or low 30s, stocks could be re-purchased and the hedges sold.    This is a characteristic of the Phase 1 movement of the Unstable Vix Pattern:  Vix Asset Allocation Model Explained Simply  Multiple Confirmations of VIX Model-Canary in a Coal Mine VIX and S & P Compared 1990 to 1997 VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern Vix Charts from 2004 2005 2006 Stable VIX Patterns Phase 1 and Phase 2

The market has been in an Unstable Vix Pattern since the Trigger Event in August 2007: VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern  That trigger event mandated both a reduction in stock exposure and a far more active trading strategy.    During the Unstable VIX Pattern, buy and hold investing is mostly thrown out the window, and my trading activity will hit close to a 1000 trades per year.   Some long term positions can be added during the catastrophic phase of the Unstable VIX Pattern, which I refer to as Phase 2.  I would wait until the market has declined at least 50% before doing so however.  The catastrophic phase lasted from late September 2008 until early Spring of 2009, hitting a crescendo in the first week of March 2009.  During the prior long term secular bear market, which started in 1965 and ended in August 1982, the catastrophic phase hit its nadir in October 1974

To form a Stable Vix Pattern, I will require three months of continuous movement below 20, allowing for some minor and temporary movement above 20 during that 3 month period.   For as long as the Unstable VIX Pattern remains in force, I am cautious and following a hyper-active trading strategy.   Once the Stable VIX Pattern forms, I will not be inclined to add hedges, and I will increase my long stock position.  More importantly, I will gravitate to buy and hold at least until the next Trigger Event.    

Headknocker has decreed that no more than 2 trades per week may occur during a Stable Vix Pattern. 

4. MKZ and the DJ UBS Commodity Futures Index (own 100 MKZ):  The DJ UBS Commodity Futures Index rose 2.7 or 1.69% last Friday to close at 162.39.   As noted in a post from last June, MKZ will revert to its 3% guarantee if there is a single day where this index closes above 165.8198 during the second annual coupon period (round to 165.82?).   Item # 4 MKZ  Given the spurt in this index, I would view that reversion event to be highly likely at this point. The second coupon period ends on June 23, 2011.   Pricing Supplement at page PS-2.

According to Fidelity, a majority of their customers do not understand this security and therefore none of their customers can purchase it now.  

If by chance there was no close above the reversion level of 165.82 before the closing date, then it would be likely that this security would pay more than its 3% guarantee.  A close at 162 on 6/23/2011, with no reversion trigger before then, would be a 27.98% increase from the starting value of 126.578 (6/23/2010 close), which would translate into an annual interest payment of $270.98 on 100 shares.  Most likely, the payment will be $30, based on the 3% guarantee, on my 100 shares. So, as the OG is fond of saying, you place your bets and take your chances.   

5. Retirement Accounts 2010 Performance and Ruminations on a Possible 2011 Strategy for the IRA accounts:  My retirement accounts are heavily weighted in bonds.  At the end of 2010, the stock weighting was probably less than 2%, consisting entirely of stock CEFs like BCF and JSN that have high dividend yields.  When judging my performance for the year, I will use as a benchmark the Vanguard Total Bond Index mutual fund, VBMFX, or its total bond market ETF, BND .   This low cost bond fund was up 6% in 2010 according to the table at I was up about 11% in my retirement accounts for 2011.  I suspect that 2011 will be a  down year for those accounts, including interest and dividends, unless I change my strategy.  In other words, I anticipate that my bonds will lose value in 2011, if held for the entire year, in an amount exceeding the distributions paid by them. 

My performance was roughly in line a mixture of the  Vanguard Intermediate Term Investment Grade  bond fund (VFICX)  and the Vanguard High-Yield Corporate bond fund (VWEXH), weighted about 80% in favor of VFICX.   I would also look for comparison purposes at a mixture of those two funds and include the   Vanguard Long-Term Investment-Grade bond for about 1/2 of the investment grade weighting since I have a number of long term investment grade corporate bonds in my IRA accounts.  No matter how I look at it, I performed just about in line with those benchmarks after substantially outperforming them in 2008 and 2009.  Of those mutual funds, I own only the Vanguard Intermediate Term Investment Graded and I pared it toward the end of last year. 

I anticipated a modest performance from bonds at the beginning of 2010:  2010 Strategy/Interest Rate Risks- Bonds

When discussing the reasons for my outperformance in 2009, I made the following comment in that post from 1/1/2010:  

"The first reason for the huge percentage gains was the performance of REIT preferred stocks, Trust Certificates, Trust Preferreds, floating rate preferred stocks, European hybrids, synthetic floaters and other bond like securities. For those who read this blog regularly, you might be under the mistaken impression that investing in TCs, TPs, European hybrids, & preferred stocks was something ordinary and business as usual here at the trading desk. Actually, prior to October 2008, I would doubt more than 10 grand was devoted to those sectors in total over the ten year period prior to 10/2008. Those types of securities were viewed as worthwhile during their meltdown period so concentrating buying activity in them was an exception to normal trading activity. So the shift of assets into those sectors was viewed more as a one off event, a brand new development, possibly a once in a lifetime opportunity for someone my age, a very spry 58 years old. This opportunity has now passed.

Staff here at HQ does not expect any further capital appreciation in these securities as a group, and will test this thesis by keeping a list of the year end 2009 and 2010 values. However, given the income generation, most of them will be kept."

For anyone interested in these mutual funds, referenced above, information about them can be found at the Vanguard web site:

Vanguard - Intermediate-Term Investment-Grade Fund Investor Shares - Overview
Vanguard - Long-Term Investment-Grade Fund Investor Shares - Overview
Vanguard - High-Yield Corporate Fund Investor Shares - Overview

Vanguard also offers several ETFs in these bond categories: 

Vanguard - Intermediate-Term Bond ETF - Overview (BIV)
Vanguard - Total Bond Market ETF - Overview (BND)
Vanguard - Long-Term Bond ETF - Overview (BLV)
Vanguard - Intermediate-Term Corporate Bond ETF - Overview (VCIT)
Vanguard - Long-Term Corporate Bond ETF - Overview (VCLT)
Vanguard - Short-Term Bond ETF - Overview (BSV)

I do not own any of those bond ETFs.   I sold out of both  BND and BSV in 2008 at $79, in order to focus more on individual bond selections. For BND: Is it Safe is not the Right Question. Instead Ask What are the Risks & Rewards/Assume Lost of Principal Possible See also:  Total Bond Market Index (BND) and IEF as Non-Correlated Assets to Stocks (May 2009);  Links to Fed Tables: Real & Nominal Rates/Dividends & Interest/The Importance of History in the Investing Process (DEC 2009); What is the More Rational Prediction for the Future-Inflation or Deflation (July 2010);   Coping with the Federal Reserve's Jihad Against Savers & Responsible Americans & the Potential Major Correction in Bonds Down the Road (August 2010);  Item # 1 Impact of Rising Rates on Bond Prices & Item # 2 Interest Rate Risks- Bonds, see also SIFMA's discussion at Rising Rates and Your Investments)

BSV closed at $80.45 last Friday.  BND  closed at $80.27. 

I currently anticipate that the decline in bonds will gather steam as 2011 progresses.    Junk bonds may continue to outperform investment grade bonds, particularly U.S. government debt of comparable maturities.    That outperformance may just be losing less. 

I am in general agreement with the opinions expressed by Ben Inker in his Barrons' interview that bonds yields are "too low, for the most part" and do not adequately compensate investor's for their risk.   Inker does recommend buying New Zealand and Australian government debt, however, since both governments have the capability of actually paying back their obligations and the yield is in excess of the expected inflation rate.    As noted in a prior post, I expect the U.S. to default on its debts sometime in the 2020 to 2025 time frame, which will be manifested by a series of failed treasury auctions.  It could happen sooner than 2020, but not later than 2025. {The 79 million baby boomers have just started to draw on Social Security and Medicare.  A History of the Baby Boom  The gross debt of the U.S. in 1980, just before Reagan took office, was 909 billion, United States public debt.  The fiscal 2010 deficit was 1.3 trillion dollars and 1.42 trillion in F/Y2009.  CBO  The deficits are likely to be in excess of 1 trillion in the 2011 and 2012 fiscal years.   The main wild card now is how much will the interest cost on the debt increase after hitting 413 billion in 2010, Government - Interest Expense on the Debt Outstanding, when the treasury was paying almost zero interest for treasury bills: 3 month treasury bill rate-monthly data since 1982:; 6 month treasury bill rates monthly data since 1982:; five year treasury note monthly data since 1953:  www.federalreserve; 30 year treasury bond yields since 1977,  A return to more normal interest rates could easily balloon the annual debt service cost in a few years to over 1 trillion dollars per year}

While I am not inclined to make major changes, I will probably need to be more aggressive with the investments purchased with the cash flow generated in the retirement accounts.  Part of that increased risk will be the incorporation of the LOTTERY TICKET strategy in the ROTH IRA account, which has been forbidden up until now.   Under that strategy,  I can spend up to $300 buying shares in a beaten down common stocks.  In the Roth, that purchase could only be made with interest received from the bond holdings.   Some of the LTs under consideration would be regional banks sold last year, primarily those in Category 1 of the  Regional Bank Stocks basket strategy. 

Another alternative would be to buy a small number of junk rated bonds, maturing in the 2015 to 2020 time frame, where I believe that the company has a good chance of survival,  a decent capital gains potential due to the purchase at a  discount to par value, and an interest rate in the 8% to 15% range.   I have purchased already some of those bonds in very small amounts in a taxable account.  

I would add that my IRAs are not important to me.  If I have need them, I will be in a mess financially, and the money will need to be there.  That  is one reason why I manage them so conservatively, and I do not try to shoot the lights out.   Still, I want to do better than a bond ETF or a bond mutual fund.  And I want to generate a positive return even when bonds decline in value.  To accomplish that last objective in 2011, I believe now that I will have to do something different than what I have done between 1/1/2008 to 12/31/2010, as documented in this blog starting in October 2008.    

6. Bought 50 PYS Position at 22.6 on Friday (see Disclaimer):   PYS is a trust certificate and that certificate represents an undivided beneficial interest in the assets of a Grantor Trust which consists of senior bonds issued by RR Donnelley.   I sold my last 50 shares of PYS at  24 last November, shortly after this security went ex interest for its semi-annual payment.  I bought those shares  at 19.59 last June. 

The underlying bond and the TC mature on 4/15/2029.  The TC has a $25 par value and a 6.3% coupon.  At a total cost of $22.6, my current yield would be about 6.97%, hardly worth a 50 share buy in my opinion.  The YTM would be better due to the discount to par value.  I came up with a YTM of 7.4% using the Morningstar Bond Calculator: Yield to Maturity.

Interest payments are made in April and October.

Finra Information on Underlying Bond: FINRA 
PYS Prospectus:
Underlying Bond Prospectus:

The FINRA data shows that the underlying bond is rated investment grade and is currently trading near or slightly above its par value, depending on the trade and the day.   The coupon on the underlying bond is 6.625%.

 Trust Certificates: Links in One Post 

If for some reason the underlying bond continues to increase in value, further above its par value, there is a possibility of a call by the owner of the call warrant.  That exercise can not occur before 4/15/2011. 

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