Monday, August 8, 2011

Bought 30 MDT at 33.4/Bought 50 NLY at 17.5/Need for a New Centrist Party/S & P Downgrades U.S. Debt-Net Short on U.S. Debt/Bought 50 KCW at 24.9/Bought 200 ACG at 7.85

S & P downgraded U.S. debt one notch from AAA to AA+ last Friday and kept its outlook at negative. WSJ   NYT   Reuters If the U.S. does not get its act together within the next two years, S & P will likely downgrade the debt again. Another possible cause for a downgrade would be an increased interest cost to service the debt which would make the government's problems even more acute.  A 1% rise in average borrowing costs would raise the debt service cost by about 150 billion dollars per year.

This downgrade is premised in large part on the contentious process recently demonstrated in connection with the debt limit increase. Basically, S & P does not see the two political tribes working effectively to raise revenue, forbidden by the GOP, and to decrease spending "especially on entitlements" which the Democrats will not restrain unless the GOP agrees to a tax increase on the wealthy which the GOP will never do of course. S&P Press Release on Downgrade

The downgrade occurred even after S & P was told of a two trillion dollar math error. WSJ After being informed of this mistake on Friday, S & P acknowledged it, and then changed the rationale for its downgrade. This article just highlights S & P's incompetence. Geithner said last night that S & P showed a "stunning" lack of knowledge about the "basic math" used to develop the U.S. budget. You would think that even the knuckleheads at S & P could at least get their facts straight on such an important event. After all, this downgrade was the most important one ever issued by S & P.

Still, unless the U.S. gets its act together soon, attacking the budget deficits with a balanced approach that includes both spending cuts and revenue increases, a "AA" rating is way too high in my opinion.

A congressional panel ensconced to investigate the causes of the Near Depression called the rating agencies  "essential cogs in the wheel of financial destruction" (page xxv at .pdf), as they rated toxic trash AAA during the housing bubble in order to insure a steady flow of fees and profits to them. UNFIT IN SO MANY WAYS (January 2009); We Drank the Kool Aid (October 2008 Post); Credit and Credibility . NOW on PBS (December 2008);  NYT 2008 Article in its Reckoining Series; MarketWatch Article from 2008.  S & P rated toxic trash AAA when the security should have been rated well into junk at the time of the rating. Investors are right to question their credibility, judgment and competency.  Paul Krugman talks about S & P's chutzpah in this column in the NYT today.

This downgrade was somewhat surprising to me. Most Americans will react with profound disgust to this event. Moody's and Fitch still have the U.S. at AAA but are not exactly enthusiastic about it.  Prior to this downgrade, the U.S. debt has always been rated AAA. Canadian government bonds are rated AAA. I own 400 shares of an ETF that invests in Canadian government bonds. Claymore 1-5 Yr Laddered Government Bond ETF, CLF (traded on the Toronto exchange bought with Canadian dollars)

An interview with Eric Cantor in the WSJ highlights the GOP's intransigence on revenue increases.  Even if the government closes an abusive tax loophole, which raises revenue, Cantor would be unwilling to use that revenue to meet the government's needs. Instead, he believes in revenue neutrality and would use the revenue to decrease marginal tax rates for the wealthy and corporations. One abusive tax shelter that Cantor wants to keep, since the beneficiaries are liberal donors to his campaign, is the carried interest loophole that magically turns hedge fund manager compensation from ordinary income into long term capital gains taxed at lower rates. That just has to be stopped. The weekend WSJ has an article on this particular abusive tax gimmick favored by the GOP. The Washington Post recently ran a story about the money train running from hedge fund mangers to Cantor.

The GOP is demanding that the entire burden associated with a restoration of fiscal responsibility be born by the poor and the middle class, with the GOP benefactors, who now have the new name "Job Creators", receiving more tax breaks. This is one reason why the two political tribes will not be able to work together. I do not see the Democrats cutting benefits for Medicare and Medicaid with the GOP stuck on revenue neutrality or worse, more tax cuts for the wealthy.

The way out of the U.S. deficit problems, advocated by the GOP, would be to elect a GOP President, and a sufficient number of senators to overcome a filibuster, that would streamline the adoption of a radical reactionary agenda on spending, severely impacting both the poor and middle class while leaving the wealthy better off. The Job Creators would get more tax breaks. This may actually happen.

It is not helpful that the GOP routinely engages in reality creation and elevates ideology into a quasi-religious doctrine over facts. As a result of this mental process, the GOP tribe members will never recognize their culpability in creating the current fiscal problems, and are generally incapable of learning anything from contemporary history, let alone the past, due their rigid ideology and reality creation.

The Washington Post highlights a long forgotten piece of information. Before Bush took office, the CBO was postulating that the nation would be able to pay off its debt in ten years. Well, that was before the Bush tax cuts for the Job Creators and the GOP decision to invade IRAQ. There is no balance in GOP politicians anymore.

The more sensible approach would be to form a new political party, the Centrist Party, with only sensible and balanced people allowed to run for office, and for that party to achieve a super majority in both houses and to elect a President. The Centrists could solve the problem quickly with revenue increases and spending cuts, a share the burden approach, and would not consider turning Medicare into a private insurance program supported in part by government vouchers for example. GOP's Plan To Bankrupt the Middle Class Both existing political parties, described here at HQ as recklessly incompetent, would become fringe parties that few would pay much attention to anymore. This will not happen, even though it is the best option.

Another approach would be to give the Democrats a super majority. The Democrats find it extremely difficult to control spending in a meaningful way. Instead of partly funding existing programs with a tax increase, for example, they passed a costly new health insurance program, arguing that new tax increases on the wealthy would partly pay for that new program. Americans sense that this new healthcare program will cost for more than the current estimates and that some of the cost savings will never materialize.  Then, when spending runs out of control, as now, they want to tax the wealthy some more to pay for benefits provided to others, as if there was no limit to that source of funding for the government or any drawback when the total tax rate becomes excessive. The wealthy understand that there is no stop to it, and that the tax code is the chosen method to redistribute wealth.  The electorate got a bad taste during Obama's first two years, concluding that the only way now to control the Democrats is with more Republicans. The GOP mistakes that knee jerk response as support for their reactionary agenda. Controlling Democrats will more Republicans is just another bad option, a cure probably worse than the disease.

In short, S & P is not off base in looking at the political situation when making a decision to downgrade the debt.

Obama is an ineffective leader and has made too many mistakes during his first two years. The stimulus plan needed to be a trillion dollars devoted to infrastructure projects to be built over a five to seven year time frame. That money needed to be spent anyway. The liberals in his party needed to be silenced on these massive transfer payments that accomplished nothing for the long term. The Bush tax cuts should have been allowed to expire at the end of 2010.  Long term tweaks in entitlement programs needed to be made by the Democrats before the fiscal problems in the U.S. gave the GOP the opening so desired by them to eviscerate social programs for the poor and the middle class, and to emasculate agencies like the SEC and the EPA. Their agenda has already been made clear to anyone willing to make observations.  

This is a link to an interactive chart at the WSJ that shows how the U.S. debt to GDP ratio compares to other nations. The U.S. obviously has a problem, and that problem has been caused by those who have had power and the American people who have grown to expect a great deal without paying for it of course.

The Labor Department reported on Friday that nonfarm payrolls rose 117,000 and the unemployment rate fell to 9.1%. Employment Situation Summary The private sector added 154,000 jobs. The government also made positive revisions to the May and June numbers. May was revised from +25,000 to +53,000. The June payrolls increase was revised to +46,000 from +18,000.  The U-6 number declined from 16.2% to 16.1%.  Table A-15. Alternative measures of labor underutilization Approximately 6.2 million people have now been out of work for more than 6 months.  The only reason the unemployment fell is that around 200,000 people gave up looking for a job and left the workforce.

Facts do not matter to True Believers, never have and never will. It is far easier to just create one's own reality.  One of their leading Creators-In-Chief, Rush Limbaugh, said last week that there is no proof that Obama was born in the U.S.A. YouTube  And, then he compared the President to Robert Mugabe, the African corrupt dictator who took away white people's farms. Media Matters for America I can not wait to listen to the GOP candidates grovel in front their kingmaker.

The number of Americans receiving benefits under the Supplemental Nutrition Assistance Program, commonly known as Food Stamps, hit a record 45.8 million in May. SNAP Monthly Data

An example of GOP talking points masquerading as economic analysis is the opinion WSJ column written by Bush's Chairman of the Council of Economic Advisors, Edward P. Lazear, from 2006 to 2008. Maybe George Jr. did not listen to Edward's sage advice and deep understanding of the forces impacting the nation's economy.

Germany reported on Friday that its industrial output fell a seasonally adjusted 1.1% in June from May.

Italy is now in the crosshairs, as explained in this WSJ article. The Italian government appears to be making some headway toward less robust spending. Reuters The Italian government's debt is running way too high at around 120% of its Italy's GDP. The Economist I would not even consider buying sovereign debt issued by Spain and Italy.

Some argue that the only firefighter left in Europe, the European Central Bank, needs to commit to buying €230 to €400 billion in Spanish and Italian government bonds, in order to stem the contagion. WSJ  The ECB announced last night that it "will actively implement" its bond buying program. NYT Hopefully, this action will have a calming effect today.

1. Bought 50 NLY at $17.5 in ROTH IRA last Thursday (see Disclaimer): Barrons summarized a report from Lazard Capital Market on Mortgage REITs. Based on recent economic data, Lazard now believes that the Fed will not start to raise the federal funds rate until the first quarter of 2013. This will benefit those mortgage REITs that borrow short term and buy longer term mortgage backed securities. Lazard raised its rating on Annaly Capital (NLY) to buy and initiated a price target of $19. Lazard also raised its price target on buy rated Cypress Sharpridge Investments (CYS)(owned) to $15.  The Real Cost of The Federal Reserve's Jihad against the Saver Class/ Bought 50 CYS at 12.97

I bought NLY at $17.5 during the market implosion last Thursday, even though the shares were not down much. The shares closed that day at $17.5. I placed the security in the ROTH IRA simply to avoid taxation of the generous dividend.

I suspect that the downgrade by S & P will adversely impact the Mortgage REITs. I discussed this issue just recently. Item # 3 Mortgage REITs and U.S. Debt Downgrade  The major clearing firms have apparently announced that they would not increase the margin requirements on U.S. treasuries, which is good news.

While the dividend of a Mortgage REIT will fluctuate, current business conditions appear to be optimal for a company like Annaly who borrows money short term and uses those funds to buy mortgage backed securities.  That spread is around 2.45% as of 6/30, widening from 2.17% three months ago, with a leverage factor of 5.7 to 1. Annaly Capital Management, Inc. The company recently completed in July a common stock offering of 138 million shares, raising approximately $2.4 billion dollars net of expenses. The shares were sold at $17.7. Annaly Capital Management, Inc. : Corporate Information

I will not be a long term holder of any Mortgage REIT. When rates start to spike, I hope to be out of them. The goal is simply to collect the dividends without losing anything on the shares. 

At a total cost of $17.50, the dividend yield is calculated by Marketwatch at 14.9%, but the dividend will change as shown in the historical information shown at NLY's web site: Annaly Capital Management, Inc. : Dividends

NLY rose 8 cents to close at $17.53 last Friday.

2. Bought 30 Medtronic at 33.4 Last Thursday (see Disclaimer): This was an automated purchase under LB's  myriad trading rules for an Unstable Vix Pattern within the context of a long term secular bear market. I recently sold out of Medtronic, disposing of 209 shares at $40.68. I mentioned in that post that I would not start buying those shares back above $36. I will buy back the shares in small odd lots, averaging down if the opportunity arises.  In the context of this kind of trading, I will focus on financially strong companies that are likely to survive and prosper over the long term. Consequently, I am not overly concerned about catching a falling knife. I am sufficiently concerned about the volatility of the share price that I will only buy small positions.  Given the purchase of only small lots, I actually prefer seeing further weakness in the shares after my initial purchase which will give me the opportunity to average down and lower my average cost over time. I then have the option later on, assuming the shares recover, to sell the higher cost shares bought first, using FIFO accounting. For MDT, I elected in May 2011 to dispose of all MDT shares then owned (209), after making a small pare first.

MDT continued to slide last Thursday after my purchase at $33.4, closing at $32.84.

The stock is rated 5 stars by Morningstar.

The current quarterly dividend is $.2425. At that rate, the yield is around 2.9% at a total cost of $33.4. The ten year treasury closed last Thursday with a 2.414% yield Java Chart - To point out the obvious, a purchaser of that 10 year note at a 2.414% would receive lower distributions than an owner of MDT before any dividend hikes by MDT. And MDT has historically raised its dividend every year. I looked at the dividend data since 2001 and the company has raised its dividend every year. The annual rate was 23 cents in 2001 and is now 97 cents at the current $.245 quarterly rate.

This is a link to the Reuters' Profile Page on MDT and to its  Key Developments Page.

The current consensus estimate is for an E.P.S. of $3.46 in the F/Y ending in April 2012. MDT Analyst Estimates  If attainable, the stock is now selling at less than 10 times forward earnings.  Even if that estimate is missed, there is  a large margin of safety given the low price paid for the future earnings.

MDT rose 47 cents last Friday to close at $33.31.

3. Bought 50 of the Trust Certificate KCW at $24.9 on Friday (see Disclaimer): I have never owned this trust certificate. The underlying security is a 7.125% senior bond, originally issued by U.S. West Communications, one of the Baby Bells.  That company was later acquired by Qwest Communication in 2000, which was recently acquired by CenturyLink (CTL). The coupon for KCW is higher at 7.5% on a $25 par value. Both the TC and the underlying bond are scheduled to mature on 11/15/2043.

I previously passed on this TC due to its maturity date and instead bought another TC that had a Qwest Capital bond with a shorter maturity as its underlying security.  Bought 50 PJA at 19.45  Bought 50 of the TC PJA at 25.06  Bought 50 PJA at 24.65  I also still own 50 of FJA, containing a senior Embarq bond.  Embarq was also acquired by CTL.  So I need to watch my total exposure to CTL. BOUGHT 100 of the TC FJA (May 2009); Bought another 50 FJA at 14.2 (May 2009) Sold 50 of 100 FJA at 24.75 The underlying bond in FJA is also very long term, maturing in 2036.

When Qwest was obligated to pay the interest on the underlying bond, the bond was rated junk. After being acquired by CenturyLink, the bond was raised to reflect CTL's rating which is currently investment grade.

This is a link to the FINRA information on the underlying bond.  According to FINRA, Moody's currently rates this bond at Baa3 and S & P has it at BBB-.

The TC may be called now by the owner of the call warrant by paying par value plus accrued interest.

This is a link to CTL's Profile Page at Reuters and to its  Key Developments page.

4. Bought Back 200 of the Bond CEF ACG at $7.85 Last Friday (see Disclaimer): This is a leveraged bond fund that invests primarily in U.S. treasuries.  I am not a fan of U.S. debt at their current yields. Apparently, based on last week's action, other investors are still falling over one another to buy U.S. debt.  And, treasury securities were negatively correlated with other asset classes during the Great Meltdown occurring after Lehman's failure in September 2009.

I have bought and sold this fund, and I am not a long term holder of it. It would not take much of a rise in short term rates to significantly reduce the fund's yield spread. Bought 200 ACG at $8.12 in Roth (May 2010); Added 400 ACG at 7.85 (May 2010); Sold 200 ACG at 8.35 (August 2010); SOLD 200 ACG 8.45 (August 2010); Bought 300 of the Bond CEF ACG at 7.63 (April 2011)-Sold 300 of the Bond CEF ACG at 7.82 (May 2011). I am satisfied to make a few bucks on the shares while collecting a few dividends.  The alternative is to hoard cash earning nothing.

Morningstar has a 3 star rating on the fund.

Dividends are paid monthly at the current rate of $.04 per share. A continuation of that penny rate would produce a yield of 6.11% at a total cost of $7.85 per share.

As of 6/30/11, 70.26% of the fund's assets were in AAA rated securities. AllianceBernstein Income Holdings The expense ratio is currently .71%.

Closed-End Fund Association Page on ACM
AllianceBernstein Income Fund, Inc.: Last Filed SEC Form N-Q Containing List of Holdings as of 3/31/11
AllianceBernstein Income Fund, Inc.: Last SEC Filed Shareholder Report

I would have waited on this purchase if I had believed that S & P would downgrade U.S. debt.  I have some minor positions in double shorts on the 7-10 treasury notes and 20+ year treasuries that make me net short U.S. treasuries.  The 10 year treasury had its biggest gain last week since August 2009. As of the close on 8/5/11, the yield on the 10 year treasury had fallen to 2.567%. The yield hit 3.74% in early February 2011. Java Chart

I do have a cushion in that ACG had a net asset value per share of $9.03 and closed Friday at $7.86, creating a discount to net asset value of -12.96.  ACG declined some on Friday in response to the early morning rumors that S & P was going to downgrade U.S. debt. So it remains to be seen whether that fall was sufficient to take into account the actual downgrade.

I had some other minor trades from Friday that I will discuss in the next post. I am for the most part trying to increase my cash flow by the purchase of income generating securities that are falling in price.

One topic that I will address in tomorrow's post is the volatility in my disfavored asset classes occurring when investors start to panic. Embracing Volatility as A Risk Management Tool In the Sub-Asset Class of Equity Preferred Stock  There are several different types of securities that are particularly susceptible to wild swings when individual investors start to panic and unload positions indiscriminately. They include closed end funds, where discounts to net asset values start to widen, equity preferred stocks, European hybrids, some trust preferred stocks, and exchange traded bonds with low volumes. I would mention for now, just as an example, the ING hybrid IGK, which fluctuated in value on Friday between $21.46 to $24.78, closing down 70 cents at $24.12 and then falling another 65 cents in after hours trading on Friday. IGK Historical Prices | ING Group, N.V. Perpectual Hybrid Stock I have pared my position in ING hybrids to just a 50 share position of INZ acquired during the Near Depression at $7.82, and I recently sold my last fixed coupon Aegon hybrid.  Sold Aegon Hybrid AEH at $23.09 Bought at $4.63 As a result, I have the capacity to play these bungee jumping securities again.

Aegon Hybrids: Gateway Post
ING Hybrids: Links in one Post


  1. You ignore that the Democrats declined to end the carried interest loophole while they controlled both congress and the white house. The main opposition came from Chuck Schumer who was carrying water for his hedge fund contributors.

    You also ignore that the Democrats have not, contrary to law, put forward a budget for over two years now in the Senate.

    Both parties are concerned primarily with maintaining their own status and privileges.

    While the Republicans are foolish about revenue, the mathematics shows that revenue alone cannot possibly solve the problem. The problem must be solved by a cut in expenditures that will hurt as well as a rise in revenues. Both of these items will hurt Democrats politically, which is why they are so strongly opposed to finding a solution.

    I only bother commenting because I admire your insight on investments. On politics however, for some reason, while you clearly see Republican transgressions and stupidity you have a blind spot for the Democrats. You do criticize them, but only in a cursory way. This is likely to bias your analysis of investments at some point.

  2. I have continually maintained that the approach to the U.S. budget deficits has to be balanced. I mentioned in a recent post that 4 dollars in spending cuts for $1 in revenue increases was a sensible approach. Obama seemed amenable to that approach which is one reason that I was not hard on him on this issue.

    It is the GOP members in the House who are insisting on large spending cuts, as reflected in their recent approval of the Ryan budget which contained substantial tax cuts for the wealthy, reducing their maximum rate to 25% while cutting spending massively in social programs including Medicare and programs for the poor. I would not characterize that as a balanced approach. I do not see the GOP House members becoming balanced anytime soon either which is influencing my investment decisions now.

    Obama did seek to end the carried interest deduction early in his term. The opposition now appears to me to come from politicians like Cantor and Schumer, who has put up road blocks too, no doubt for the same reason as many in the GOP including the Speaker of the House Eric Cantor.

    My point is simple. Those kind of benefits for the super rich have to end and they have to end now, as in today. And Cantor would not use any funds raised by closing an abusive loophole to reduce the deficit or to help pay the government's bills. Instead, like many in the GOP, he believes in revenue neutrality and spending cuts, a totally out of balance approach.

  3. The US spends more on Defense than the next 17 countries added together. Adding in Special Opps, it's well over $1 Tril a year! I heard Simpson say today the automatic Defense cuts, should the commission to cut the budget fail, is classified as SECURITY! NOT Defense! Connect the dots.
    The US is finished. We will be like Japan next 10 yrs will be the 2nd lost decade.

  4. I first addressed the potential parallel with Japan in a blog dated December 20. 2008, and saw then a number of reasons for making a distinction between Japan's plight since 1989 and our own. Some of those reasons still hold.

    However, the recent precipitous decline in the U.S. stock market may be a sufficient trigger event to send an already faltering economy into another recession. The odds are certainly increasing by the day. The government is out of bullets to cushion the fall in the event a recession occurs now, and the possibility of a large contraction is consequently within the realm of possibility. For all practical purposes, except for corporate profits, there has yet to be a recovery from the Near Depression.

    If another recession in fact occurs now, it may take several more years for the U.S. to recover. Five would be my guess, maybe longer. It is therefore imperative for action to be taken right now to shore up confidence, not next week or next month but now.

    That action would include a bipartisan agreement to immediately cut some discretionary spending and end some tax loopholes such as the carried interest tax break for hedge fund billionaires, effective immediately. Those funds would then be used to fund a 200 billion dollar infrastructure build lasting three to four years.

    If nothing is done, like right now, the odds of another recession will increase substantially, and thereby make it more likely that a Japan like experience will happen to the U.S.

    Eric Cantor said today that he was still opposed to any revenue increases. He is, along with all House GOP members, totally lacking in any balance.

    Japan has been in a lost decade since 1989. It is important to avoid that kind of rut.

  5. Inrfastructure build will be all graft and corruption, even S&P said they oppose a "bank" because of that. They will dig holes and fill them with asphalt, then replace with concrete. Rinse and repeat after the contractors take local officials for drinks at the nudie bar.