Friday, August 5, 2011

Bought 50 WIN at 12/Bought 1 Select Medical 7.625% Senior Subordinated Bond Maturing 2/1/2015 at 98.21/VIX and Trading Rules in An Unstable Vix Pattern Within the Context of a Long Term Secular Bear Market

The market downdraft yesterday was primarily tied to the European sovereign debt problems.  MarketWatch That caused panic among many investors, whose worries about the European sovereign debt crisis became even more acute. Those concerns were reflected in the downdraft in both European bank shares and their hybrid securities. The hybrid securities are particularly vulnerable to fears.

Another reason was that the market finally realized that the odds of a double dip recession in the U.S.  had increased significantly based on recent data. The tipping point may have been the GDP report from last Friday. GDP and Inflation-Worrisome (8/1/11 Post). Floyd Norris discusses the dreaded "double dip recession" in his NYT this morning.

So the European sovereign debt problems are getting worse, not better. Is that news to anyone?

There is still excessive debt and now there is an abundance of fear about the possible problems lurking in the future caused by that debt, the need to refinance it, and the slowdown resulting from the Great Contraction of Debt.    Item # 3 Precipitating Cause of Long Term Bear Markets (6/30/11 Post);  The Importance of Identifying the Underlying Causes of Long Term Bull and Bear Markets (6/27/11 Post); Underlying Cause of the Current Long Term Bear Market is Too Much Debt (June 2010 Post).

I liquidated yesterday all of my double short stock ETFs, which were being used as hedges. One of them was up 12% when I sold it. They served their purpose of cushioning the downward market crush. And I now have even more capital to invest after already significantly reducing my stock allocation. (see, e.g.:  LB is In a Slow Mo Trading Mode While Preserving Recently Raised Cash Stash (6/7/11 Post); Item # 2 SOLD: 100 EXC @ 44.67, 100 APF @ 17.47, 50 DLN @ 49.38, 100 PEO @ 30.62, 100 MSFT @ 27.9  (7/27/2011 Post); Sold 103+ of the Stock ETF OEF at $59.98 (7/25/11 Post);  Sold 100 of the stock ETF VV at $60.69 (3/1/22 Post);  Sold 100 VEU at 49.19 (3/3/11 Post);  Jobs (6/6/11 Post).

Generally, under the trading rules for an Unstable Vix Pattern within the context of a long term secular bear market, I am allowed to buy those hedges when the VIX falls below 20. More on VIX AND ASSET ALLOCATION (November 2008);  Trading and Asset Allocation in Stable and Unstable VIX Pattern (November 2008); Continuation of Unstable VIX Pattern/Possible Head and Shoulders in the S & P 500 Forming (7/28/11) I am then required to take them off when the VIX spikes toward 30. This is a mechanical trading strategy once the LB has identified the market as being in an Unstable VIX Pattern.  The  VIX closed yesterday at 31.66, up 35.41% for the day.

The pattern in the Phase of the Unstable VIX Pattern is a whipsaw action in the VIX, mostly between 20 to 30. Vix Asset Allocation Model Explained There are periods when the VIX will fall below 20, and the markets would be enjoying an up move at that time. This is the time that our Left Brain (LB) allows the Old Geezer (OG) to put on the hedge.  The LB does not allow the OG to think too much which makes his head hurt.

Another reason for taking the hedge off, other than a spike towards 30 in the VIX, would be the formation of the Stable VIX Pattern. The last Stable Vix Pattern was obliterated by the Trigger Event in August 2007, which was followed by multiple confirmation Trigger Events, a clear Get of Dodge danger signal under this model. 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 spike in the VIX yesterday was merely consistent with the Phase 1 stage of an Unstable Vix Pattern. I am not too worried unless a Phase 2 pattern emerges as it did in last September 2008. SEPTEMBER 2008: FORMATION OF THE DEADLY PHASE 2 OF THE UNSTABLE VIX PATTERN (May 2009) Heightened Volatility=More Risk=Potential for Lower Prices to Compensate for the Increased Risks (May 2009).

The most important hedge, which I have already accomplished, is to sell stocks until I reach a comfort level.  I started to deploy some cash yesterday in what I would call a typical fashion.  I bought 30 shares of a blue chip company at $33.4, having just sold over 200 shares above $40. I will discuss the trades from Thursday in the next post.  If there is another downdraft in the market today, I may place some odd lot buy limit orders.

P & G's CEO said that his company was preparing for a period of little or no growth in developed countries. I would not question that forecast for PG or many other companies. 

Bill Gross has not changed his pessimistic outlook for U.S. budget deficits, referring to the recent budget deal as one small step toward fiscal solvency: Kings of the Wild Frontier For sovereign bonds, he still favors nations with cleaner "dirty shirts" such as Canada, Brazil, and Germany. He also continues to recommend shading fixed income and equity investments toward non-dollar assets in faster growing developing countries.

Linda Evangelista is asking for $46,000 a month in child support. Video After watching this Video, I understand better now how the super rich create jobs. Perhaps, the Bush tax cuts, originally passed in the 2001 & 2003, and extended in 2010, will soon cause the Job Creators to actually create some jobs. WSJ Article: Bush On Jobs: The Worst Track Record On Record When you credit Bush with the jobs lost in 2009, which were already baked into the cake, then we are still waiting for the Job Creators to create jobs in exchange for their tax breaks.  I do not credit the Job Creators with the temporary jobs created as a result of a bubble in home prices.   "Blondes" and Fox "News"/Irresponsible Fools with Power/Taxes and the "Job Creators"  And the answer is to give them more tax breaks?

The rich are understandably skeptical that any increase in marginal rates will simply be a means to transfer funds from them to the Democrat voters. If either party had their focus on the underlying causes of the nation's predicament, and they do not, there would have been in early 2009 a bipartisan "stimulus" package of at least 1 trillion dollars devoted almost entirely to infrastructure projects over a five to seven year time span, roughly the period of time necessary to recover from a severe recession caused by a financial crisis. This is not what happened.

The Democrats would have had to accept that some people would suffer temporarily and that large transfer payments lasting a year or two solved nothing. Laid off local government workers would have to learn  how to use a shovel. That was the lesson that FDR taught the Democrats in 1933 which has been forgotten by them.

The GOP would have to recognize for the first time that tax cuts for the wealthy were not going to cause a pick up in demand. And the problem now is that private demand is at best lackluster and may recede further with no funds from government picking up the slack. In fact, governments are cutting back spending throughout the developed world, contributing to lower demand numbers and to the unemployment rate with layoffs.  In short, both political tribes in the United States are recklessly incompetent.

Eric Cantor, the GOP leader in the House, has a message for those under 55 now. He did not say it in quite this way, but he said "you are fuc---, get use to it".  WSJ  In case a TB reads this blog, which I doubt, I thought that it might be necessary to translate his comments into a framework capable of being understood.

Bank of New York is starting to charge large customers for holding their cash (WSJ), yet another consequence of the Federal Reserve's Jihad against savers.

For those interested in asset allocation theory, yesterday provided a real time lesson in the correlation of asset classes. Most asset classes have been running together since the U.S. stock market hit bottom in March 2009. (see chart at Item # 2  Unusual Allocation Funds). When this happens, it is hard to find an asset class with negative correlation with the market averages. I did have some securities go up in value yesterday, but not enough.   Excluding the large cash allocation which is very important and the double short stock ETFs, those negatively correlated assets included three Canadian bond ETFs, several investment grade corporate bonds and synthetic floaters, and a few securities like SCEDN and UL.  I will also look for securities with very low positive correlations on a day like yesterday, and I had several of those.  So, I need to work some on my allocation.

For U.S. securities, the most negatively correlated asset classes yesterday were treasury bonds, investment grade corporate bonds and the USD. (see, e.g.,  iShares Trust Barclays 20+ Year Treasury Bond Fund, TLT +3.56%;  iShares iBoxx $ InvesTop Investment Grade Corp. Bond Fund, LQD +.73%; PowerShares DB US Dollar Index Bullish Fund, UUP +1.61%)

Yesterday, the S & P 500 saw 497 of its stocks fall in value.  

1. Bought 50 WIN at $12 Last Tuesday (see Disclaimer): This brings my position up to 300 Windstream shares. I view this position as an alternative to owning the WIN's senior bonds that have lower yields than the common stock. I would consider buying one of the bonds, provided I could make the purchase at below par value and capture a yield greater than 7% for a bond maturing prior to 2021. Windstream Bonds The benefit of the senior bond is that its payout can not be cut. 

At a total cost of $12, the common stock yield is around 8.33%. Windstream is not likely to raise its dividend. A consistent increase in the dividend is one benefit for owning the stock rather than the bond.  For investors buying the common, the question has generally been whether or not it will cut this high payout.  While the dividend payout ratio  was around 150% in 2010, the dividend is supported by free cash flow. S & P estimates that WIN will use about 55% of its free cash flow to pay the dividend in 2011.  S & P rates the common 4 stars with a 12 month price target of $14. 

I have bought WIN shares as low as $6.36. Windstream My last add was 50 shares at $12.46. Item # 5 Added 50 Windstream at 12.46 (March 2011).  I am now near break-even after the shares decline 47 cents yesterday to close at  $11.47. Windstream Corp., WIN Stock Quote 

WIN recently announced an agreement to acquire PAETEC Holdings (PAET) for $2.3, including PAET's debt. SEC Filed Press Release  S & P does not believe that this all stock deal will impact WIN's ability to support the current dividend payout.

Given the dividend yield, taxed currently at the qualified dividend rate, I would be satisfied to sell shares for any profit.  In the event the shares approached that $14 target, I would likely pare my position some. 

Windstream reported net income of just five cents for the first quarter of 2011, down from 17 cents in the first quarter of 2010. The quarterly dividend is $.25 per share. Form 10-Q The debt is high as shown in note 5 at page 11. As of 3/30/11, Windstream had 3.3 million access lines and 1.3 million internet customers in 29 states.   

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

After I published this post, WIN posted earnings for the 2nd quarter, reporting adjusted E.P.S. of 19 cents per share, meeting estimates, on $1.03 billion in revenue. Windstream Reports Second-Quarter Results Adjusted free cash flow was $227 million, a 15% increase year-over-year. Consumer broadband revenue increased 10%. Business services revenues increased 3%. Access lines declined by 30,100 or 3.6% year-over-year.

2. Bought 1 Select Medical 7.625% Senior Subordinated Bond Maturing on 2/1/2015 at 98.21 (Junk Bond Ladder Strategy)(see Disclaimer): A bond in this ladder, issued by Warner Music, is about to be redeemed, and this Select Medical bond is its replacement. The Warner Music bond would have matured in 2014.

Select Medical Holdings (SEM) is a publicly traded company that operates, through its subsidiary Select Medical Corporation, speciality hospitals and outpatient rehabilitation clinics. I took a chance in buying this bond since earnings were going to be released the day after my purchase. It is usually better to wait and make sure that there are no unpleasant surprises.  But, this bond is normally not available in small lots so I went ahead and bought 1 while I had the chance.

This bond is rated well into junk territory at Caa1 by Moody's and CCC+ by S & P.

This is a link to the FINRA Information about this bond.

The bond was originally issued as a private placement and was then exchanged for a bond registered with the SEC:  Prospectus  Interest is paid semi-annually on 8/1 and 2/1.  I paid the seller less than two bucks in accrued interest.

I am rating this bond at a 7+ in my Personal Risk Ratings For Junk Bonds.

Select Medical Corporation recently completed a refinancing of its senior secured facilities.  The company announced that $266.5 million of that refinancing would be use to repurchase the 7.625% note. The senior secured facility includes $850 million seven year term and a $300 million five year term, both expiring after the 2015 senior subordinated note.

Select Medical Holdings announced second quarter earnings after the close yesterday. Excluding a change relating to the early retirement of debt, the company had a net income of 20 cents per share. Net operating revenues increased 20%. The consensus estimate was for 19 cents. SEM Analyst Estimates

My confirmation states that the current yield at my cost is 7.7% and the YTM is 7.955%.

3. Junk Bond Ladder Table: This is how my junk bond ladder table looks now:

Given the risks, I anticipate at least one default and would not be surprised by two or three.  The first default may be in the General Maritime senior bond that I rate at a 10+.

I am tracking realized gains and losses at Item # 5 Realized Gains Junk Bond Ladder Strategy.

See also Item # 5 More on Rationale for Junk Bond Ladder Strategy

Needless to say, junk bonds will not fare well during an economic downturn. Since I am focusing on individual bonds, mostly maturing in 2014 to 2018 time frame, I am concerned with the company surviving to pay off the loan, rather than temporary price declines caused by investor panic and fears. 

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