Friday, August 19, 2011

Sold 200 IGI at $21.52+/CPI/Bought 50 HBAPRF at $19.89/Bought 1 USG 6.3% Senior Bond Maturing on 11/15/16 at 80.98/MORT

In my opinion, the market's decline yesterday was precipitated by an number of coincident factors, including a WSJ story that the Fed was intensifying its scrutiny of European banks' U.S. operations, a cut in U.S. and world GDP growth rates by two brokerage firms, the demand by some European governments that Greece put up cash collateral for further loans, and the Philly Fed survey on manufacturing conditions that was consistent with the onset of another recession. August 2011 Business Outlook Survey In that survey, the general index of current activity fell to -30.7 in August from a positive 3.2 in July. Any reading below zero indicates contraction. The expectation was for a positive 3.7 reading.

Some of these developments suggest that it would not be outlandish to predict the end of the EU, as the more solvent nations refuse to participate in additional bailouts and each nation goes its own way. Another increasing possibility is that there will be further losses on sovereign debt issues as "restructuring" becomes the most viable remaining option.

The market action since late July is consistent with a forecast of a new recession in the U.S., either one that has already started or will soon occur. While the market is far from foolproof in those kind of predictions, it is a barometer for future business conditions that has to be considered with other data. Those other data points, including the manufacturing surveys, the double dip in housing prices, treasury bond and gold prices, recent comments from CEOs about existing and future business conditions, the impact of the negative feedback loop, the worsening sovereign debt crisis in Europe, stubbornly high unemployment and the withdrawal of fiscal stimulus, are consistent with the market's economic downturn forecast.

If a recession is now in progress or about to occur, then buying opportunities are more likely to occur several months down the road, rather than at the outset of a market correction. My downside target for this cyclical bear market is 950 on the S & P 500, which simply means a point where I am likely to become serious about increasing my stock allocation. That level on the S & P 500 was last prevailing in July 2009, ^GSPC, and in October 1997, S&P 500 INDEX.

In this post from May 2010, Stocks & Politics: The Roller Coaster Ride of the Long Term Secular Bear Market, I mentioned that I expected a range bound movement in the S & P 500, mostly between 950 to 1250, through 2012.

According to Reuters, Morgan Stanley cuts its global growth forecasts for 2011 and 2012, saying that the U.S. and Europe were "dangerously" close to a recession. Goldman Sachs cuts its U.S. 2011 GDP forecast to 1.7% from 1.8%, and its 2012 U.S. GDP estimate from 3% to 2%. Even those reduced estimates may be too high.

With this kind of uncertainty, the OG becomes extremely cautious. Stock purchases will mostly be financed from cash flow or the sale of another stock position, at least until valuations become much more compelling or there are signs of an improving economy.

I still believe that the U.S. has a slightly better than 50/50 chance of avoiding a recession, based on generally favorable retail sales, the low interest rates, and the fall in commodity prices particularly oil (see generally interview with Bob Johnson at Morningstar). Still, even in a best case scenario, growth is likely to be sluggish and insufficient to make much, if any, dent in unemployment and will consequently feel like an ongoing recession to a lot of people.

Market Vectors has launched an ETF for Mortgage REITs. WSJ  This is a link to the sponsor's web page: Mortgage REIT Income ETF - MORT Mortgage REITs use a considerable amount of leverage to buy mortgage backed securities. Given the abnormally low short term rates, these firms are enjoying good spreads between their cost for short term borrowings and the yield on those longer term securities, which spread is magnified by the leverage being used by them. A recent synopsis of the leverage factors can be found in this Seeking Alpha article.

I own small positions in AGNC, NLY, CYS, MFA, and the ETF REM. MORT closed $24.12 yesterday, down 85 cents. One concern is that falling interest rates could increase refinancings, causing the loss of higher yielding mortgage securities and their replacement with lower yielding ones. (see discussion at

The Labor Department reported that CPI rose .5% in July. Core inflation was up .2%. Over the past year, CPI has increased 3.6% on a non-seasonally adjusted basis. Consumer Price Index Summary The index level, which is used in the CPI floaters OSM and PFK, stood at 225.922.  I explain how those exchange traded CPI floaters compute their monthly interest payments in Item # 1 Added to OSM at 18.47.  Historical data can be found at the stlouisfed.

The Labor Department also reported that initial jobless claims rose 9,000 to a seasonally adjusted 408,000.

If elected President, Michele promises to padlock the doors at the EPA. NYT The GOP's hostility to environmental protection laws has been growing. Her election would aid those electric utilities smarting under a new EPA regulation on coal plant emissions.

A TIP with 4 years and eight months remaining was auctioned by the treasury yesterday with a current yield of minus The ten year treasury closed at a 2.066% yield yesterday. Chart - Thumbing through the weekly data for ten year treasury yields since 1962, available for downloading at the Federal Reserve, I did not see a rate that low.  The prior weekly low was during the height of the financial crisis on 12/26/08, with a 2.18% ten year treasury yield. FRB: H.15 Release--Selected Interest Rates--Historical Data

I did not have any trades yesterday. I did cancel two GTC sell limit orders on leveraged closed end municipal bonds funds. I decided that a 7% tax free yield looks better to me now. The OG may go into hibernation. 

1. Sold 200 of the Bond CEF IGI at 21.52+ Last Wednesday (see Disclaimer): These shares were bought in two 100 shares lots. Bought 100 IGI at 20.69 (August 2011) Bought 100 IGI at 20.7 in Roth IRA (July 2011). IGI was ex dividend on the  Wednesday, so I clipped that dividend plus another small gain on the shares. I suspected that the $21.52 exceeded the fund's net asset value. On Tuesday, IGI closed at a NAV of $21.34. That NAV would have to be adjusted down to reflect the ex dividend of $.1045 per share. I will not hesitate to sell this fund at any profit when its share price exceeds its net asset value. I have bought and sold IGI many times. Added 100 of the CEF IGI at 19.78 (February 2010); Bought 100 CEF IGI at $19.89 in IRA (February 2010); Sold 100 IGI at 21.26 In IRA (June 2010); Sold:100 IGI @ 20.75 (November 2010); Added 100 IGI at 19.65 (March 2011); Sold 100 IGI @ 20.76 (May 2011).    

One lot was filled at $21.5244 and the other at $21.528. I owned 100 of those shares in the ROTH IRA where I am keeping an abnormally high level of cash, expecting better buying opportunities in income generating securities down the road, an opportunity probably caused by individual investor panic. 

IGI is a closed end fund that invests mostly in investment grade corporate bonds. It is expected to liquidate in 2024.

IGI closed last Wednesday at $21.62, and that price was a 1.36% premium to its then NAV.  The premium increased on Thursday. I may replace IGI with an investment grade bond CEF that uses leverage.

2. Bought 1 USG 6.3% Senior Bond Maturing on 11/15/16 at 80.98 Last Wednesday (Junk Bond Ladder Strategy)(see Disclaimer): USG is a large wallboard manufacturer and has been hurt by the severe downturn in new home construction. The current consensus estimate is for a loss of $2.93 per share this year and $1.65 in 2012.

I have bought and sold this bond: Bought 1 Senior USG Bond at 89 Maturing in 2016 at 89.8 with concession Sold 1 USG Senior Bond at 94.25 The bond has declined about 15% in price since that last sale.

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

This is a link to the bond's prospectus: USG 2016 6.3% Senior Notes Prospectus

This is a link to the  Reuters' profile page for USG.

This is a link to the last SEC Form 10-Q filing: e10vq The debt is discussed at pages 11-14. The company has a senior note coming due in 2014, with a $300 million principal amount, and then the 2016 note. Hopefully, conditions will improve before the 2014 notes needs to be refinanced.

As of 6/30/11, USG had $660 million of cash and short term marketable securities. Page 4 e10vq

My confirmation states that the current yield is 7.703% and the YTM is 10.963%.  Moody's rates this bond at Caa2 and S & P has it at B-.

I am assigning a 7 risk rating to it.   Personal Risk Ratings For Junk Bonds

3. Bought 50 HBAPRF at $19.89 Last Wednesday (see Disclaimer): HBAPRF is a non-cumulative equity preferred floater issued by HSBC USA, a non-public indirect subsidiary of HSBC Holdings (HBC). This security pays qualified dividends at the greater of 3.5% or .75% above the 3 month LIBOR rate based on a $25 par value. This kind of security is perpetual, but may be called at the discretion of the issuer. This issue fell along with other equity preferred floaters in trading yesterday. 

Due to the Fed's ongoing Jihad against the Saving Class, likely to last for at least two more years, the current coupon is 3.5%. This translates into a current yield of around 4.4% at a total cost of $19.89. Even that dividend yield looks good in today's abnormally low interest rate environment. It would look better when and if the 3 Month LIBOR rate returns to a normal level.  HBA.PF  fell 44 cents yesterday, closing at $19.40. 

Prospectus: SEC FILING

Although HSBC USA is not a public company, it does file reports with the SEC. This is a link to it Form 10-Q for the Q/E 6/2011: 10-q Its capital ratios can be found at page 57 of that filing.

The preferred stock issues of HSBC USA are discussed in footnote 19 to its 2010 Annual Report, found at p. 197: SEC Form 10-K I have also bought and sold HBAPRG and HBAPRD.

I discuss in more detail the type of security in this Gateway Post: Advantages and Disadvantages of Equity Preferred Floating Rate Securities

My last two trades for HBAPRF are discussed in these posts: Bought 50 HBAPRF at 20.69/ Fidelity Prohibits Purchase of HBAPRF (January 2011); Sold 50 HBAPRF at 22.44 (May 2011). I first mentioned this floater in a 2008 post: Bary's Column In This Week's Barron's: Floating Rate Preferred Stocks METPRA GSPRA HBAPRF BACPRE

During the Dark Period, many of these equity preferred floaters fell into the single digits. They were extremely volatile to the downside in early August of this year. Fear and Enhanced Volatility in Certain Classes of Income Securities  While they serve a purpose in my portfolio, providing a measure of inflation and deflation protection in the same security, I have tended to focus on their many disadvantages, trading them often for relatively small profits. Inflation or Deflation: Bond and Equity Preferred Stock Alternatives Equity Preferred Stocks as a Disfavored Sub-Asset Class (May 2009 Post)

As of 8/18/11, I currently own the following that I place in this category:

200 AEB  (distributions taxed as qualified dividend but actually a bond, distributions cumulative) Aegon
50 SCEDN (the only non-financial)  Southern California Edison
80 STDPRB   Santander Finance
50 GSPRA  Goldman Sachs
30 USBPRH   U.S. Bank
150 METPRA       Met Life
100 MSPRA      Morgan Stanley 
100 BMLPRJ   Bank of America (originally Merrill Lynch)
50 BMLPRH     (")
50 ZBPRA   Zions Bancorp

I managed to buy only 30 of STDPRB and USBPRH during the most recent meltdown, which shows how much I respect their downside potential: Bought: STDPRB at 13, USBPRH at 18.12, AEF at 19 (8/10/11 Post). AEB was bought during the Near Depression period at between $4 and $8, as was METPRA. Buy of 50 AEB at 4.8 (February 2009); Added to AEB at 5.5 (October 2008); Added To METPRA at $12.5.  I have sold some of my AEB and METPRA shares.

SCEDN was bought at $84 and is still owned (October 2009):

SCEDN AVG Cost per share= $84.16 from 2009
Snapshots of the current 200 shares of AEB can be found at Item # 1 Aegon Repays Dutch Government-Mandatory Payment Event 

I am playing with the house's money on ZBPRA due to one trade: Bought 100 ZBPRA at $7.8 Sold 100 ZBPRA @ 18.95  Bought 50 ZBPRA at 12.5 in IRA SOLD ZBPRA in IRA at $16.85

I will try to trade the volatility for this type of security, but I will limit my overall exposure given their volatility. 

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