Friday, October 7, 2011

Bought 30 PEP at $59.95/EK/Greeks and the Entitlement Mindset/Bought 100 MTY at $10.03/Louise Yamada on Stocks and Gold

The Greek civil servants are unhappy and have shut down their government in protest.  I read a number of interviews with those striking employees, none of whom blame themselves for the dire situation. Instead, the Greeks blame just about everyone other than themselves for their predicament. A common source of the blame is assigned to foreigners who lent the Greek government money, later consumed by those striking government employees. To an outside observer, these people are in aggressive denial and are simply unable to form rational judgments. Possibly, it needs to be made a felony for any national government or financial institution outside Greece to make a loan to the Greek government or to its citizens. In about thirty or forty years, a new generation of Greek citizens might be able to form rational judgments based on reality and to see the past more clearly. At least, that is conceivable. There is no hope for those Greeks alive today.

It is interesting that those living on the public dole in Greece, which appears to be most of the citizens since that country is after all a patronage state, want their outlandish benefits even when there is no money to pay for them. "I am entitled to what I want, when I want it, even if there is no money to give me what I want". 

The entitlement mindset is of course not unique to the Greeks. The Greeks simply take it to breathtaking proportions. Greece Governments and citizens in other developed countries are afflicted with the same disease. The general predisposition is to tell the government how much you want from it, and then the government borrows money to fund those wants and desires. The borrowing increases over time at ever growing amounts, since a corollary is that the citizens do not actually want to pay for that they want from government.  The Greeks just ran up against the wall first and others will join them in the years to come including the United States. Freedom from responsibility must be a fundamental human desire, nurtured, encouraged and even rewarded by most governments in developed countries. Our government is a master at promoting and rewarding irresponsible behavior.

Who has paid for the financial crisis in the U.S., just as an example of the point that I am making? Responsible Americans have paid for it, those who borrowed only what they could pay back, spent and saved like rational human beings, and never lied on a mortgage application. Those Americans did not cause the disaster but are paying for it now, without question, in many ways including the miserly income now generated on their savings as a result of the Federal Reserve's Jihad against the Saving Class.

The Masters of Disaster in America's financial institutions made a ton of money, billions of dollars, by enabling irresponsible Americans to purchase homes that they could not afford, all too frequently based on mortgage applications known to contain fraudulent financial information. Then, the toxic trash was bundled into securities that had to be designed by Satan.  When the bubble burst, people who should have never bought a home might lose it, but who really pays for their inconvenience of moving into an affordable apartment. The ones who pay are the homeowners who have seen the value of their properties decline due to the bursting of the housing bubble, created from easy credit provided to non-qualified mortgage applicants. Rather than leaving the home, a more plausible scenario is that the borrower will just default and live rent free for severals months or more frequently now for years, a policy encouraged by the actions of the federal and many state governments who make foreclosures difficult even when there is no question that the borrower signed a note and quit making payments.

Randall Forysth provides a lot of useful information to the staff here at HQ that would otherwise not be available. Needless to say, Headknocker is not going to spend money on research services (other than Morningstar), newsletters or anything else for that matter.  So we only know what Louise Yamada is thinking when someone is kind enough to provide us (HK, RB, LB, & the OG) with the details. I am always interested in his views. I sometimes link a CNBC interview with her. In his recent Barrons' column, Forsyth summarizes the latest advice given by Louise to her subscribers. To cut to the gist, she advises investors to emphasize preservation of capital. That seems wise to me. She is bullish on gold, viewing the $1600 range as providing the floor for consolidation. In a prior interview, she sees that gold could reach $5,200 by 2018. YouTube Her views on the world's stock markets seem to be identical to the opinions expressed by her in an interview last August. YouTube (that video may be taken down by YouTube)

Tiernan Ray summarizes a very negative report on Kodak in his Barrons column. While the 2013 bond price has recovered some since crashing into the 20s, I am still pessimistic about receiving par value at maturity and would be surprised now by a positive outcome. Needless to say, as an owner of 2 of those bond, I hope that I am wrong.   

1. Added 100 MTY at $10.03 Last Wednesday in the ROTH IRA (see Disclaimer): I have discussed this security in several posts. This purchase brings me up to 200 shares. MTY is a senior, unsecured note issued by Citigroup Funding and guaranteed by Citigroup as set forth in the prospectus. For this kind of security, it is imperative to read and to fully understand the prospectus. 

MTY is sometimes called a "principal protected" note, which is a misnomer. The owner of this security is subject to the credit risk of Citigroup, just like any other buyer of unsecured senior bonds. Item # 1 Principal Protected Notes (April 2010 Post). 

MTY is traded on the stock exchange and volume is typically light. Last Wednesday, the volume was just 1000 shares and the shares traded in a $9.95 to $10.03 range. Par value is $10. 

MTY is an interesting security to me.  It will make an annual interest payment at the greater of 3% or up to 35%, based on the percentage increase in the price of gold during the annual coupon period, with an important caveat. If there is one day, just one will do it, where the price of gold closes above that 35% increase, then MTY will pay the 3% coupon no matter how much gold increases during the coupon period. Final Pricing Supplement I call that proviso the Maximum Level Violation or sometimes the Reversion, just as a shorthand for long time readers.  

There are a few facts that need to be driven home with this security. 

The current annual period started on July 27, 2011. A potential buyer or current owner has to know the starting value of gold for the current period. This security will use the London P.M. fix. Kitco Inc. - Past Historical London Fix The London P.M. fix for gold on 7/27/2011 was $1,625. Gold can increase during the current annual period up to 35% without triggering the Reversion back to 3%. This would put the Maximum Level Violation number at $2,193.75 (1.35 x. starting value of $1,625=$2,193.75). One close above that number on or before the closing date of July 27, 2012 will cause the Reversion to 3%, no matter what happens to the price of gold. This happened in the last coupon period. MTY Reversion to 3% Minimum Coupon Today; see also discussion at Stocks, Bonds & Politics: MTY MTY did have a good payday during its first annual period. So, place your bets and take your chances, just like anything else. 

Since I paid close to par value, and this is a short term note maturing in 2014, the main risk is the credit risk of Citigroup. If Citigroup survives to pay off the note, the worst result would be to receive a 3% coupon for each of the three remaining payment periods (2012, 2013, 2014). I have the potential of receiving a lot more and have received more for similar type of notes tied to stock or commodity indexes. (see snapshots at Stocks, Bonds & Politics: MTY)

A few months ago, institutional investors were buying fixed coupon Citigroup bonds, maturing in 2014, and receiving yields around 2 1/2%. Those bonds have come down in price and up in yield. The YTM for the fixed coupon 2014 Citigroup senior bonds are now closer to a 4% to 4 1/2% range.

FINRA Information: Fixed Coupon 6.375% Maturing 8/12/2014
FINRA Information: Fixed Coupon 5.125% Maturing 5/5/2014 

MTY matures on 8/11/2014 at $10.

On the day of my purchase, the London P.M. fix for 10/5/2011 was $1617. The P.M fix yesterday was at $1635. That number is without much significance. There is a lot of room to run before triggering a Maximum Level Violation. And, there has been no Maximum Level Violation during the current coupon period so far. The highest close to date was on 9/5/11 and 9/6/11 at $1895. I sold gold for the first time on 9/6/11, snapshot at Recent Gold and Silver Sales.

I now have $9,000 in exposure to Citigroup senior bonds. Those bonds are my sole exposure to Citigroup. My limit is $10,000 in exposure to the securities issued by one firm. I am slightly uncomfortable being so close to that limit for Citigroup, even with the entire exposure in senior bonds. I do not own the Citigroup common, equity preferred or trust preferred securities.  I may sell down to $8,000 before the end of the year. One candidate for a sell would be MOL, which is also linked to gold, but with a smaller allowable increase in the gold price during its annual terms.  

The Citigroup exposure is now in the following exchange traded senior, unsecured notes:

Bought 100 MTY at 10.49 (plus the 100 bought on Wednesday in the ROTH IRA)

Information about gold prices can also be found at the LBMA website. 

2. Bought 30 Pepsico at $59.95 Last Wednesday & Trading Strategy for Unstable Vix Pattern for this Type of Security (Large Cap Valuation Strategy and Common Stock Dividend Growth)(see Disclaimer): With the recent price decline, Pepsico shares qualify under both of these strategies. However, in an Unstable Vix Pattern within the context of a cyclical bear market, I will anticipate that the risks are to the downside and will chop orders up into small pieces. 100 shares could be bought, but only in three odd lot increments. The first and second purchases will generally be 30 shares and the third would be 40 shares. Each increment has to be at least $2 per share lower than the last purchase.  I am expecting to average down, but I am not 100% sure that I will be afforded that opportunity.

I may also sell the first bought shares at over $65, assuming a completion of the entire purchase, and possibly buy those shares back at below the price paid for the last shares bought. That strategy is catered to the probable volatility in the share price, where some profits are taken when they become available and the average cost of the remaining shares are lowered as a result.  If I get caught holding the security by a serious and long term downdraft in the stock price, then I would prefer that happen with a dividend paying company that is sound financially. I would then have the option of using that dividend to buy shares at lower prices. Eventually, provided I do not pay too much initially for the shares, I would expect the price to recover allowing me to exit the position at a profit within a reasonable amount of time, measured at most in a few years, barring a second Great Depression whereupon the wait would be considerably longer to recover my original principal.   

Pepsico meets the criteria set out in this Post for the Dividend Growth Strategy: Item # 6  Common Stock Dividend Growth vs. Long Term Investment Grade Bonds The current yield is over 3%. PEP has a long history of paying the dividend and increasing it.  The payout ratio will generally be below 50%, or slightly above. The rate of dividend growth is supported by the rate of earnings growth. There has not been a dividend cut. See generally PepsiCo Dividend Information |

The current quarterly dividend rate is $ .515 per share or $2.06 per share annually. At a total cost of $59.95, that would equate into an annualized yield of 3.44%. In the annual payment period starting in May 2001, the annual rate was 58 cents, so that is a significant increase over a decade. While the historical rate of dividend increases is not assured for the future, the prior history is nonetheless an important consideration for investors looking for increasing income on a constant cost basis.

The stock also qualifies for purchase under the Large Cap Valuation Strategy, based on the P/E and the P.E.G. The current estimate for 2012 is for an E.P.S. of $4.77. At a total cost of $59.95, that estimate gives me a forward P/E of 12.57, at the low end of historic ranges for this stock. The PEG ratio, estimated for the next five years, is currently 1.59 which is reasonable for this type of company. PEP Key Statistics

PepsiCo closed at $60.47 in trading yesterday.

In two prior posts, I mentioned an interesting story about Herman Lay, the "Lay" in Frito-Lay, Pepsico's jewel of a snack food business.  Pepsico Buy at less than $50 May 2009   PEP & Origins of Frito Lay

Herman was a Nashville businessman. Actually, when he was in his mid-20s during the Great Depression, he was delivering and selling potato chips for a company called Barrett Food Company.

There was an Esso (now Exxon) gas station near Belmont University, owned by Ed Johnson and his wife Bernice, who often extended Herman credit for gas to keep his trucks running.  In 1947, he offered the Johnson's an opportunity to invest $8,000 in his effort to buy the Barrett Food Company. That was about the entire life savings of this couple. There was some disagreement, with Ed wanting to make the investment and the Mrs. being fearful of losing their retirement savings Ultimately, all of that was resolved somehow, possibly with Mr. Johnson not telling the Mrs. until the check had cleared the bank. In 2008, the Johnson's estate made a ten million dollar gift to Belmont University,  Belmont Receives $10 Million Donation from Johnson Estate | Belmont University News and Media Eight million dollars had previously been given to the University. Belmont was one of the beneficiaries of the Johnson's fortune, originating from that stock purchased in Lay's company. Those funds did not come from pumping gas during the Great D and few years thereafter.

Some of that history can be found, along with other interesting stories about Nashville entrepreneurs, in Fortunes, Fiddles and Fried Chicken : A Business History of Nashville.

I will discuss in my next post my recent email correspondence with Mark Hulbert on the use of the VIX as a timing model for stock allocation. 

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