Tuesday, August 9, 2011

Sold HNZ at $50.10/ Fear and Enhanced Volatility in Certain Classes of Income Securities/Bought 30 DFP at 20.99/Added to CEFs BTZ SWZ GDV and ERH

In my lifetime as an investor, now spanning over 40 years, there is one cliche about the stock market that bears repeating, the ride down is a lot faster than the ride up.

The DJIA's 634.76 decline yesterday had an eerie familiarity to it. It was not long ago, during the Near Depression period, when the DJIA sank from 11,143.13 on Friday 9/26/2008 to 10,365.45 on the next trading day. ^DJI Historical Prices The decline that monday, 9/29, was 7%. The DJIA then declined 733.08 points on 10/15/2008 and 679.95 points on 12/1/2008. I have done that, and really have no need to do it again.

GS had some positive comments about Coca Cola yesterday. MarketWatch That decision means that I will stay with KO and may start reinvesting the dividends again provided the shares fall below $55.

Nouriel Roubini is now predicting that there is over a 50% chance of a recession within the next 12 months. MSN Money Video Interview

Bill Gross refers to the economic conditions as consistent with a classic delevering cycle lasting the next several years. MSN Money Video Interview

The treasury bonds went up in value yesterday, one of the few refuges from the slaughter. The iShares Barclays 20 Year Treasury ETF (TLT) rose $3.23 yesterday.

The inflation data from China added to turmoil in Asia last night. China's CPI rose 6.5% in July from a year earlier, higher than the consensus estimate of 6.3%.  The July CPI was up .5% from June.

It would be fair to say that the government is tapped out and is in no position to cushion the blow caused by a new recession, particularly when the damage from the last one is a long way from being healed, as shown in the double dip in housing prices, the number of long term unemployed, and the still highly leveraged American household.

The U.S. economy was already sinking again before the latest sovereign debt issues arose and the precipitous fall in the U.S. stock market. A natural reaction would be for consumers to restrain spending further and to increase their savings. The negative psychological impact of the debt downgrade and the recent events in Washington are likely to add to that caution. Since the American economy is dependent on consumer spending, which requires confidence about the future, a pullback will likely increase the chances for another recession. Another recession could easily be worse than the last one for the reasons discussed in this NYT article.

The BALTIC DRY INDEX  Index is now below where it was in April 2009.

In yesterday's post, I mentioned that one of the GOP's reactionary agendas was to emasculate the SEC.  For support of that statement, I would refer to James Steward's column in the NYT and to Arthur Levitt's opinion column in the NYT yesterday titled "Don't Gut the SEC", which is exactly what the GOP is trying to do now. {see generally my earlier discussions at Conservative: Each to his Own Definition (January 2009); Modern Day GOP: No Longer A Conservative Party;  Ideology and Facts: Coexistence Not Allowed (December 2008); Is the Failure to Learn from History Consistent with Conservatism? (February 2009); The Most Abused Word: Reform/Santayana: An Inability to Remember History or Just Creating Your Own Reality to Fit an Ideology (March 2009); What is the Appropriate Political Label (January 2009)}.

I also mentioned yesterday that the GOP wanted to eviscerate the Environmental Protection Agency for obvious reasons unrelated to their purported budget concerns. This article from the Los Angeles Times is apropos on that subject. The GOP also proposed a 1.53 billion cut in EPA's funding, mostly at the expense of clean water programs.

If I had believed that S & P was going to downgrade the U.S. last Friday, I would not have made any of the purchases last Friday discussed in this post. Instead, I would have waited until Monday to make any buys. I did make several 30 share buys on Monday, as I chop up orders into very small pieces, buying income generating securities in severe downdraft mode. I discuss one of those purchases, 30 shares of DFP, below, a junior bond from Delphi Financial that had fallen over 9% when I place the order.

In my posts, I have made it clear that a balanced approach is necessary to solve the nation's debt problem. I mentioned favorably the approach advanced by the President that sought to cut spending by $4 for every $1 in revenue increases.  The most recent post discussing that specific allocation was from July 29, 2011: Delusions and The Budget Crisis

I regard the 4 to 1 as a Centrist approach under the prevailing economic circumstances, while most republicans would view those comments as liberal or even socialistic. I am not one who intentionally wants to disadvantage the poor in favor of the wealthy. I don't think Jesus would approve. As previously noted the Tea Party crowd and their fellow travelers voted for a budget with  9 trillion in cuts with no revenue increases, a budget advanced by the reactionary congressman from Ohio, Jim Jordan, that received over a 100 GOP votes in the House, Republican Study Committee (RSC). One does not need to be told about who would bear the brunt of those cuts. That was their alternative to the Ryan budget plan with close to 6 trillion in cuts and tax cuts for the wealthy and corporations. Bloomberg All GOP politicians would extend the Bush tax cuts. Ryan's budget just gives them more.  Ryan is a disciple of Ann Rand, and his budget certainly reflects her philosophy. The Atlantic While others may differ, I would not call either Paul Ryan or Ms. Rand a conservative.

Hopefully, the downdraft in the market yesterday will at least have one beneficial result, knocking some much needed sense into politicians from both tribes.  Though, I suspect most of them are impervious to having any sense knocked into them. A few GOP tribe members realize that a balanced approach is necessary, but only a few of those persons hold elected office and none of them are in the House.

1. Enhanced Price Volatility in CEFs, European Hybrids, and Equity Preferred Stocks During Periods of Fear: When fear is palpable, its concrete manifestation can be found in the VIX, the volatility index for the S & P 500. Similar indexes exist for the Russell 2000 (RVX), the Nasdaq 100 (VXN) and the DJIA (VXD).

A reading below 20 would mark a period of relatively subdued volatility. Conditions are ripe for positive stock returns when volatility is low. 

As volatility starts to spike above 20 for a stock index, I would anticipate to see a negative correlation with stocks (i.e. volatility up, stocks down) Last week, the volatility indexes spiked to over 30 and to over 40 yesterday. As volatility increases, the natural human reaction is to flee, and that results in a deluge of sell orders overwhelming potential buyers, many of whom hesitate or withdraw their bids. In short, the market compensates for increased volatility by lowering the price. Most humans do not run toward danger but away from it. 

For some income securities, the volatility can be far more extreme than the movement of major stock averages, even though those securities have greater yields than common stocks. Their enhanced volatility is caused by their lowly status in a firm's capital structure and the fact that most issuers of them are financial companies. During periods of financial stress, investors start to obsess that financial firms have made numerous and incredibly stupid bad loans and investments, and that fear is not irrational. The conclusion that a firm will stop paying distributions on the junior securities is usually not entirely based on rational thinking, however, and is more the result of a decision making process dominated by the fear impulse.  

Most of these securities, manifesting enhanced volatility characteristics, fall into the following categories: equity preferred stocks (both cumulative and non-cumulative); European hybrids (combining equity and junior bond characteristics), business development companies, and exchange traded junior bonds, particularly those in the Trust Preferred form of ownership originating from financial institutions. 

I discuss those types of securities in more detail elsewhere:

The fear about these securities involve two separate issues. The first fear is that the firm will become insolvent and the junior security will become as worthless as its common stock.  The second fear is that the firm may survive, but the distribution will be eliminated in the case of non-cumulative dividends or deferred for cumulative distributions. Those two fears combined will cause wild fluctuations in price. 

I mentioned earlier that prices for many of these securities fluctuated as much as 20% intra-day last Friday. That is not even that much compared to what was happening during the Near Depression, when prices sometimes swung even more wildly. 

IGK, for example, which is an ING hybrid, swung between $21.46 and $24.78 last Friday. IGK pays a 8.5% coupon on a $25 par value. Prospectus That is pretty extreme. But on March 9, 2009 this security closed at $3.89, IGK Historical Prices, yielding at that closing price a whopping 54%, and the dividends are qualified. ING has not yet missed a dividend.  I was buying these securities, trading them frequently, during those days.  

So, what can you say. In times of turmoil, these types of securities are not for the faint of heart. Prices will move up and down wildly based on fears, and those fears do have some factual support. But, with the enhanced volatility and risks, there comes opportunity, a point that I continually made about these securities throughout the fall of 2008 and into 2009. 

There are some general observations that I made during the Near Depression period. When a financial firm has both non-cumulative equity preferred and trust preferred outstanding, which is the case for many of the big banks, the equity preferred will be more volatile than the trust preferred, but both securities will be volatile with a downside bias. The European hybrids issued by financial firms will be extremely volatile with a downside bias when the fear involves a financial crisis, as opposed from a garden variety recession. And the non-cumulative preferred issues from those institutions will suffer an even greater smackdown in price.

Another class of securities, closed end funds, will likely suffer an expansion of their discounts to net asset values during period of market stress. Those funds are heavily owned by individuals who will sell them, while other individuals refuse to buy. During October 2008, some funds expanded to 30%+ discounts to their net asset value during periods of extreme market volatility.

Another type of security, subject to extreme volatility, consists of virtually all Exchange Traded Bonds with low volumes and particularly those rated in junk territory. I bought 30 shares of one yesterday, discussed below in Item # 2.

Lastly, business development companies, such as PSEC, ARCC and AINV, will be clobbered during such periods. I recall buying AINV, for example, at $2.35 during the Dark Period. Buy 50 AINV at $2.35 in IRA/Revisions to top Twelve Causes of the Not So Great Depression (3/10/2009 post) These companies generally lend to risky credits. The fear of a weaker economy will cause many investors to assume an acceleration of bad loans and a lower net asset value. AINV traded under $8 yesterday after closing at $10.6 on 7/7/11. AINV Historical Prices 

My approach to these securities will be roughly the same as during the Near Depression period.  Since I have no idea, nor does anyone else, how low they will go, I will space out my buys in time and chop the orders into small pieces. I may manage some positions using volatility, as the market yanks these securities up and down in wide increments. During the Dark Period, some daily moves were well in excess of 20%. I made a note in a post from March 2009 that some of my hybrids had increased 80% to 90% in one week. Bungee Jumping Aegon and ING Preferred Stocks/ BlackJack and Stock Investing: Lessons Learned & Applied

To highlight the volatility, with a downside bias, in these securities, I will just mention the trading in some of them yesterday:

METPRA (owned from Near Depression buys) Days Range $19.4 to $23.08, closed at $22.91
IGK: Days Range of  $20.08 to $23.58 closed at $20.45, down $3.67 or 15.22%
AEF (bought 30 yesterday at $19): Days Range of $17.66 to $21.43 closed at $18.75 down $3.66 or 16.33%
HBAPRG: Days Range of $16.12 to $20.6, closed at $17, down $4.44 or 20.71%
GYB: Days Range of $15.89 to $18.31, closed at $15.89, down $2.51 or 13.64%
STBPRB (bought 30 yesterday at $13): Days Range of $12.01 to $15.32, closed at $14 down 11.67%
USBPRH (bought 30 yesterday at $18.12): Days Range $17.2 to $21.01, closed at $20.89 down 4.52%

Yesterday, I bought a few securities in this volatile class, in 30 share lots, and I place the odd lot limit order anywhere from 70 cents to $1 below the then market price after a greater than 10% decline during the day. And I had fills. I will generally allocate anywhere from $750 to $1250 for purchases on these down days, breaking orders into several small lots.

2. Bought 30 of DFP at 20.99 Yesterday in the Roth IRA (see Disclaimer): I have previously bought and sold this Exchange Traded junior bond on several occasions. Bought 100 DFP at $17.1 Bought 50 DFP at $17.10 & Sold 50 DFY in Roth Sold 50 of the 150 DFP Added 50 DFP at 19.75 Sold 50 of 150 DFP at 21.7 Sold: 50 DFP @ 23.10 and @ 23.17 (October 2010). This is a a hopefully temporary investment, made with the purpose of generating some income when the alternative is no income paid by a money market fund. I am being forced back into some of these securities given the likely continuation of the Federal Reserve's Jihad against the saving class. One way for the federal government to increase revenue would be for the Fed to end its Jihad. I would make more from my conservative investments and pay more in taxes. That sounds like a good deal for our destitute Uncle Sam.  What Are the Reasons for a Continuation of the Fed's Jihad Against the Saver Class The Real Cost of The Federal Reserve's Jihad against the Saver Class

DFP is a junior bond issued by the insurance company Delphi Financial Group (DFG). I also owned a senior exchange traded bond issued by this company which was called last year. DFP pays a 7.376% fixed coupon on a $25 par value until May 15, 2017, whereupon it will start to pay a floating rate based on a 3.19% spread over the 3 month LIBOR rate. Prospectus I have adequately discussed this security in the above linked posts. 

While this security pays the fixed coupon rate, the yield at a total cost of $20.99 is around 8.78%.

This is a link to Delphi Financial Group Inc (DFG) Profile page at Reuters and to its Key Developments page.  Delphi recently increased its common share dividend. The continued payment of a common dividend provides the owner of this junior bond some comfort, since DFP's interest payments can not be deferred as long as it pays a dividend on a junior security which would mean common stock for Delphi. 

My total realized gains from trading this security is currently $735.11:  

Any capital gain on a bond transaction is viewed as a positive since I would be content with no gain and the interest payments.

DFP closed at $20.99 yesterday, down $2.01 or 8.74%. The security traded in a range of $20.18 to $22.68. Of the 30 share lot orders placed yesterday, this was the only one where I hit the then existing ask price with the odd lot limit order. The rest were limit orders placed well below the market price at the time of the order entry.

3. Shotgun Scatter Adds to CEFs BTZ at 12.26, SWZ at 12.98, GDV at 14.54 and ERH at 10.61 Last Friday (see Disclaimer):  All of these buys were 30 shares which is now my lot size during a turbulent market with a strong downside bias. In the event the market continues to decline, I may add 30 more shares after a 5% to 10% decline from Friday's close. All of these securities suffered severe declines yesterday. The purchases were made last Friday. The decline yesterday is one reason for chopping orders now into very small pieces. CEFs will generally be impacted more in an investor panic than a comparable ETF, causing their discounts to widen.

BTZ, GDV and ERH pay monthly dividends and consequently add to my cash flow used to fund purchases particularly during period of market turbulence. I am now taking the distributions paid by ERH, GDV and BTZ in cash. I had previously used the distributions paid by BTZ to buy additional shares on 1/2 of my position. I am reinvesting the dividend paid by SWZ. 

SWZ is a closed end stock fund that invests in companies based in Switzerland. I have nothing to add to my recent discussion, except that $12.98 is a lower price than $13.75. Added 50 SWZ at 13.75 (8/2/2011 Post). 

ERH is a balanced fund that owns primarily junk bonds and utility stocks. I have nothing to add to my recent discussions on that security, except to say that $10.61 is a lower price than $11.69 and $11.88 and the yield goes up as the price goes down.  Bought 100 ERH at 11.69 Bought 100 ERH at 11.88 ERH had a bad day yesterday closing at $9.54, down 11.75%.

BTZ is primarily an investment grade bond fund. I have nothing to add to my recent discussions except to say that I am averaging down, the expansion of the BTZ discount rose after my purchase due to a dividend cut, and the yield goes up as the price goes down. Sold 100 ERC at 16.27 and Bought 200 BTZ at 13.14 That was a pared trade. Given the decline in ERC's price, I am not really worse off yet. BTZ closed at $11.66 yesterday, down 5.28%.

Gabelli Dividend & Income Trust (GDV) is a closed end stock fund run by the Gabelli fund group. I last added shares in August 2010.  Added 200 GDV at 13.33 

This is a link to the sponsor's web site for GDV:  GAMCO Investors, Inc. The dividend is paid monthly at the current rate of 8 cents per share. GDV Distributions This gives me about a 6.6% yield at a total cost of $14.54. The fund is rated 3 stars by  Morningstar. This is a link to the most recently filed shareholder report: Period Ending 12/31/2010. The last filed SEC Form N-Q discloses the holdings as of 3/312011. 

Based on data from last  Friday, 8/5/11, these CEFs were selling at the following discounts to their net asset values:

BTZ: -14.1 based on a NAV of $14.33 per share and a closing price of $12.31
GDV: -11.46 based on a NAV of $16.49 per share and a closing price of $14.6. 
SWZ: -9.74 based on a NAV of $14.47 per share and a closing price of $13.06
ERH: -5.67 based on a NAV of $11.46 per share and a closing price of $10.81.

Information about closing net asset values can be found at the Closed-End Fund Association, the CEF section at the WSJ's Markets Data Center, and at the sponsors' web sites.    

Since I do not know, nor does anyone else, what is about to happen, I will often use a shotgun scatter approach to add to existing positions which will allow me to average down in the event prices fall further. Taking positions is small bits and pieces is a trading strategy for long term secular bear markets, where sell the rips and buy the dips is the mantra.

Yesterday, I made a number of small 30 share prices which I will mention in the next post. I reference them in Item # 1 above. I have the capacity to make those kind of buys on a daily basis, but I will space them out more in time.

I would note that ACG, bought last Friday, closed with a net asset value of $9.02 and its discount expanded to -15.08 yesterday based on a NAV per share of $9.02. Closed-End Fund Association That represented a one cent per share decline in NAV from Friday but the shares declined 20 cents. 

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