Big Picture Synopsis
Stocks
Stable Vix Pattern (Bullish)
Short Term: Expecting a 10%+ Correction
Intermediate to Long Term: Bullish
During August, the S & P 500 did decline below its 50 day SMA but is still comfortably above its 200 SMA line. S&P 500 Index Chart The S & P closed last Friday at 1,632.97, declining just 3.13% for the month. From the closing high of 1709.67 hit on 8/2/13, Historical Prices, the decline was about 4.49%. A 10% correction from that closing high number would take the S & P 500 down to about 1,538.
Last Friday, my regional bank basket hit an air pocket. The SPDR S&P Regional Banking ETF fell 1.49%, much worse than the .32% fall in the S & P 500. My regional bank basket declined 1.63% led by a decline in FISI: $18.54 -0.93 (-4.78%). The 2014 consensus E.P.S. for FISI is $1.92, FISI Analyst Estimates, giving it a forward P/E of 9.65 and a 4% dividend yield at the $18.54 price.
Recently, I lightened up by selling a number of bank stocks whose prices had jumped to more than 15 times estimated 2014 earnings.
During August, the S & P 500 did decline below its 50 day SMA but is still comfortably above its 200 SMA line. S&P 500 Index Chart The S & P closed last Friday at 1,632.97, declining just 3.13% for the month. From the closing high of 1709.67 hit on 8/2/13, Historical Prices, the decline was about 4.49%. A 10% correction from that closing high number would take the S & P 500 down to about 1,538.
Last Friday, my regional bank basket hit an air pocket. The SPDR S&P Regional Banking ETF fell 1.49%, much worse than the .32% fall in the S & P 500. My regional bank basket declined 1.63% led by a decline in FISI: $18.54 -0.93 (-4.78%). The 2014 consensus E.P.S. for FISI is $1.92, FISI Analyst Estimates, giving it a forward P/E of 9.65 and a 4% dividend yield at the $18.54 price.
Recently, I lightened up by selling a number of bank stocks whose prices had jumped to more than 15 times estimated 2014 earnings.
Bonds:
Short to Long Term: Slightly Bearish Based on Interest Rate Normalization (The Difficult Path to Interest Rate Normalization)
The JPM fixed income strategists predict that tapering will start in September and the ten year treasury will hit 3.15% by year end. They further expect QE to end by June 2014. Barrons.com
The respected fund manager of T. Rowe Price's Capital Appreciation fund, David Giroux, stated in a recent Morningstar interview that fair value for the 10 year treasury was 4%. I would agree with that opinion.
Last week, the ten year treasury declined a tad in yield and was range bound between 2.7% to 2.8%, lower than the prior week's range between 2.8% to 2.9%. Daily Treasury Yield Curve Rates Some of the economic data, particularly on consumer spending, was positive for bonds. I suspect that the overall weakness in the stock market may also be responsible for the better bond results last week.
The break-even spread for the 10 year treasury declined slightly to 2.1%. That number represents a market forecast for the average annual rate of inflation over the next ten years.
The treasury will hit its borrowing limit by mid-October unless the debt ceiling is raised by Congress. WSJ By raising the debt ceiling the treasury is able to make payments authorized by Congress. A large number of republicans have already threatened to shut the government down, possibly causing a debt default, unless their demands are met to defund Obamacare. The Hill
The JPM fixed income strategists predict that tapering will start in September and the ten year treasury will hit 3.15% by year end. They further expect QE to end by June 2014. Barrons.com
The respected fund manager of T. Rowe Price's Capital Appreciation fund, David Giroux, stated in a recent Morningstar interview that fair value for the 10 year treasury was 4%. I would agree with that opinion.
Last week, the ten year treasury declined a tad in yield and was range bound between 2.7% to 2.8%, lower than the prior week's range between 2.8% to 2.9%. Daily Treasury Yield Curve Rates Some of the economic data, particularly on consumer spending, was positive for bonds. I suspect that the overall weakness in the stock market may also be responsible for the better bond results last week.
The break-even spread for the 10 year treasury declined slightly to 2.1%. That number represents a market forecast for the average annual rate of inflation over the next ten years.
The treasury will hit its borrowing limit by mid-October unless the debt ceiling is raised by Congress. WSJ By raising the debt ceiling the treasury is able to make payments authorized by Congress. A large number of republicans have already threatened to shut the government down, possibly causing a debt default, unless their demands are met to defund Obamacare. The Hill
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Recent Economic Reports:
The government revised its estimate for second quarter real GDP growth to 2.5% from 1.7%. News Release: Gross Domestic Product Nominal GDP rose at a 3.2% rate.
I noted in my 8/10/13 post that economist Brian Wesbury was predicting an increase to 2.5%. Wesbury.PDF In the first estimate, the government estimated that the trade sector had a .8% drag on real GDP. Subsequent to that estimate, the Commerce Department reported that the June trade deficit had fallen to $34.2B in June, down from $44.1B in May. census.gov.pdf Based on the lower trade deficit number, Wesbury predicted that the drag was close to zero so he estimated that the second quarter revision would be increased to 2.5%.
For July, personal disposable income increased by .2% and by .1% adjusted for inflation. The government revised those numbers up for June, where the previous estimate of +.2% in disposable income was revised to +.3%. The price index for personal consumption expenditures rose .1% in July, down from .4% in June. Excluding food and energy (who needs those items?), the increase was .01% for July and .2% in June. Consumer spending was anemic rising just .1% in July, the lowest growth since April. Nominal spending rose 3.1% Y-O-Y down from 3.4% in June. News Release: Personal Income and Outlays
In response to the consumer spending number, several firms cut their GDP forecasts for the third quarter. MarketWatch
Orders for durable goods declined 7.3% in July due to a 52.3% plunge in nondefense aircraft orders which had surged 33.8% in June and 67.6% in May. Excluding that volatile segment, orders fell .6%. Orders for cars and trucks rose .5%. Computers and related products declined 19.9%. census.gov.pdf
The Case Shiller National Home Price Index increased 7.1% in the second quarter and 10.1% over the prior four quarters. Homeprice.PDF
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Weakness in Consumer Staples:
Coca Cola is now trading below its 50 and 200 day SMA. KO Interactive Chart Unilever is another one that has pierced those lines to the downside. UN Interactive Chart I own Coca Cola and Unilever. Another one that I own, GIS, is comfortably above its 200 day SMA but has declined below its 50 day SMA. GIS Interactive Chart
Other consumer staple stocks have declined below their 50 day SMA and are near their 200 day. PG Interactive Chart; CL Interactive Chart; PEP Interactive Chart. CL bounced off its 200 day SMA last Friday: CL: $57.77 +0.52 (+0.91%)
The justifications for the recent price declines were expressed by Jim Cramer (Video) and include valuations, the rise in interest rates and oil, and the decline in emerging market stocks and currencies. He noted that emerging market stocks have been crushed recently and "maybe the purchasing power of the people in the emerging markets are getting crushed too". I view that last remark as just silly.
In his view, these stocks are viewed by investors as bond substitutes, and the recent upward spike in interest rates was causing them to lose their allure. I do not find that argument convincing. If I had a choice between buying KO or a ten year treasury, I would buy KO even if the starting yields were the same or slightly in favor of the 10 year treasury.
A purchaser last Friday of a fixed coupon treasury is stuck with less than a 2.8% yield for ten years, while KO will be raising its dividend annually. Based on the prior historical rate of dividend growth, I would expect the KO dividend to double within 6 to 8 years.
I would view the decline as being tied primarily to valuations for these slow growing companies. At a $38.15 price, Coca Cola would be selling at over 20 times trailing earnings and at 16.81 times estimated 2014 earnings. KO Key Statistics That is near the top end of my reasonable valuation range. I have noted that KO shares were outside of that range when selling near the recent trading range between $40-$43. KO Historical Prices
If I did not already have a full position in KO shares, I would be looking for an opportunity to buy shares during the current dump phase. The consensus E.P.S. estimate for 2014 is currently $2.27. A 15 multiple applied to that consensus estimate would produce a $34 price. I doubt that KO will decline that far. A 16 multiple would result in a $36.32 price per share.
If there is a decline to $34 or lower, which would surprise me, I may use the KO cash dividends paid to me to fund a small odd lot purchase. I have not been reinvesting the dividend since 2010.
Closing Price Last Friday: KO: $38.18 +0.08 (+0.21%)
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1. Added 50 MLPG at $35.15 (see Disclaimer):
Snapshot of Trade:
Security Description: The UBS AG E-TRACS linked to Alerian Natural Gas MLP Index (MLPG) is an ETN that tracks a natural gas infrastructure MLP index.
An ETN is an unsecured senior note. The issuer of MLPG is UBS, so an owner of MLPG is subject to the credit risk of UBS just like any other owner of a UBS issued senior unsecured note.
UBS Stock Quote (UBS)
An ETN is an unsecured senior note. The issuer of MLPG is UBS, so an owner of MLPG is subject to the credit risk of UBS just like any other owner of a UBS issued senior unsecured note.
UBS Stock Quote (UBS)
Distributions will be variable and are paid quarterly. The last dividend was $.4407 per share and went ex dividend on 7/11/13. Based on the last four distributions, totaling $1.7495 per share, the dividend yield would be about 4.98% at a total cost of $35.15 per share. The total distribution was $1.7342 in 2012 and $1.5022 in 2011 (click Distribution Tab at sponsor's webpage for MLPG).
The annual tracking fee is .85%.
This ETN owns MLPs that transport, store and process natural gas and natural gas liquids.
Index Weightings:
According to the sponsor, the total return for MLPG between 8/22/12 to 8/22/13 was 25.28%.
The annual tracking fee is .85%.
This ETN owns MLPs that transport, store and process natural gas and natural gas liquids.
Index Weightings:
According to the sponsor, the total return for MLPG between 8/22/12 to 8/22/13 was 25.28%.
Prior Trades: I previously bought 50 shares at a lower price: Item # 4 Bought 50 MLPG at $31.26-ROTH IRA (February 2013) I did not want to own more shares in an retirement account, so I bought this lot in a taxable account.
I have copied and edited some of my prior discussion about the natural gas super cycle.
I have copied and edited some of my prior discussion about the natural gas super cycle.
Rationale: (1) Natural Gas Super Cycle: I discuss the RB's "vision thing" for a multi-decade super-cycle for natural gas demand in a previous post. Item # 4 Bought 50 FCG at $15.84 This ETN was the most direct way to play the super cycle in the MLP space. This is part of my discussion found in that earlier post:
When playing super cycles, I could care less what happens to a stock next year or the year after. Instead I am looking way out into the future. No one will be able to time when, or even whether, natural gas demand will cause a substantial non-temporary rise in price. I do not know, nor does anyone else who is not a divine being. I am going to admit up front that the Lord has not given me any guidance on this one, possibly draining the well of divine stock advice after sending me a sign about reinvesting the GE dividends. Stocks, Bonds & Politics: GE (introductory section near snapshot of GE buys)
The article in a UK trade journal intrigued the LB so it proceeded to read it: "GE bets on 25-year gas super-cycle": Gas to Power Journal UK The main guy at GE Power was predicting a 25 year natural gas super cycle. LB is always interested in super cycles, such as the one recently discussed in connection with the parabolic rise of middle class consumers in emerging markets or the super cycle that led to the long term bull market starting in 1982. The next article read had the following title and was even more intriguing: "Gas-fired CCPPs will dominate US power market": Gas to Power Journal UK In that article, a Siemens V-P stated that the competitive advantage of large coal fired plants was being eroded by the economics of low cost gas generation.
Back in the day when LB knew something about energy production from natural gas turbines, approximately 30 years ago, gas fired turbines were used by electric utilities over short term cycles to meet peak demand (e.g. the hottest part of a summer day). When that demand fell off, they would be turned off. The power cost from those units was high cost. Power produced by large coal and nuclear units was much cheaper, due to economies of scale, and those units were used to provide what is known as the base load requirements. Base Load and Peaking Power; SmartPlanet Those units would be running 24/7 except when shutdown for periodic maintenance. The guy from Siemens was saying that the cost advantage of coal generation was eroding in favor of the natural gas fired units. Coal units are only used to meet base load. So will the natural gas fired units be the new base load, running 24/7, burning up all of that natural gas to produce energy instead of coal?
It just appears to me that there may be no other choice. Nuclear plants take an incredibly long time to build, and utilities are not exactly beating down the door to build new ones in the U.S.
Yet, the Obama administration has clearly embarked on an environmental policy to shut down a significant number of coal generating stations by making it uneconomical to retrofit those plants with pollution devices to meet new clean air standards promulgated by the EPA.
I am not going to repeat my discussion about those EPA rules, contained in the comment section of this SeekingAlpha article: Seeking Alpha The author of that article was recommending an Illinois Basin coal producer, so I took issue with that recommendation based on what was happening with the EPA.
In my capacity as an investor, it is irrelevant whether I agree or disagree with the EPA policy. The relevant consideration starts with a very simple question that trial lawyers always want to know: "what are the facts". Once an investor has a grip on the relevant facts, the issue then is simply how to respond. Knowing about the direction and potential impacts of EPA's emissions rules, which have already resulted in plant shutdowns, I would not be in the market for a coal stock. The product is in abundance and the demand is about to fall.
I suspect that the estimate made by a consultant group will be close to what will happen. America is about to lose 20% of its coal fired generation over the next several years
Reuters Article Containing Consultant Estimate of 20% Closure Rate: Reuters
EPA Explanation of its Cross Border Emission Rules: Basic Information | Air Transport | US EPA
In a 2-1 decision, split along party lines, the District of Columbia Court of Appeals recently struck down the EPA's Cross-State Air Pollution Rule, as exceeding the EPA's authority under the Clean Air Act. The Supreme Court is set to review that decision. WSJ.com
Other relevant recent news:
Coal Plants Affected by EPA Regulations
AEP - News Releases - AEP Expects To Retire 585-Megawatt Coal-Fueled Unit In Ohio
FirstEnergy to Deactivate Two Coal-Fired Power Plants in Pennsylvania
A recent article in the WSJ noted that more crude oil is being transported by barge, train and truck in the U.S. than at anytime since the government started to keep records.
(2) Total Return Potential: Hopefully, the cash distributions will trend up over time and the existing distribution rate is desirable in a a low yield world.
UBS AG E-Tracs Alerian Natural Gas MLP ETN (MLPG) Chart
(3) The ETN Structure Eliminates the K-1 Hassle: As noted in the sponsor's fact sheet, the distributions are reported as ordinary income in a 1099 and the owner of this security will not receive a K-1 form. This is a major selling point for me since I hate fooling with K-1s at tax time.
Risks: (1) UBS Credit Risk: An ETN is a senior unsecured note. As such, the owner of MLPG is subject to the credit risk of UBS. If UBS goes bankrupt the owner of this security will be in the same position as all other owners of the issuer's unsecured senior debt. While the amount of recovery in such an eventuality is unknowable, I generally would anticipate around 15 to 25 cents on the dollar after a prolonged period in bankruptcy where nothing would be paid to the owners of the issuer's debt.
(2) Concentration and Market Risk.
Other risks, including the call right, are described in the prospectus and the fact sheet: prospectus_supplement.pdf and factsheet.pdf
Last Friday's Closing Price: MLPG: $34.69 -0.27 (-0.77%)
2. Sold 100 PCBK at $12.994 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer):
Snapshot of Trade:
Snapshot of Profit: PCBK was initially purchased as part of the lottery ticket basket strategy and later elevated to the regional bank basket strategy based on reported earnings. I will credit the entire gain to the regional bank basket.
Added 70 PCBK AT $9 (October 2012); Bought 30 PCBK as LT at $9.42 (April 2011)
Rationale: The primary motivation was profit taking.
I also did not like what I read about a recently filed lawsuit.
Pacific Continental Bank announced last Friday that it had been named in a lawsuit brought by individuals who had "placed" money in Berjac of Oregon and Berjac of Portland, both of whom are now in bankruptcy. I had never heard of those entities, so I did some digging.
The founder of Pacific Continental was Fred "Jack" Holcomb who was also named as a defendant along with the Holcomb Family Limited Partnership. Jack Holcomb also founded Berjac and ran it until he turned it over to his sons Michael, who served for years as a Director of PCBK, and Gary. OregonLive.com
I reviewed the allegations in the Complaint: Berjac Class Action Complaint.pdf The plaintiffs allege that they were victims of "Ponzi scheme" that was "conducted by defendant Fred "Jack" Holcomb, Michael S. Holcomb, Gary L. Holcomb, Berjac of Oregon, an Oregon general partnership, and Berjac of Portland, an Oregon general partnership". The two sons were not named as defendants since they are in bankruptcy.
Without going into detail, the gist of the allegation is that the Berjac entities were engaged in insurance premium financing. Berjac would pay the annual insurance premiums for a business who would pay Berjac back monthly after making a 25% down payment. To finance its operation, money was raised from investors by promising returns of 6% or more and allowing for frequent withdrawals. I never will understand why individuals line up to throw money at such offers. At some point, the Berjac entities started to use the money to speculate in real estate and many of those investments did not prosper, a typical LB understatement and attempt at humor.
After reading most of the Complaint, and taking some allegations with the usual and appropriate level of skepticism, the case did not not appear to be very strong against the two banks named in the lawsuit, Pacific Continental and Umpqua Holdings Corporation (UMPQ).
I previously sold UMPQ based on valuation. Sold 50 UMPQ at $16.12
The trustee in Berjac bankruptcy proceedings has sued the Holcomb Family Limited Partnership which the trustee alleges received millions from Berjac. OregonLive.com
A detailed discussion of Berjac's history can be found at OregonLive.com As reflected in that article, the two sons, at a minimum, lacked sufficient business acumen and competence to run Berjac. Sloppy is just one of many unfavorable words that describes their management.
Still, there is enough stink alleged in that complaint to cause me to sell my 100 shares PCBK shares.
I recently received a regular quarterly dividend of $.09 per share and a special dividend of $.12 per share. Pacific Continental
Future Buys: I am not likely to even consider buying this stock again until the foregoing litigation is resolved and the shares present are reasonably priced based on then existing earnings.
Friday's Closing Price: PCBK: $12.57 -0.43 (-3.31%)
3. Added 50 BTZ at $12.35 (see Disclaimer): After skipping two weeks, I elected to nibble at a bond CEF last week.
Snapshot of Trade:
Security Description: BlackRock Credit Allocation Income Trust (BTZ) is a leveraged closed end bond fund.
CEFConnect Page for BTZ
Data as of Friday 8/23/13:
Closing Net Asset Value Per Share: $14.53
Closing Market Price: $12.37
Discount: -14.87%
Data as of Monday 8/26/13 (day of purchase)
Closing Net Asset Value Per Share: $14.55
Closing Market Price: $12.36
Discount -15.05%
Average 1 Year Discount= -9.43%
BTZ closed last Friday, 8/30, at a -14.91% discount to its $14.62 net asset value per share.
Last SEC Filed Shareholder Report-Period Ending 4/2013: BLACKROCK CREDIT ALLOCATION INCOME TRUST (list of holdings starts at page 10)
The portfolio is weighted in BBB or higher rated bonds, but there is a significant junk bond exposure:
BlackRock Credit Allocation Income Trust (BTZ) Dividend Date & History
The current monthly dividend rate is $.0785 per share.
Assuming that rate is continued, which is in no way assured, the dividend yield at a total cost of $12.35 per share would be about 7.63%.
Fund Website: BlackRock
The fund sponsor states that the "option adjusted" duration was 6.88 years as of 6/28/13, with leverage at 32.5%. (under portfolio tab at sponsor's website). The credit quality as of 6/28/13 was 46.4% in BBB; 14.6% in A and 3.2% in AA or AAA, with 18.2% in BB and 13.5% in B.
Generally speaking, an investor can multiply the duration number by the percentage increase in interest rates to arrive at a ballpark potential loss number. A 1% rise in rates for a fund with a 7 year duration could result in an approximate 7% loss, Get to know your bond fund: Duration| Vanguard.
Prior Trades: After initially trading this bond CEF profitably, I reentered at an inopportune time and consequently been averaging down. I am reinvesting the dividend.
I am now back up to 347+ shares in a taxable account, with a $13.12 average cost per share, and another 304+ shares held in the Roth IRA. With the recent price decline, I have started to reinvest the dividend paid by all of those shares.
Some of the following discussion is copied from prior posts on BTZ.
Rationale: The discount to net asset value has just become excessive for this bond CEF.
I am reinvesting the dividend to buy more shares and have started to do so only recently after a long hiatus for the position held in the taxable account. The ROTH IRA positions are new.
For the next two years, and probably longer, I am not going to earn anything by keeping money in a money market account. My main taxable account now has about 25% in cash earning nothing.
Before taxes and inflation, this bond CEF would have to go down about 7.63% to wipe out the income generation over the next year. Even if the decline happens, I would be even before taxes and inflation, compared to the income generation in a money market account.
I am trying to balance the desire for some income with the potential principal losses inherent in buying bond funds now. I have for now arrived at a balance where I will invest up to $1,000 per week in a bond CEF and reinvest monthly dividend distributions to acquire more shares. I am also skipping a few weeks. That balance was struck after considering the following items.
(1) The declines in market prices for bond CEFs are substantially higher than the declines in net asset values per share, and the discounts now exceed the averages for 1, 3 and 5 years. As the price falls more than the net asset value, I increase my current yield with new purchases, and the yields are attractive in the current abnormally low interest rate environment. BTZ is weighted, moreover, in BBB or higher rated bonds.
(2) Inflation expectations over the next 10 years remain low and would cap bond losses due to interest rate normalization provided that expectations remains close to 2% per year.
(3) Short term borrowing costs are likely to remain low for several more years for two reasons. The FED is likely to continue ZIRP into 2015, which will anchor short term rates near zero, and will likely raise its federal funds rate much slower than in previous tightening cycles. So, the cost side of the interest rate spread is likely to remain favorable for leveraged bond CEFs for the next 2-3 years and possibly longer. I would add the usual caveat. I would not want to own a leveraged bond fund when both short term and long term rates are rising, particularly when the later increases are due to accelerating inflation and inflation expectations.
I noted in a recent SA comment that investors may start to front run the rise in short term rates before the FED even starts to raise short term rates. In this context, front running could result in the discounts of leveraged bond CEFs increasing, due to share liquidations and the disappearance of buyers, in anticipation that their borrowing costs would increase and their net interest spread would decrease. High Retirement Income With Floating Rate Loan Funds - Seeking Alpha
The market will front run the FED, as shown by the recent spike in intermediate and long term interest rates, as inflation expectations have declined some, in anticipation of tapering and the eventual end of QE.
Risks: (1) CEF Prices are Determined by Frequently Irrational Investors: This is risk applicable to all CEFs. Irrationality can result in a CEF selling at a significant premium to net asset value or at an increasing discount even when the net asset value per share is going up.
(2) Rise in Interest Rates: When interest rates start to rise, the leveraged bond CEF would be one of the worst investments to own. The fund's borrowing cost would be going up at a time when the bonds are going down in value. Most likely, the discount to net asset value would be widening in that scenario-The Infamous Triple Whammy!
The process of interest rate normalization will be difficult as I have noted many times previously. Stocks, Bonds & Politics: The Difficult Path to Interest Rate Normalization As long as bond prices are moving down and yields up, investors will continue to flee bond funds and bond CEFs in particular, placing additional downward pressure on pricing of bond CEFs that is likely to exceed the percentage decline in net asset value.
That pricing action is a known risk for CEFs since the pricing is not dependent on the closing net asset value, which is the case for a bond mutual fund, but on the supply and demand factors characteristic of a common stock, with no mechanism available to bring price back into line with net asset value per share which exists for bond ETFs.
The foregoing presents a risk but also an opportunity to acquire assets at discounts to net asset value per share, which increases the investor's yield compared to a bond mutual fund selling at net asset value, and the yield increases as the discount expands, just like buying a bond at a discount to its par value.
The problem is that the discount can continue to widen after purchase which is then made worse by a concomitant diminution in net asset value per share. Leverage aids to the losses as the assets bought with borrowed money decline in price.
Leverage adds potential risks and benefits. The benefits are a higher yield due to the spread between the short term borrowing cost and the higher yield paid by the bonds purchased with those borrowed funds and more of a net asset per share gain when the assets purchased with borrowed funds are increasing in value which has not been the case recently of course.
The interest rate risk exists but is mitigate to some degree by the duration. Credit risk always exists for this fund, but is not as pronounced as a pure junk bond fund given the weighting in investment grade securities.
(3) Default and Credit Risk: Junk bonds have a significant default rate and can go down significantly in price even without a default as shown by what happened in the last recession. The average yield for junk bonds spiked to over 22.5%. BofA Merrill Lynch US High Yield Master II Effective Yield ( - St. Louis Fed
Future Buys-Sells: I may continue to add small lots provided the discount to net asset value continues to expand. It just seems to me that the widening in the discount over normal levels already reflects a 6% to 8% further decline in net asset value per share based on another 1% or so rise in interest rates.
Friday's Closing Price: BTZ: $12.44 +0.05 (+0.40%)
4. Added 50 ENY at $14.04 (see Disclaimer):
Snapshot of Purchase:
Security Description: The Guggenheim Canadian Energy Income ETF (ENY) is an ETF that owns Canadian energy and pipeline stocks.
This ETF has performed poorly for reasons that are not entirely clear. I will discuss some possible reasons below.
A long term chart reveals that the ENY price topped out at close to $33 back in May 2008, when oil shot over $140 per barrel, and then slid to less than $8 by March 2009. While that slid is understandable under the circumstances, the current price is not, and is wallowing below the price prevailing in June 2009. Canadian Energy Income ETF Chart
Sponsor's Website: ETF
Fund Holdings: ETF
Top Ten Holdings as of 8/23/13:
I already own Husky, Pembina and Suncor and have unrealized profits in my current positions. Bought 100 PBA at $29.21 (reinvesting monthly dividend); Bought 50 SU at $28.67; Bought 100 HUSKF at $26.42 (7/6/13 Post)
I have also traded Husky profitably in the past.
Prior Trades: While I have traded individual Canadian energy companies profitably, and currently have unrealized gains in Suncor and Husky Energy, I am sitting on an unrealized loss in ENY shares, so I decided to average down. I am also reinvesting the dividend to buy additional shares, another method for averaging down.
I believe my last discussion was in Item 4 Added 50 ENY at $15.6
I had two small flips before starting this blog. One of the flips was a 100 share lot held for 11 days in 2007. I sold those shares for over $27. I am certainly grateful that I no longer own them:
I then did two more flips in late 2007 and into early 2008:
I thereafter stayed away from this ETF until August 2009, when I was able to buy shares at $13.6
Item # 1 Bought 50 ETF ENY at $13.6 (August 2009)- Item # 7 Sold ETF ENY at $15.75 (November 2009); Item # 5 Bought 50 ENY at $17.18 (January 2012)-Item # 2 Sold 50 ENY at $18.25 (February 2012)
So, before digging myself into a small hole, I had realized a total gain trading this ETF of $366.69.
Rationale: Canada is not Venezuela, Argentina, Russia or the Middle East. The current price is attractive in my opinion for a long term hold, as the Canadian energy companies are likely to prove their value in the years to come. Canada may at times take some action that adversely impacts profitability, but nationalization is most likely never to be on the agenda. Christine Kirchner, the President of Argentina, nationalized a 51% interest in YPF to the dismay of Repsol, Seeking Alpha, a pattern that has been followed throughout the developing world for decades.
This ETF has recently added some Canadian pipelines that will generate more income.
Many of these companies have long lived assets. Suncor reportedly has an 80 year reserve life. Financial Post
I do not pretend to know where oil prices will be the coming years. With increasing demand from a hoped for cycle of worldwide economic growth, and dramatically increasing oil consumption in developing markets, particularly in China, one outcome in the coming decade would be a substantial surge in oil's price from existing levels. I try not to over think possible future outcomes. This seems like a realistic possible outcome which is sufficient for me to put some cash into this theme.
The Canadian oil sands do contain a long life crude oil asset The government of Alberta estimates that there is about 173 billion barrels of oil that can be extracted from the oil sands located in that province using current technology and based on prevailing oil prices.
There have been a number of recent acquisitions of Canadian companies exposed to oil sand production, including the recently approved purchase of Nexen by CNOOC. CBC News The Canadian government may not be receptive to more acquisition by oil companies controlled by foreign governments.
In previous discussions about Canadian energy companies, I referenced an interview with Charles Maxwell published in 2011 by Barrons who was then predicting $300 oil by 2020 and recommended two Canadian energy companies, Suncor and Cenovus, with heavy exposure to the oil sands. While $300 oil by 2020 is a stretch, I would view it as more likely than not by 2025-2030.
Risks: I would describe the risks as normal ones for a sector stock ETF that invests in foreign companies. The foreign company angle adds currency and country risk. When I think about country risk, the first image that pops into my mind is Hugo Chavez. Needless to say, Canada is not likely to follow Hugo's example, but there is always the possibility that the federal or provincial countries will enact laws (particularly increased taxes) and regulations adversely impacting the profitability of its energy companies or the acquisition of those companies at premium prices by foreign entities.
The expense ratio is high at .79% and .7% after a fee waiver.
I suspect that some of the weakness in Canadian energy companies originates from the renewed strength of U.S production as well as the lack of adequate pipeline capacity to move the Canadian products. One of the proposed pipelines, Keystone, is being held up by the Obama administration due to environmental concerns. Financial Post Hopefully, the transportation logjam will lighten up. "Alberta sinking billions into pipeline plan to send oil east" | Financial Post; "Pipeline project quietly moving forward would send oil across Canada to West Coast" | Oil and Gas | ADN.com
Future Buys/Sells: I may buy another 50 shares at below $13.5.
Friday's Closing Price: ENY: $14.10 -0.02 (-0.14%)
5. Sold 200 XFR:CA at C$20.12 (see Disclaimer):
Snapshot of Trade:
Bought 200 of the Canadian Bond ETF XFR at 20.13 CADs
Rationale: My ownership of this security revealed a personality flaw as an investor. My broker, Fidelity, would periodically lose the pricing of this security for extended periods and then manage to find the price, known to everyone else, for a brief period. Sometimes, another Canadian ETF, CLF:CA, would become invisible to Fidelity's computers, and I own 700 shares of that one. When the pricing of both disappeared from my account value, the impact could be around $17,000.
I was apparently becoming increasingly annoyed in a 5/6/13 about my inaccurate account values, as I discussed this problem then and took a couple of snapshots showing no values assigned to these ETFs: More Problems with Fidelity (introduction under the heading "Fidelity Calculation of Account Values")
Maybe I am just getting old and a bit ornery. I do like to know my true account value.
Recently, the price of both CLF:CA and XFR:CA disappeared for a couple of weeks, and then Fidelity found CLF's price while continuing to be unable to locate the price of XFR. I reached a maximum level of annoyance and consequently sold XFR.
Here are the prices that anyone can find at a financial website, or the Toronto exchange, Stock Market Quotes.
iShares 1-5 Year Laddered Government Bond Index Fund (CLF:TOR)
iShares DEX Floating Rate Note Index Fund (XFR:TOR)
XFR is not paying much of a dividend now, which is another reason for selling it in order to reduce my annoyance level with Fidelity's inability to find its market price.
6. Bought 300 WIW at $11.4359 (see Disclaimer):
Snapshot of Trade:
Security Description: The Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW) invests mostly in U.S. treasury inflation protected securities, weighted at 79.18% as of 7/31/13. The fund also owns some corporate bonds. SEC Filed Shareholder Report as of 12/31/12
The fund is able to pick up some yield by investing in high yield and investment grade corporate bonds plus a small weighting in foreign sovereign bonds (2.2% as of 12/31/12). The fund had a small weighting (5.2%) in treasury inflation protected bonds issued by Canada and the U.K.
SEC Form N-Q (holdings as of 3/31/13)(shows reduction in non-U.S. TIPs to 2.3% and sovereign bonds to 2.1%.
The sponsor lists the duration as 8.01 years as of 7/31/13.
The fund is currently unleveraged. I would view the absence of leverage to be prudent given the low TIP yields, the trend toward higher nominal rates due to interest rate normalization, and the relatively benign inflation numbers.
A treasury inflation protected security will increase the bond's principal amount (par value) semi-annually by CPI. Smart Bond Investing: TIPS and STRIPS - FINRA
Since this bond CEF is weighted in TIPs, the current yield will be low. The lower current yield, compared to non-inflation protected treasuries or corporate bonds, is the trade off for the inflation protection.
The fund is paying a monthly dividend of $.0335 per share.
At a total cost of $11.44 per share, the yield would be about 3.51%. At least that yield is better than the .01% paid by the money market fund used to fund this purchase.
CEFConnect Page for WIW
Sponsor's Website Guggenheim Investments
Credit Quality as of 7/31/13:
While the price of WIW had declined 4 cents, the price of the ETF TIP had risen .43% at the time of my WIW purchase: TIP: $111.43 +0.47 (+0.43%)
On the day prior to my purchase, WIW closed at a -14.58% discount to its net asset value per share.
Data as of Monday 8/26/13 (day before purchase):
Closing Net Asset Value Per Share: $13.44
Closing Market Price: $11.48
Discount: -14.58%
Data as of Tuesday 8/27/13 (day of purchase):
Closing Net Asset Value Per Share: $13.53
Closing Market Price: $11.52
Discount: -14.86%
Discount at $11.44 purchase: -15.45%
WIW closed last Friday, 8/30, at a -14.7% discount to a net asset value per share of $13.47.
Closing Price of TIP ETF on 8/27/13: TIP: $111.64 +0.68 (+0.61%)
Closing Price of TIP ETF on 8/30/13: TIP: $110.74 -0.34 (-0.31%)
Prior Trades: I have repeatedly flipped this CEF:
Total Realized Gain to Date: $585.54
Bought 300 of the CEF WIW at $11.94 March 2010 Post
SOLD 200 of 300 WIW at $12.5 May 2010 Post
Bought 200 WIW at 12.29 June 2010 Post
Sold 300 WIW at $12.53 September 2010 Post
Bought 300 of the Bond CEF WIW at $12.14 December 2010 Post
Sold 300 WIW at 12.43 December 2010
Bought Back 300 of the CEF WIW at $12.17 January 2011 Post
Sold 300 WIW at $12.61 February 2011 Post
Bought Back 300 WIW at 12.47 July 2011 Post
Sold 300 WIW at 12.85 August 4, 2011 Post
Bought 200 WIW at $12.63 September 2011 Post
Sold 200 WIW at $12.91 March 2012 Post
Bought 300 WIW at $12.75-ROTH IRA April 2012
Sold 300 WIW at $13.01-Roth IRA June 2012
I have also traded the functionally equivalent IMF.
Bought 300 CEF IMF at $16.51 May 2010 Post
Sold: 300 IMF @ $17.23 October 2010 Post
Bought 200 of the Bond CEF IMF at $16.64 February 2011 Post
Sold 200 IMF at $17.15 February 2011 Post
Bought 200 IMF at $17.7-ROTH IRA February 2012
Sold 200 of the CEF IMF at $17.98-Roth IRA May 2012
Snapshots of IMF realized gains can be found in the last linked post and total $404.5.
I am glad that I have not bought either WIW or IMF back until I made the 300 WIW share purchase last Tuesday.
Price Intra-day 8/27/13: IMF: $16.07 +0.03 (+0.16%) : Western Asset Inflation Management
Rationale: With the tensions rising in the mideast, investors may move toward the risk off direction which could easily cause a significant, though temporary bounce, in high quality bonds.
WIW is selling an attractive discount.
If I am caught holding WIW for the long term, I am fine with that result. Prior to this last purchase, I did not own any TIPs, directly or through a TIP fund.
There is a place for TIPs in a bond allocation due to their inflation protection and negative to low positive correlation with other asset classes. (Stocks, Bonds & Politics: Treasury Inflation Protected Securities as a Non-Correlated Asset; and see Cristine Benz article at Morningstar.)
Recently, however, due to a spike in interest rates unconnected to a rise in CPI, TIPs have been positively correlated to other bond classes to the downside, as nominal treasuries and other bond classes reset toward market based rates uninfluenced by massive FED buying.
Risks: A treasury inflation protected security will not protect an investor from a rise in rates due to interest rate normalization rather than to an increase in inflation and inflation expectations. As the comparable maturity non-inflation protected securities started to decline in price and rise in yield, the TIPs did the same. Since May, the modest rise in inflation was nowhere near enough to offset the rise in rates.
On 4/30/13, WIW closed at $13.33. WIW Interactive Chart Unadjusted for subsequent dividend payments, the price declined 14.18% until I purchased shares at $11.44 on 8/27.
Intermediate and long term nominal rates started to rise on 5/2. The five and ten year TIPs were in negative current yield territory in early May.
5/2/13 10 Year TIP Current Yield: -.62%
Daily Treasury Real Yield Curve Rates
By 8/26/13, the 10 year TIP current yield had risen to +.64%. Importantly, CPI has remained tame during that yield rise. In order to go from a negative .62% to a positive .64%, vintage TIPs would have to decline significantly in price in order to cause that swing.
The TIP ETF has also declined in price over this time period: TIP Historical Prices TIP closed at $121.68 on 5/2/13 and at $110.96 on 8/26/13.
See also, Stocks, Bonds & Politics: Advantages and Disadvantages of Treasury Inflation Protected Securities
When I sold my individual 10 year TIPs last May, the purchaser acquired bonds that had a negative yield of -.89%: Item # 1 Sold 3 TIP Bonds Maturing in 2019 at $120.45 I calculated at the time that my profit of $838.87 (see snapshot) would likely exceed the interest payments and principal accretion from CPI until maturity on 7/15/2019. I was then receiving less than $60 annually from that TIP with a 1.875% coupon purchased at auction. Needless to say, the pricing of that TIP at a -.89% current yield made no sense to me at all.
In addition, a bond CEF carries its own risks as to pricing. There is nothing to prevent investors from dumping shares and causing the discount to expand further after a purchase. While there would seem to be a rational limit on such an expansion, there is in reality an indeterminable one. The most severe crunch came in October 2008 when bond CEF discounts went over 30% and briefly over 40% in some cases.
Future Buys/Sells: Given my views about the future course of interest rates, I am not likely to buy more and will flip this 300 share purchase for a relatively small gain. While it would probably make more sense to buy WIW in the ROTH IRA, I bought the shares in a taxable account. I simply did not want to devote the available ROTH IRA cash to such a low yielding security.
Friday's Closing Price: WIW: $11.49 +0.04 (+0.35%)
This post is long enough. To date, I have not received any disagreement about similar statements made in prior posts. I will discuss three other trades made last week in the next post.
When playing super cycles, I could care less what happens to a stock next year or the year after. Instead I am looking way out into the future. No one will be able to time when, or even whether, natural gas demand will cause a substantial non-temporary rise in price. I do not know, nor does anyone else who is not a divine being. I am going to admit up front that the Lord has not given me any guidance on this one, possibly draining the well of divine stock advice after sending me a sign about reinvesting the GE dividends. Stocks, Bonds & Politics: GE (introductory section near snapshot of GE buys)
The article in a UK trade journal intrigued the LB so it proceeded to read it: "GE bets on 25-year gas super-cycle": Gas to Power Journal UK The main guy at GE Power was predicting a 25 year natural gas super cycle. LB is always interested in super cycles, such as the one recently discussed in connection with the parabolic rise of middle class consumers in emerging markets or the super cycle that led to the long term bull market starting in 1982. The next article read had the following title and was even more intriguing: "Gas-fired CCPPs will dominate US power market": Gas to Power Journal UK In that article, a Siemens V-P stated that the competitive advantage of large coal fired plants was being eroded by the economics of low cost gas generation.
Back in the day when LB knew something about energy production from natural gas turbines, approximately 30 years ago, gas fired turbines were used by electric utilities over short term cycles to meet peak demand (e.g. the hottest part of a summer day). When that demand fell off, they would be turned off. The power cost from those units was high cost. Power produced by large coal and nuclear units was much cheaper, due to economies of scale, and those units were used to provide what is known as the base load requirements. Base Load and Peaking Power; SmartPlanet Those units would be running 24/7 except when shutdown for periodic maintenance. The guy from Siemens was saying that the cost advantage of coal generation was eroding in favor of the natural gas fired units. Coal units are only used to meet base load. So will the natural gas fired units be the new base load, running 24/7, burning up all of that natural gas to produce energy instead of coal?
It just appears to me that there may be no other choice. Nuclear plants take an incredibly long time to build, and utilities are not exactly beating down the door to build new ones in the U.S.
Yet, the Obama administration has clearly embarked on an environmental policy to shut down a significant number of coal generating stations by making it uneconomical to retrofit those plants with pollution devices to meet new clean air standards promulgated by the EPA.
I am not going to repeat my discussion about those EPA rules, contained in the comment section of this SeekingAlpha article: Seeking Alpha The author of that article was recommending an Illinois Basin coal producer, so I took issue with that recommendation based on what was happening with the EPA.
In my capacity as an investor, it is irrelevant whether I agree or disagree with the EPA policy. The relevant consideration starts with a very simple question that trial lawyers always want to know: "what are the facts". Once an investor has a grip on the relevant facts, the issue then is simply how to respond. Knowing about the direction and potential impacts of EPA's emissions rules, which have already resulted in plant shutdowns, I would not be in the market for a coal stock. The product is in abundance and the demand is about to fall.
I suspect that the estimate made by a consultant group will be close to what will happen. America is about to lose 20% of its coal fired generation over the next several years
Reuters Article Containing Consultant Estimate of 20% Closure Rate: Reuters
EPA Explanation of its Cross Border Emission Rules: Basic Information | Air Transport | US EPA
In a 2-1 decision, split along party lines, the District of Columbia Court of Appeals recently struck down the EPA's Cross-State Air Pollution Rule, as exceeding the EPA's authority under the Clean Air Act. The Supreme Court is set to review that decision. WSJ.com
Other relevant recent news:
Coal Plants Affected by EPA Regulations
AEP - News Releases - AEP Expects To Retire 585-Megawatt Coal-Fueled Unit In Ohio
FirstEnergy to Deactivate Two Coal-Fired Power Plants in Pennsylvania
A recent article in the WSJ noted that more crude oil is being transported by barge, train and truck in the U.S. than at anytime since the government started to keep records.
UBS AG E-Tracs Alerian Natural Gas MLP ETN (MLPG) Chart
(3) The ETN Structure Eliminates the K-1 Hassle: As noted in the sponsor's fact sheet, the distributions are reported as ordinary income in a 1099 and the owner of this security will not receive a K-1 form. This is a major selling point for me since I hate fooling with K-1s at tax time.
Risks: (1) UBS Credit Risk: An ETN is a senior unsecured note. As such, the owner of MLPG is subject to the credit risk of UBS. If UBS goes bankrupt the owner of this security will be in the same position as all other owners of the issuer's unsecured senior debt. While the amount of recovery in such an eventuality is unknowable, I generally would anticipate around 15 to 25 cents on the dollar after a prolonged period in bankruptcy where nothing would be paid to the owners of the issuer's debt.
(2) Concentration and Market Risk.
Other risks, including the call right, are described in the prospectus and the fact sheet: prospectus_supplement.pdf and factsheet.pdf
Last Friday's Closing Price: MLPG: $34.69 -0.27 (-0.77%)
2. Sold 100 PCBK at $12.994 (REGIONAL BANK BASKET STRATEGY)(see Disclaimer):
Snapshot of Trade:
 |
| Sold 100 PCBK at $12.994 |
.jpg){kind=small} |
| 2013 Sold 100 PCBK +$363.92 (ST-266.04; LT $96.88) |
Rationale: The primary motivation was profit taking.
I also did not like what I read about a recently filed lawsuit.
Pacific Continental Bank announced last Friday that it had been named in a lawsuit brought by individuals who had "placed" money in Berjac of Oregon and Berjac of Portland, both of whom are now in bankruptcy. I had never heard of those entities, so I did some digging.
The founder of Pacific Continental was Fred "Jack" Holcomb who was also named as a defendant along with the Holcomb Family Limited Partnership. Jack Holcomb also founded Berjac and ran it until he turned it over to his sons Michael, who served for years as a Director of PCBK, and Gary. OregonLive.com
I reviewed the allegations in the Complaint: Berjac Class Action Complaint.pdf The plaintiffs allege that they were victims of "Ponzi scheme" that was "conducted by defendant Fred "Jack" Holcomb, Michael S. Holcomb, Gary L. Holcomb, Berjac of Oregon, an Oregon general partnership, and Berjac of Portland, an Oregon general partnership". The two sons were not named as defendants since they are in bankruptcy.
Without going into detail, the gist of the allegation is that the Berjac entities were engaged in insurance premium financing. Berjac would pay the annual insurance premiums for a business who would pay Berjac back monthly after making a 25% down payment. To finance its operation, money was raised from investors by promising returns of 6% or more and allowing for frequent withdrawals. I never will understand why individuals line up to throw money at such offers. At some point, the Berjac entities started to use the money to speculate in real estate and many of those investments did not prosper, a typical LB understatement and attempt at humor.
After reading most of the Complaint, and taking some allegations with the usual and appropriate level of skepticism, the case did not not appear to be very strong against the two banks named in the lawsuit, Pacific Continental and Umpqua Holdings Corporation (UMPQ).
I previously sold UMPQ based on valuation. Sold 50 UMPQ at $16.12
The trustee in Berjac bankruptcy proceedings has sued the Holcomb Family Limited Partnership which the trustee alleges received millions from Berjac. OregonLive.com
A detailed discussion of Berjac's history can be found at OregonLive.com As reflected in that article, the two sons, at a minimum, lacked sufficient business acumen and competence to run Berjac. Sloppy is just one of many unfavorable words that describes their management.
Still, there is enough stink alleged in that complaint to cause me to sell my 100 shares PCBK shares.
I recently received a regular quarterly dividend of $.09 per share and a special dividend of $.12 per share. Pacific Continental
Future Buys: I am not likely to even consider buying this stock again until the foregoing litigation is resolved and the shares present are reasonably priced based on then existing earnings.
Friday's Closing Price: PCBK: $12.57 -0.43 (-3.31%)
3. Added 50 BTZ at $12.35 (see Disclaimer): After skipping two weeks, I elected to nibble at a bond CEF last week.
Snapshot of Trade:
 |
| 2013 Added 50 BTZ at $12.35 |
Security Description: BlackRock Credit Allocation Income Trust (BTZ) is a leveraged closed end bond fund.
CEFConnect Page for BTZ
Data as of Friday 8/23/13:
Closing Net Asset Value Per Share: $14.53
Closing Market Price: $12.37
Discount: -14.87%
Data as of Monday 8/26/13 (day of purchase)
Closing Net Asset Value Per Share: $14.55
Closing Market Price: $12.36
Discount -15.05%
Average 1 Year Discount= -9.43%
BTZ closed last Friday, 8/30, at a -14.91% discount to its $14.62 net asset value per share.
Last SEC Filed Shareholder Report-Period Ending 4/2013: BLACKROCK CREDIT ALLOCATION INCOME TRUST (list of holdings starts at page 10)
The portfolio is weighted in BBB or higher rated bonds, but there is a significant junk bond exposure:
 |
| Credit Quality Allocation as of 4/30/13 |
The current monthly dividend rate is $.0785 per share.
Assuming that rate is continued, which is in no way assured, the dividend yield at a total cost of $12.35 per share would be about 7.63%.
Fund Website: BlackRock
The fund sponsor states that the "option adjusted" duration was 6.88 years as of 6/28/13, with leverage at 32.5%. (under portfolio tab at sponsor's website). The credit quality as of 6/28/13 was 46.4% in BBB; 14.6% in A and 3.2% in AA or AAA, with 18.2% in BB and 13.5% in B.
Generally speaking, an investor can multiply the duration number by the percentage increase in interest rates to arrive at a ballpark potential loss number. A 1% rise in rates for a fund with a 7 year duration could result in an approximate 7% loss, Get to know your bond fund: Duration| Vanguard.
Prior Trades: After initially trading this bond CEF profitably, I reentered at an inopportune time and consequently been averaging down. I am reinvesting the dividend.
 |
| 2012 BTZ 388+ Shares +$279.19 |
 |
| 2010 BTZ 200 Shares +$134.61 |
Some of the following discussion is copied from prior posts on BTZ.
Rationale: The discount to net asset value has just become excessive for this bond CEF.
I am reinvesting the dividend to buy more shares and have started to do so only recently after a long hiatus for the position held in the taxable account. The ROTH IRA positions are new.
For the next two years, and probably longer, I am not going to earn anything by keeping money in a money market account. My main taxable account now has about 25% in cash earning nothing.
Before taxes and inflation, this bond CEF would have to go down about 7.63% to wipe out the income generation over the next year. Even if the decline happens, I would be even before taxes and inflation, compared to the income generation in a money market account.
I am trying to balance the desire for some income with the potential principal losses inherent in buying bond funds now. I have for now arrived at a balance where I will invest up to $1,000 per week in a bond CEF and reinvest monthly dividend distributions to acquire more shares. I am also skipping a few weeks. That balance was struck after considering the following items.
(1) The declines in market prices for bond CEFs are substantially higher than the declines in net asset values per share, and the discounts now exceed the averages for 1, 3 and 5 years. As the price falls more than the net asset value, I increase my current yield with new purchases, and the yields are attractive in the current abnormally low interest rate environment. BTZ is weighted, moreover, in BBB or higher rated bonds.
(2) Inflation expectations over the next 10 years remain low and would cap bond losses due to interest rate normalization provided that expectations remains close to 2% per year.
(3) Short term borrowing costs are likely to remain low for several more years for two reasons. The FED is likely to continue ZIRP into 2015, which will anchor short term rates near zero, and will likely raise its federal funds rate much slower than in previous tightening cycles. So, the cost side of the interest rate spread is likely to remain favorable for leveraged bond CEFs for the next 2-3 years and possibly longer. I would add the usual caveat. I would not want to own a leveraged bond fund when both short term and long term rates are rising, particularly when the later increases are due to accelerating inflation and inflation expectations.
I noted in a recent SA comment that investors may start to front run the rise in short term rates before the FED even starts to raise short term rates. In this context, front running could result in the discounts of leveraged bond CEFs increasing, due to share liquidations and the disappearance of buyers, in anticipation that their borrowing costs would increase and their net interest spread would decrease. High Retirement Income With Floating Rate Loan Funds - Seeking Alpha
The market will front run the FED, as shown by the recent spike in intermediate and long term interest rates, as inflation expectations have declined some, in anticipation of tapering and the eventual end of QE.
Risks: (1) CEF Prices are Determined by Frequently Irrational Investors: This is risk applicable to all CEFs. Irrationality can result in a CEF selling at a significant premium to net asset value or at an increasing discount even when the net asset value per share is going up.
(2) Rise in Interest Rates: When interest rates start to rise, the leveraged bond CEF would be one of the worst investments to own. The fund's borrowing cost would be going up at a time when the bonds are going down in value. Most likely, the discount to net asset value would be widening in that scenario-The Infamous Triple Whammy!
The process of interest rate normalization will be difficult as I have noted many times previously. Stocks, Bonds & Politics: The Difficult Path to Interest Rate Normalization As long as bond prices are moving down and yields up, investors will continue to flee bond funds and bond CEFs in particular, placing additional downward pressure on pricing of bond CEFs that is likely to exceed the percentage decline in net asset value.
That pricing action is a known risk for CEFs since the pricing is not dependent on the closing net asset value, which is the case for a bond mutual fund, but on the supply and demand factors characteristic of a common stock, with no mechanism available to bring price back into line with net asset value per share which exists for bond ETFs.
The foregoing presents a risk but also an opportunity to acquire assets at discounts to net asset value per share, which increases the investor's yield compared to a bond mutual fund selling at net asset value, and the yield increases as the discount expands, just like buying a bond at a discount to its par value.
The problem is that the discount can continue to widen after purchase which is then made worse by a concomitant diminution in net asset value per share. Leverage aids to the losses as the assets bought with borrowed money decline in price.
Leverage adds potential risks and benefits. The benefits are a higher yield due to the spread between the short term borrowing cost and the higher yield paid by the bonds purchased with those borrowed funds and more of a net asset per share gain when the assets purchased with borrowed funds are increasing in value which has not been the case recently of course.
The interest rate risk exists but is mitigate to some degree by the duration. Credit risk always exists for this fund, but is not as pronounced as a pure junk bond fund given the weighting in investment grade securities.
(3) Default and Credit Risk: Junk bonds have a significant default rate and can go down significantly in price even without a default as shown by what happened in the last recession. The average yield for junk bonds spiked to over 22.5%. BofA Merrill Lynch US High Yield Master II Effective Yield ( - St. Louis Fed
Future Buys-Sells: I may continue to add small lots provided the discount to net asset value continues to expand. It just seems to me that the widening in the discount over normal levels already reflects a 6% to 8% further decline in net asset value per share based on another 1% or so rise in interest rates.
Friday's Closing Price: BTZ: $12.44 +0.05 (+0.40%)
4. Added 50 ENY at $14.04 (see Disclaimer):
Snapshot of Purchase:
 |
| Added 50 ENY at $14.04 |
This ETF has performed poorly for reasons that are not entirely clear. I will discuss some possible reasons below.
A long term chart reveals that the ENY price topped out at close to $33 back in May 2008, when oil shot over $140 per barrel, and then slid to less than $8 by March 2009. While that slid is understandable under the circumstances, the current price is not, and is wallowing below the price prevailing in June 2009. Canadian Energy Income ETF Chart
Sponsor's Website: ETF
Fund Holdings: ETF
Top Ten Holdings as of 8/23/13:
I have also traded Husky profitably in the past.
Prior Trades: While I have traded individual Canadian energy companies profitably, and currently have unrealized gains in Suncor and Husky Energy, I am sitting on an unrealized loss in ENY shares, so I decided to average down. I am also reinvesting the dividend to buy additional shares, another method for averaging down.
I believe my last discussion was in Item 4 Added 50 ENY at $15.6
I had two small flips before starting this blog. One of the flips was a 100 share lot held for 11 days in 2007. I sold those shares for over $27. I am certainly grateful that I no longer own them:
 |
| 2007 Sold 100 ENY $78.95 |
 |
| 2008 ENY 140 Shares +$138.73 |
Item # 1 Bought 50 ETF ENY at $13.6 (August 2009)- Item # 7 Sold ETF ENY at $15.75 (November 2009); Item # 5 Bought 50 ENY at $17.18 (January 2012)-Item # 2 Sold 50 ENY at $18.25 (February 2012)
 |
| 2009 ENY 50 Shares +$90.97 |
 |
| 2010 ENY 101+ Shares +$20.46 |
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| 2012 ENY 50 Shares +$37.58 |
Rationale: Canada is not Venezuela, Argentina, Russia or the Middle East. The current price is attractive in my opinion for a long term hold, as the Canadian energy companies are likely to prove their value in the years to come. Canada may at times take some action that adversely impacts profitability, but nationalization is most likely never to be on the agenda. Christine Kirchner, the President of Argentina, nationalized a 51% interest in YPF to the dismay of Repsol, Seeking Alpha, a pattern that has been followed throughout the developing world for decades.
This ETF has recently added some Canadian pipelines that will generate more income.
Many of these companies have long lived assets. Suncor reportedly has an 80 year reserve life. Financial Post
I do not pretend to know where oil prices will be the coming years. With increasing demand from a hoped for cycle of worldwide economic growth, and dramatically increasing oil consumption in developing markets, particularly in China, one outcome in the coming decade would be a substantial surge in oil's price from existing levels. I try not to over think possible future outcomes. This seems like a realistic possible outcome which is sufficient for me to put some cash into this theme.
The Canadian oil sands do contain a long life crude oil asset The government of Alberta estimates that there is about 173 billion barrels of oil that can be extracted from the oil sands located in that province using current technology and based on prevailing oil prices.
There have been a number of recent acquisitions of Canadian companies exposed to oil sand production, including the recently approved purchase of Nexen by CNOOC. CBC News The Canadian government may not be receptive to more acquisition by oil companies controlled by foreign governments.
In previous discussions about Canadian energy companies, I referenced an interview with Charles Maxwell published in 2011 by Barrons who was then predicting $300 oil by 2020 and recommended two Canadian energy companies, Suncor and Cenovus, with heavy exposure to the oil sands. While $300 oil by 2020 is a stretch, I would view it as more likely than not by 2025-2030.
Risks: I would describe the risks as normal ones for a sector stock ETF that invests in foreign companies. The foreign company angle adds currency and country risk. When I think about country risk, the first image that pops into my mind is Hugo Chavez. Needless to say, Canada is not likely to follow Hugo's example, but there is always the possibility that the federal or provincial countries will enact laws (particularly increased taxes) and regulations adversely impacting the profitability of its energy companies or the acquisition of those companies at premium prices by foreign entities.
The expense ratio is high at .79% and .7% after a fee waiver.
I suspect that some of the weakness in Canadian energy companies originates from the renewed strength of U.S production as well as the lack of adequate pipeline capacity to move the Canadian products. One of the proposed pipelines, Keystone, is being held up by the Obama administration due to environmental concerns. Financial Post Hopefully, the transportation logjam will lighten up. "Alberta sinking billions into pipeline plan to send oil east" | Financial Post; "Pipeline project quietly moving forward would send oil across Canada to West Coast" | Oil and Gas | ADN.com
Future Buys/Sells: I may buy another 50 shares at below $13.5.
Friday's Closing Price: ENY: $14.10 -0.02 (-0.14%)
5. Sold 200 XFR:CA at C$20.12 (see Disclaimer):
Snapshot of Trade:
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| Sold 200 XFR:CA at C$20.12 |
Rationale: My ownership of this security revealed a personality flaw as an investor. My broker, Fidelity, would periodically lose the pricing of this security for extended periods and then manage to find the price, known to everyone else, for a brief period. Sometimes, another Canadian ETF, CLF:CA, would become invisible to Fidelity's computers, and I own 700 shares of that one. When the pricing of both disappeared from my account value, the impact could be around $17,000.
I was apparently becoming increasingly annoyed in a 5/6/13 about my inaccurate account values, as I discussed this problem then and took a couple of snapshots showing no values assigned to these ETFs: More Problems with Fidelity (introduction under the heading "Fidelity Calculation of Account Values")
Maybe I am just getting old and a bit ornery. I do like to know my true account value.
Recently, the price of both CLF:CA and XFR:CA disappeared for a couple of weeks, and then Fidelity found CLF's price while continuing to be unable to locate the price of XFR. I reached a maximum level of annoyance and consequently sold XFR.
Here are the prices that anyone can find at a financial website, or the Toronto exchange, Stock Market Quotes.
iShares 1-5 Year Laddered Government Bond Index Fund (CLF:TOR)
iShares DEX Floating Rate Note Index Fund (XFR:TOR)
XFR is not paying much of a dividend now, which is another reason for selling it in order to reduce my annoyance level with Fidelity's inability to find its market price.
6. Bought 300 WIW at $11.4359 (see Disclaimer):
Snapshot of Trade:
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| 2013 Bought 300 WIW at $11.4359 |
Security Description: The Western Asset/Claymore Inflation-Linked Opportunities & Income Fund (WIW) invests mostly in U.S. treasury inflation protected securities, weighted at 79.18% as of 7/31/13. The fund also owns some corporate bonds. SEC Filed Shareholder Report as of 12/31/12
The fund is able to pick up some yield by investing in high yield and investment grade corporate bonds plus a small weighting in foreign sovereign bonds (2.2% as of 12/31/12). The fund had a small weighting (5.2%) in treasury inflation protected bonds issued by Canada and the U.K.
SEC Form N-Q (holdings as of 3/31/13)(shows reduction in non-U.S. TIPs to 2.3% and sovereign bonds to 2.1%.
The sponsor lists the duration as 8.01 years as of 7/31/13.
The fund is currently unleveraged. I would view the absence of leverage to be prudent given the low TIP yields, the trend toward higher nominal rates due to interest rate normalization, and the relatively benign inflation numbers.
A treasury inflation protected security will increase the bond's principal amount (par value) semi-annually by CPI. Smart Bond Investing: TIPS and STRIPS - FINRA
Since this bond CEF is weighted in TIPs, the current yield will be low. The lower current yield, compared to non-inflation protected treasuries or corporate bonds, is the trade off for the inflation protection.
The fund is paying a monthly dividend of $.0335 per share.
At a total cost of $11.44 per share, the yield would be about 3.51%. At least that yield is better than the .01% paid by the money market fund used to fund this purchase.
CEFConnect Page for WIW
Sponsor's Website Guggenheim Investments
Credit Quality as of 7/31/13:
While the price of WIW had declined 4 cents, the price of the ETF TIP had risen .43% at the time of my WIW purchase: TIP: $111.43 +0.47 (+0.43%)
On the day prior to my purchase, WIW closed at a -14.58% discount to its net asset value per share.
Data as of Monday 8/26/13 (day before purchase):
Closing Net Asset Value Per Share: $13.44
Closing Market Price: $11.48
Discount: -14.58%
Data as of Tuesday 8/27/13 (day of purchase):
Closing Net Asset Value Per Share: $13.53
Closing Market Price: $11.52
Discount: -14.86%
Discount at $11.44 purchase: -15.45%
WIW closed last Friday, 8/30, at a -14.7% discount to a net asset value per share of $13.47.
Closing Price of TIP ETF on 8/27/13: TIP: $111.64 +0.68 (+0.61%)
Closing Price of TIP ETF on 8/30/13: TIP: $110.74 -0.34 (-0.31%)
Prior Trades: I have repeatedly flipped this CEF:
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| 2010 WIW +$266.07 |
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| 2011 WIW $215.45 |
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| 2012 WIW +$63.97 |
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| 2012 WIW $40.05 |
Bought 300 of the CEF WIW at $11.94 March 2010 Post
SOLD 200 of 300 WIW at $12.5 May 2010 Post
Bought 200 WIW at 12.29 June 2010 Post
Sold 300 WIW at $12.53 September 2010 Post
Bought 300 of the Bond CEF WIW at $12.14 December 2010 Post
Sold 300 WIW at 12.43 December 2010
Bought Back 300 of the CEF WIW at $12.17 January 2011 Post
Sold 300 WIW at $12.61 February 2011 Post
Bought Back 300 WIW at 12.47 July 2011 Post
Sold 300 WIW at 12.85 August 4, 2011 Post
Bought 200 WIW at $12.63 September 2011 Post
Sold 200 WIW at $12.91 March 2012 Post
Bought 300 WIW at $12.75-ROTH IRA April 2012
Sold 300 WIW at $13.01-Roth IRA June 2012
I have also traded the functionally equivalent IMF.
Bought 300 CEF IMF at $16.51 May 2010 Post
Sold: 300 IMF @ $17.23 October 2010 Post
Bought 200 of the Bond CEF IMF at $16.64 February 2011 Post
Sold 200 IMF at $17.15 February 2011 Post
Bought 200 IMF at $17.7-ROTH IRA February 2012
Sold 200 of the CEF IMF at $17.98-Roth IRA May 2012
Snapshots of IMF realized gains can be found in the last linked post and total $404.5.
I am glad that I have not bought either WIW or IMF back until I made the 300 WIW share purchase last Tuesday.
Price Intra-day 8/27/13: IMF: $16.07 +0.03 (+0.16%) : Western Asset Inflation Management
Rationale: With the tensions rising in the mideast, investors may move toward the risk off direction which could easily cause a significant, though temporary bounce, in high quality bonds.
WIW is selling an attractive discount.
If I am caught holding WIW for the long term, I am fine with that result. Prior to this last purchase, I did not own any TIPs, directly or through a TIP fund.
There is a place for TIPs in a bond allocation due to their inflation protection and negative to low positive correlation with other asset classes. (Stocks, Bonds & Politics: Treasury Inflation Protected Securities as a Non-Correlated Asset; and see Cristine Benz article at Morningstar.)
Recently, however, due to a spike in interest rates unconnected to a rise in CPI, TIPs have been positively correlated to other bond classes to the downside, as nominal treasuries and other bond classes reset toward market based rates uninfluenced by massive FED buying.
Risks: A treasury inflation protected security will not protect an investor from a rise in rates due to interest rate normalization rather than to an increase in inflation and inflation expectations. As the comparable maturity non-inflation protected securities started to decline in price and rise in yield, the TIPs did the same. Since May, the modest rise in inflation was nowhere near enough to offset the rise in rates.
On 4/30/13, WIW closed at $13.33. WIW Interactive Chart Unadjusted for subsequent dividend payments, the price declined 14.18% until I purchased shares at $11.44 on 8/27.
Intermediate and long term nominal rates started to rise on 5/2. The five and ten year TIPs were in negative current yield territory in early May.
5/2/13 10 Year TIP Current Yield: -.62%
Daily Treasury Real Yield Curve Rates
By 8/26/13, the 10 year TIP current yield had risen to +.64%. Importantly, CPI has remained tame during that yield rise. In order to go from a negative .62% to a positive .64%, vintage TIPs would have to decline significantly in price in order to cause that swing.
The TIP ETF has also declined in price over this time period: TIP Historical Prices TIP closed at $121.68 on 5/2/13 and at $110.96 on 8/26/13.
See also, Stocks, Bonds & Politics: Advantages and Disadvantages of Treasury Inflation Protected Securities
When I sold my individual 10 year TIPs last May, the purchaser acquired bonds that had a negative yield of -.89%: Item # 1 Sold 3 TIP Bonds Maturing in 2019 at $120.45 I calculated at the time that my profit of $838.87 (see snapshot) would likely exceed the interest payments and principal accretion from CPI until maturity on 7/15/2019. I was then receiving less than $60 annually from that TIP with a 1.875% coupon purchased at auction. Needless to say, the pricing of that TIP at a -.89% current yield made no sense to me at all.
In addition, a bond CEF carries its own risks as to pricing. There is nothing to prevent investors from dumping shares and causing the discount to expand further after a purchase. While there would seem to be a rational limit on such an expansion, there is in reality an indeterminable one. The most severe crunch came in October 2008 when bond CEF discounts went over 30% and briefly over 40% in some cases.
Future Buys/Sells: Given my views about the future course of interest rates, I am not likely to buy more and will flip this 300 share purchase for a relatively small gain. While it would probably make more sense to buy WIW in the ROTH IRA, I bought the shares in a taxable account. I simply did not want to devote the available ROTH IRA cash to such a low yielding security.
Friday's Closing Price: WIW: $11.49 +0.04 (+0.35%)
This post is long enough. To date, I have not received any disagreement about similar statements made in prior posts. I will discuss three other trades made last week in the next post.
I've been waiting for a good entry point for KO, so was pleased to see it mentioned in your blog this week. There is an article about Coke on Seeking Alpha today (http://seekingalpha.com/article/1670112-coca-cola-makes-serious-changes-to-stay-on-top) which discusses the trend toward using stevia (a natural zero-calorie sweetener) in beverages and how Coke is responding.
ReplyDeleteCathie: I read that SA article earlier today. I put one of the stocks mentioned in my Lottery Ticket monitor list. I do not have a feel about whether stevia is a viable substitute for sugar.
ReplyDeleteI am personally finicky about my coca cola beverage and do not like any of the sugar substitutes compared to the original.
KO was downgraded today to Underperform from Outperform at Crédit Agricole. I do not have access to that report. It may account for the weakness today.
My average cost per share is around $25. I am content to harvest the dividend and to hold long term for the dividend growth which will improve, hopefully, every year my dividend yield based on my constant cost number.
Generally, for a buy under my dividend growth strategy, I want a 3% dividend yield or higher as a starting point. KO raised its quarterly dividend by 10% earlier this year from $.255 to $.28 per share or $1.12 annually. A $37 total cost price would give an investor about a 3% starting yield.
Enjoy your approach and willingness to share the way in which you are thinking about a given issue.
ReplyDeleteBOI looks like it is worth monitoring for a reasonable yield at a low duration. Spread is driven by CMBS/MBS/YH holdings. Sometimes new CEFs don't trade well which creates opportunities.
Enjoy your approach and your willingness to share the way in which you think about an issue.
ReplyDeleteBOI may be worth monitoring for its yield and low duration. Nothing is risk free: spread is from MBS/CMBS/HY. New CEFs sometimes trade poorly which creates opportunities.