Wednesday, July 13, 2011

The Real Cost of The Federal Reserve's Jihad against the Saver Class/Alcoa (AA)/Bought 50 CYS at 12.97/Added 50 of the Bond CEF PSY at 10.18

A recent article in Forbes identified Nashville as #3 on its list for the next biggest boom towns. Forbes I would put Nashville higher than # 3.  One reason has to do with its location.  With several interstate systems intersecting (I-24, I-65, and I-40), products can be delivered to a large part of the U.S. population within one day by truck. The city is also located on the Cumberland River, and has several lakes (Old Hickory, Percy Priest & Radnor). Water is plentiful. The airport is relatively new and large. Nashville may be one of the better managed large cities, and property taxes are low compared to other large cities. Tennessee has no income tax on earned income. The city is home to several universities, and is already has significant positions in several industries including healthcare (e.g. HCA) and music. Even the Democrats that control the city government are business friendly as noted by the Forbes columnist.

The treasury auctioned almost 32 billion in three year notes yesterday, priced to yield .67%. While politicians from the two tribes trade jabs on the borrowing limit, Uncle Sam is able to borrow whatever it wants at ridiculously low rates.

Gold spurted after the release of the Federal Reserve minutes for their June meeting. 24-hour Gold  Some Fed members raised the possibility of more easing, though others were concerned about inflation:

"Against this backdrop, members agreed that it was appropriate to maintain the Committee's current policy stance and accumulate further information regarding the outlook for growth and inflation before deciding on the next policy step. On the one hand, a few members noted that, depending on how economic conditions evolve, the Committee might have to consider providing additional monetary policy stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run. On the other hand, a few members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant the Committee taking steps to begin removing policy accommodation sooner than currently anticipated." FRB: FOMC Minutes, June 21-22, 2011

It would not be surprising to see MTY suffer a maximum level reversion today. Stocks & Politics: MTY

As previously noted, the GOP is extremely reckless and irresponsible in tying anything to their approval of a debt limit increase. Their Senate leader, Mitch McConnell, made a statement yesterday, that indicated to me that the GOP was engaged in political brinkmanship on the debt limit issue for the purpose of defeating Obama in 2012. Then, the GOP could force through their tax decreases for the super wealthy and cut programs like Medicare and food stamps that benefit the poor and middle class. GOP Comes Out of the Closet on Medicare Undoing Medicare: The Real 'Death Tax The GOP Budget Plan and The Middle Class Ryan Budget Would Slash SNAP Funding by $127 Billion Over Ten Years — Center on Budget and Policy Priorities  David Stockman and the GOP/GOP Reaffirms Commitment to Ryan's Plan for Medicare, Medicaid and Food Stamps

This is the statement made by McConnell: “After years of discussions and months of negotiations, I have little question that as long as this president is in the Oval Office, a real solution is probably unattainable.”  McConnell made it crystal clear that his most important priority was not the credit standing of the United States, but defeating Obama in 2012. 

Senator Kyl was standing next to McConnell when that statement was made. It was Senator Kyl (R-AZ) who was ready to shut down the government earlier in the year, based on the Democrat's refusal to cut 363 million dollars in funding for family clinics. (see Steven Colbert's take on the false statement made by Kyl in support of his position).

I of course realize that I can do nothing to change what will happen. Nonetheless, it is important to assess what is happening and the potential consequences to plan my family's investments.  If the current GOP House members were in power during the summer of 2008, I would have owned nothing but gold and possibly U.S treasuries and Swiss Francs, and would have had a massive short position on stocks. 

1. The Real Cost of the FED's JIHAD Against Savers: In a recent report authored by Willaim Ford, a former President of the Atlanta Federal Reserve, and Polina Vlasenko, an attempt is made to conservatively measure the negative impact resulting from the  Federal Reserve's Jihad against savers. During 2010, Ford and Vlasenko estimate that the Fed's artificially low interest rate caused a 1.75% reduction in U.S. GDP due to a 256 billion reduction in spending. The savers have seen their incomes drop as a result of the prolonged Jihad conducted against them by the Federal Reserve, and have consequently reduced their spending. 

Interestingly, the authors estimate that the loss of consumption has resulted in 2.4 million fewer jobs.  While these numbers are at best estimates, I would certainly agree that the Fed's Jihad is doing more harm than good now, and has resulted in substantial reductions in discretionary spending by the saver class, including most retired people living trying to live on social security and their savings. Those folks are not earnings anything on their savings now, and that has forced many of them to consume their principal. This has not gone unnoticed by them. That process would naturally result in the curtailment of discretionary spending by the saver class, and has had a profound negative ripple effects for the U.S. economy. The FED is causing more harm by persisting in the abnormally low interest rate policy, particularly in light of the true cash inflation rate eating more into savings. 

The report is available to members of the American Institute for Economic Research. AIER's Research Briefs I have discussed this negative influence on consumption in prior posts, a fact that is never mentioned by the Federal Reserve. For example, I made the same point in a July 2010 Post (Second paragraph from the top) The article published at AIER is discussed in a newspaper column, written by Richard Grant, published last Sunday in the Nashville Tennessean. Frequently, a link to articles in the Tennessean will at best work for a few days.

2. Bought 50 CYS at 12.97 in the ROTH IRA Last Monday (see Disclaimer): I have recently added some low yielding Synthetic Floaters in the ROTH IRA. The small add of 50 shares of CYS balances that out some.  Cypress Sharpridge Investments is a mortgage REIT that borrows money short term to buy agency securities. The current dividend is 60 cents per share which gives me a dividend yield of around 18.5%. This company was mentioned by Randall Forsyth in one of his recent Barrons' columns. Cypress was a recommendation made by an analyst at Stifel for the reasons discussed in Forsyth's column.

On Monday, the stock declined 16 cents or 1.22% to close at $12.97. I may average down by buying another 50 shares at below $12.5. Fear of a U.S. default could send the shares of mortgage REITs investing in GSE securities tumbling. If the market starts to question the U.S. ability to back the GSEs, then these mortgage REITs will not fare well. So these kind of investments may have more risk than normal at the current time due to the crazies.

I am also wary of mortgage REITs due to their use of leverage to generate income. I have never borrowed money to buy investments myself. I have no debt.

The Mortgage REITs are in a favorable environment now given the abnormally low short term rates that provide them with a nice spread. When short rates start to rise, and the value of the securities bought with borrowed funds decline, these firms will suffer. Hopefully, I will be able to exit my position for a small profit when the worm turns against them, and it will. Given the high dividend yield, an excellent return in the ROTH is possible simply by collecting a few dividends and selling the shares at a $1 profit or even at a small loss.

The manager at Cypress is Kevin Grant, who has a lot of experience with mortgage securities. He used to manage Fidelity's Mortgage Securities fund and other bond funds. Cypress Sharpridge Investments, Inc | Leadership

Cramer is suspicious about how CYS is able to pay the big dividend. I have no comment one way or the other. If you are able to borrow a ton of money at very low rates, and buy higher yielding mortgage securities that may even be increasing in value, allowing the managers to reap some capital gains, there is room in that model to make and lose a lot of money. I personally stay away from leverage due to the "losing" money part of that equation. I am not adverse to nibbling at some of these mortgage REITs now, with no expectation of actually making money on the shares. I simply hope to avoid losing money on the shares while collecting a few dividends.

Cypress Sharpridge Investments closed at $13.01 in trading yesterday, up 4 cents.

This article published at Seeking Alpha discusses 6 Mortgage REITs, including CYS, that yield over 13%.  Two other mortgage REITs, Hatteras Financial (HTS) and Capstead Mortgage (CMO), are discussed favorably in this article published on Monday, written by Dimitra Defotis. Those two REITs invest largely in adjustable rate mortgages backed by Fannie, Freddie and Ginnie Mae. Dimitra also mentions the ETF REM. I own 200 shares of REM.  Added 100 of REM at 15.12

iShares FTSE NAREIT Mortgage PLUS Capped Index Fund (REM) closed at $14.82 yesterday, down 10 cents, after its largest holding, Annaly Capital Management, declined after selling 120 million shares at $17.7.

I also own 50 shares of MFA Financial in the ROTH IRA which went ex dividend for its quarterly distribution yesterday. Bought 50 of MFA at 8 in ROTH IRA

3. Added 50 of the Bond CEF PSY at $10.18 Last Monday (see Disclaimer):  In my taxable accounts, I last bought shares in this closed end fund @ 10.53 and at $10.1 last November and December respectively. I have not sold any shares in that taxable account but have flipped shares of PSY owned in the ROTH IRA.

This fund is classified as an investment grade bond fund, though it owns some junk bonds.  As of 3/31/11, the junk weightings included 17.3% in BB; 6.2% in B; and 1.5% at CCC: PSY : Fund Profile

For reasons that are not clear, the sponsor of this fund, Blackrock, is frequently unable to compute its net asset value  after the market close, until the next day.  I find that disconcerting.

For some reason, the shares rallied after my purchase and closed at $10.3 on Monday.

The fund is selling at over a 11% discount to its net asset value: PSY: Fund Profile CEFA - Closed-End Fund Association As of 7/11/11, the net asset value was $11.62 per share. Based on a closing price of $10.30 that day, this created a discount to net asset value of -11.36%.

Distributions are paid monthly at the current rate of $.0535 per share, which was recently reduced last November from 6.35 cents. PSY: Fund Profile I would prefer a dividend cut to a return of capital, but other individual investors will sell whenever there is a dividend cut to avoid a return of capital.

At a total cost of $10.18, I computed the dividend yield at 6.31%. Better than nothing, which is the rate on the money fund used as the source of funds to make this purchase.

This is a link to the last SEC filed shareholder report for the period ending in April 2011: Semi-Annual Report  The PSY holdings start at page 22.  I also own over 400 shares of BTZ, which is also included in this report. Those two funds have similar holdings.

PSY is a leveraged bond fund.

BlackRock Credit Allocation Income Trust II (PSY) closed at $10.3 yesterday and is ex dividend today for its monthly distribution.

4. Alcoa (own): Alcoa reported revenues of 6.59 billion, a 27% increase, and earnings of 32 cents per share excluding items. There was some disagreement among news organizations about the consensus estimates on both revenues and earnings. The revenues exceeded any of the consensus forecasts. AA stood by its prediction of 12% growth for aluminum demand this year and a doubling of demand by 2020.  AA did call the economic recovery "uneven".

I have a small position in Alcoa, with some shares bought in the open market at at $5.6 in March 2009at $10.95 last July and at $ 15.75 earlier this year. As mentioned in that last linked post, I hope to realize over a $1000 gain on the shares and then use that profit to buy 1 Alcoa bond. I prefer to wait until I can buy that bond with an 8% yield. AA bond yields are currently nowhere close to that number.    FINRA List Alcoa Bonds I briefly had a thousand in unrealized profit before AA corrected in price, but I decided to hold onto the shares long term or until I could buy that bond with an 8% yield with my profit on the common shares.

163.646 AA Shares +$800.6 as of 7/9/2011

For reasons that can not be rationally explained, the OG is reinvesting the meager dividend to buy additional shares.

Alcoa fell 20 cents in trading yesterday to close at $15.71.  

1 comment:

  1. re: PSY- they were chasing ahead of ex-div date today, I've had bad results buying a day(s) before ex-div dates, and this has a habit of going down after, look at June. Longer term probably ok. I stopped buying CEFs because liquidity dried up and can't get out if needed.