Wednesday, August 24, 2011

FFBC Colt Defense/Making Your Own Informed Judgments/Bad Choices/Junk Bonds-Positive Correlation with Stocks/Perry's Texas Style Crony Capitalism/SOLD 100 BDF at $18.85

When I own a bond, I would not ask anyone why it is going down or up. I would make that judgment for myself.  An investor really has to do that kind of assessment for themselves.  I may have an opinion, but another investor looking at the same facts could disagree with me and be right.

Junk bonds are now going down as an asset class due to fears about a recession. I would view junk bonds to have a positive correlation with stocks. And this can be seen by overlaying a chart of a junk bond ETF with the S & P 500:

5 Year Chart: Blue is Junk Bond ETF HYG and Red is S & P 500

Both started to rise in tandem in March 2009, both fell a lot during the Dark Period, and both asset classes have declined recently based on the same recession concerns.  Those concerns raise legitimate issues about the credit risk of junk bonds. In addition, junk bond mutual funds are experiencing redemptions which causes even more selling.

Some junk bonds will lose more than the average based on quarterly results and/or other news such as a downgrade in credit ratings. Earnings releases for private companies who have registered their bonds can be found at the SEC website: Company Search. There is no excuse other than laziness for refusing to review filings at the SEC. For example, the Colt Defense bond has lost value and it is not difficult to ascertain why by simply reviewing the earnings report. The company is losing money and eating up its cash, as inventories swell. Form 10-Q for Q/E 6/2011 This is not brain surgery. I own just one bond and stated earlier that I would buy no more after reviewing the 2011 first quarter report which presaged the second quarter.

An article written by Peter Fisher, head of Blackrock's fixed income group, points out that volatility and low rates makes the world a riskier place for investors.  Morningstar.

The abnormally low rates force investors into riskier assets which are becoming more volatile for a variety of reasons. The risk of principal loss is significant. If a 1% to 2% yield on savings is inadequate to fund expenses for a retiree, then there is a risk going with that option. That risk has to be compared with the risk inherent now in reaching for a more satisfactory yield. It is a difficult balance to reach given the length of the  Federal Reserve's Jihad against the Saving Class, likely to continue for at least two more years.

One way to deal with these two undesirable choices is to keep savings tilted toward preservation of capital and to cut discretionary spending, obviating at least to some degree the need to earn more on savings.  For the OG, that would mean moving from the normal spendthrift frugal mode to the extreme you have got to be kidding frugal mode (i.e. no renewals of magazine subscriptions, temperature set two degrees higher at HQ, coasting down all hills with the Saturn, no new clothes purchases unless a pair of socks has a hole the size of a fist; cutting down on snack foods including hershey kisses; no more popcorn; washing clothes and dishes only with full loads; and no new book purchases-just read what has not been read in the large HQ library) And that is not because I have to do it.  

The treasury sold 35 billion in two year notes yesterday at a yield of .222%, a record low. Historical treasury bond, note and bill yields can be downloaded from the Federal Reserve's website: FRB: H.15 Release--Selected Interest Rates--Historical Data In September 1981, the two year note hit a 16.46% yield. Between October 2005 to October 2007, it fluctuated mostly in a 4% to 5% range.  

As noted by Kurt Andersen in his NYT opinion column, true believers like Rick Perry and Michele Bachmann really do believe in their reality creations.

I previously referenced an article in the WSJ about Perry's version of crony capitalism, where state grants, contracts and tax favors appear to be dependent on donors making large contributions to his campaigns. A similar article with more detail can be found in Sunday's NYT. Many of the TBs would look with disfavor on such news items but are unlikely to ever come into contact with accurate information. So Perry is in no danger of having his record examined by TBs with reliable information in tow.

I do believe that low tax states like Texas and Tennessee have an advantage, particularly now, compared to high tax states like Illinois, California, New York, Massachusetts and New Jersey. Several firms have relocated to my region from those high tax states, which also have higher costs in most living expenses.

During downturns in the stock market, no matter how severe, I will continue to use cash flow to buy common stocks. This will in effect mean small purchases spaced out over time. While I receive a constant flow of interest and dividend payments, most of the distributions are paid at or near the end of the month or on the 15 day of a month, with the highest amounts paid at the end of each calender quarter.

This strategy, which is my most basic one, places a premium on reliable cash flow. The stream of income from senior bonds is more reliable than common stock dividends as shown by events during the recent Near Depression period. In 2009, more than 800 firms reduced or eliminated their dividends. That is not an option for the issuer of a senior bond, short of bankruptcy. In the common stock universe, I would not regard any bank dividend as safe. Dividends from consumer staple companies are generally more reliable, and I will be interested in buying their stocks during serious stock downturns. Dividend paying companies are not immune to stock downdrafts.

I will do most of my buying of consumer staple stocks during major cyclical bear markets.  While I do not expect that PG or PEP will fall below $50, an entry level point for the catastrophic phase of the current long term bear market occurring between September 2008 to March 2009, I would look to buy shares at below $55, possibly starting a position at below $58.  Bought PG at $47.59 (March 2009 Post); Pepsico Buy (May 2009).

The Richmond Fed released its survey of manufacturing which showed a "marked" pullback in August. The composite index decline to -10, indicating contraction. richmondfed.pdf

The government reported that new home sales for July fell to a very anemic seasonally adjusted annual rate of 298,000.  The competition for homebuilders is coming from foreclosed homes that make up about 33% of existing home sales. In short, new home construction is in a major rut and not likely to climb out of it for a long time and consequently will not be providing any impetus to job creation or GDP growth.

The market may have rallied yesterday based on the hope that the Fed will ride to the rescue, again, as maintained by the news headlines. WSJ  Maybe so, but that is a false hope. There is no magic left in the Fed's bag of magic tricks that would change the course of the economy for the better.  Something could be done in Washington to keep the nation from sliding into another recession, but that is highly unlikely to happen.

Another explanation is that the market is reassessing the odds of a recession in a manic depressive state. I mentioned in yesterday's post that the market had driven bank stocks down to levels that would only be consistent with an ongoing recession, and that result was assuming a condition not yet in evidence so to speak. Item # 2 Averaged Down: Bought 30 FMER at 11.35, 50 TRST at $4.01 and 40 VLY at 10.58

The Baltic Dry Index has turned up in recent days. BALTIC DRY INDEX

1. Sold 100 BDF at $18.85 Yesterday (see Disclaimer): This bond CEF was bought in two lots last November.  Bought 50 BDF @ 17.73  Bought 100 BDF @ 18.46 (previously sold 50 of this 100 lot using FIFO accounting) So, I collected a few quarterly dividends and made a profit on the shares. I am content with that result.

I bought two higher yielding junk bonds to replace BDF which I will discuss in the next post.

2. First Financial Bancorp (FFBC)(own: regional bank stock basket strategy): First Financial Bancorp announced that it will start paying out 100% of its quarterly net income in dividends. This will result in a 12 cent regular dividend for the second quarter plus an additional 15 cents based on the reported net income for the second quarter. This new policy was initially announced in late July when the bank reported its second quarter earnings: First Financial Bancorp Reports Second Quarter 2011 Financial Results 

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