Thursday, August 25, 2011

The Big Picture Questions/Bought 1 Penn Virginia Resources 8.25% Senior Bond Maturing 4/15/2018 at 98 & 1 Vulcan Materials 7% Senior Bond Maturing 6/15/2018 at 95.5

Many investors want to know what stock or bond to buy. There are more important issues that need to be addressed before an investor drills down to the particulars. I would simply refer to these critical issues as big picture macro issues. You do not need a degree in economics or a pet MIT quant to answer these questions. In fact, it might be beneficial to be free from those types of intellectual restraints. The investor will need to pay attention to what is actually happening in the world, which requires daily reading, and exercise a measure of common sense and good judgment uninfluenced by predetermined rigid ideological constructs. The main questions are as follows:

1.  Is the market currently in a long term bear or bull market, generally lasting around 15 or so years?

2. What are the reasons for the market being in a long term bull or bear cycle?

3.  For long term bear markets, have the underlying causes been remedied?  And, if those causes are close to being remedied, what will likely power the next long term bull cycle?

4. Is the market in a cyclical bear or bull market?

5. And, what asset classes are positively correlated under current market conditions? What is the overall decree of correlation (strong, average or weak), and the main reason(s) for that correlation? 

For stocks, the end of a long term bull market is likely to coincide with excessive valuations. The start of a long term bull market would likely be marked by lower than normal valuations. Historical Shiller P/E10 Ratio for S&P 500 Peaks were reached, for example, in 1929, 1965-66 and 1999-2000. The 1982 long term bull market started with the Shiller P/E 10 below 10.

The current P/E10 ratio is being influenced by two recessions occurring within the past ten years.

In the blow out phase of the long term bull market, valuations become exceedingly irrational. The natural correction process is for the market averages to stagnate for about 15 years as earnings catch up. The market overreacts to the downside, pricing large companies with single digit or low double digit P/Es. 

Those are the most important issues for an investor to answer correctly. Looking back, it would not be difficult to determine that inflation was the primary economic reason underlying the longevity of the 1966 to August 1982 long term secular bear market.

 And, too much debt is the problem now.  Spending borrowed money in rapidly increasing amounts provided fuel for the long term secular bull market that ended in October 1997 (or 2000 for everyone dating it other than me). Once that issue was identified as a potential source of future problems, the investor would be honed into that issue above virtually all others.

I need to answer these questions correctly in order to adopt the most basic trading strategy: buy and hold or trade with constant up and down allocation shifts.  The Roller Coaster Ride of the Long Term Secular Bear Market The Importance of Identifying the Underlying Causes of Long Term Bull and Bear Markets Static v. Dynamic Asset Allocation Long Term Stock Risks and Situational Risk/Managing Lost Opportunity Risk in a Long Term Secular Bull and Bear Markets Historical VIX Patterns  More on Failures of Standard Asset Allocation Models and Target Funds/Use of Volatility in an Asset Class to Make Adjustments to an Asset Allocation Instability & Volatility in Asset Correlations

For stocks, I believe that the market is currently in a cyclical bear market within the context of a long term bear market. I suspect that this long term bear cycle will last another two years. This is at best a guess about the future, subject to constant reevaluation. That belief, which may change based on new data, may lead me at some point to initiate some positions for long term holds, assuming I can see the light at the end of this long dark tunnel. I also acquired some long term positions, still held, during the catastrophic phase of the current long term bear market such as KO at $38.72.

Each long term bear market has at least one catastrophic phase which can occur at any point during the long cycle. Examples of catastrophic phases would be October 1929 to 1933, 1973-1974, and the recent Dark Period from late September 2008 to early March 2009. The catastrophic phase of a long term bear market is defined to mean more than a 50% loss relatively quickly in the S & P 500, usually within a one year period.  There will also generally be a snapback rally after that catastrophic period lasting approximately two or so years, where the market recovers a significant percent of the prior loss but not all of it.  The snapback rally after the 1973-1974 catastrophic phase lasted roughly from October 1974 to December 1976:

S & P 500 in Ongoing Long Term Bear Market Lasting Until August 1982/Catastrophic 1974 Phase and Snapback Rally

1974 or 1982: Start of Cyclical Bull in a Long Term Secular Bear Market or the Start of Secular Bull Market? More on 1982 or 1974 Continued Discussion on 1982 or 1974

Those references to 1982 or 1974 are important. I am asking this question. Is the rally off the March 2009 low a typical snapback rally, similar to 1974 to 1976 or 1933 to 1937, or the start of a long term bull market. The last long term bull market started in 1982 whereas the run starting in 1974 was merely another short cyclical bull market within the context of an ongoing long term bear market. The answer to that question will dictate my trading pattern (buy and hold, or continue the hyper trading and constant allocation shifts appropriate for long term bear cycles). I have answered that question consistently since raising it and have responded in accordance with that opinion.

For bonds, I believe that the market is currently in the final phase of a long term secular bull market which started also in 1982. 

For commodities, I believe that we are in the early stages of a long term bull market.

The GOP was adamantly opposed to Obama's strategy in Libya, as summarized in this CNN article and the House GOP members wanted to defund U.S. involvement. House Republicans

Greenspan does not believe the EU will survive in its current form. He has serious doubt about the EURO surviving.  WSJ  Businessweek  

1. Bought 1 Penn Virginia Resources 8.25% Senior Bond Maturing on 4/15/2018 at 98 (Junk Bond Ladder Strategy)(See Disclaimer): Penn Virginia Resources is a publicly traded partnership that owns coal and natural resources and properties involved in natural gas processing, gathering and related services (midstream assets).  Penn Virginia Resource Partners LP (PVR)  This is a link to the last filed Form 10-Q and to the 2010 Penn Virginia Resource Partners, L.P. - Form 10-K. The long term debt is discussed in note 11 starting at page 90 of the Annual report. 

This is a link to the Prospectus: Penn Virginia Resource Partners, L.P.

This is a link to the FINRA Information on this bond: FINRA According to FINRA, it is rated B2 by Moody's and B by S & P.  My confirmation has the same ratings information.

The confirmation states that the current yield at my cost is 8.35% and the YTM is 8.486%. I had to pay $30.02 in accrued interest to the seller. 

2 . Bought 1 Vulcan Materials 7% Senior Bond Maturing on 6/15/2018 at 95.5 (Junk Bond Ladder Strategy)(See Disclaimer): I discuss Vulcan, a large aggregate company, in a recent post. Item # 1 Bought 1 Vulcan Materials 7.5% Senior Bond Maturing 6/15/2021 at 99.874 in Regular IRA 

Since that post, VMC reported better than expected results for the 2011 second quarter. On an adjusted basis, the company reported net income of seven cents per share, compared to an expectation of a 5 cent per share loss.  The company noted improved pricing in all business segments. SEC Filed Press Release  EBITDA was $115.6 million for the quarter up from $97.3 million in the June 2010 quarter. 

As of 6/30/11, VMC had $106.744 million in cash and cash equivalents. Property, plant and equipment net of depreciation was shown at $3.543 billion. Inventories were at $329.265 million. Short term borrowings were reported at $100 million. Long term debt was high at $2.535 billion. A discussion of the debt can be found in note 11 starting at page 15 of the last filed SEC Form 10-Q: e10vq  The company was able to sell $1.1 billion in notes last June. Five hundred million was raised at 6.5%, maturing in 2016, and another $600 million at 7.5% maturing in 2021. 

This is a link to the FINRA information about this bond: FINRA 

This is a link to the prospectus for this bond:  SEC

Profile |

The confirmation states that the current yield is 7.268% and the YTM is 7.706%. This bond is rated Ba 1 by Moody's and BB by S & P.

Both of the junk bonds bought last Tuesday are of higher quality than the average bond in my junk bond ladder strategy.

These two bonds are viewed as the substitutes for 100 shares of the lower yielding bond CEF BDF sold on Tuesday.  I am attempting to increase my cash flow without dipping much into my cash stash raised primarily from a significant reduction in my stock allocation.

I am rating both of these bonds at "6" in my Personal Risk Ratings For Junk Bonds.

This article in the WSJ, titled "Rush Out of Junk", summarizes what has been happening in the risky junk bond market over the past few weeks. Returns in August from the Barclays Capital U.S. HIgh Yield Index has fallen to a negative 5.1%, the worst performance since November 2008. Selling appears to be widespread. The yield spread in the Barclay's High Yield Index over treasuries has expanded to 7.66%, the highest level since November 2009.  In the event the U.S. falls into a recession, junk bonds will continue to underperform investment grades bonds with similar maturities.  I would expect them to outperform the investment grade corporates when it becomes evident that the economy is once again picking up a good head of steam. 

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