Big Picture Synopsis:
Stocks:
Stable Vix Pattern (bullish)
Vix Asset Allocation Model Explained Simply
Use of the VIX as a Timing Model
Stocks:
Stable Vix Pattern (bullish)
Vix Asset Allocation Model Explained Simply
Use of the VIX as a Timing Model
Short Term: Praying for a 10+% Correction
Intermediate and Long Term: Bullish
Bonds:
Short to Long Term: Slightly Bearish (Based on Interest Rate Normalization: The Difficult Path to Interest Rate Normalization)
Intermediate and Long Term: Bullish
Bonds:
Short to Long Term: Slightly Bearish (Based on Interest Rate Normalization: The Difficult Path to Interest Rate Normalization)
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Shiller P/E 10
The Shiller P/E 10 ratio, as known as the CAPE Ratio, is calculated by dividing the S & P 500's price by the index's average real reported earnings over the prior ten years. The average historical CAPE ratio is 16.5.
As of 7/31/13, using the S & P 500 monthly close of 1685.73, the CAPE ratio was calculated by Doug Short at 23.7: Cheap? The market is far from cheap using the CAPE ratio and is 25% above Short's regression line.
This blog, P/E10 Ratio Research Catalog, links a large number of articles written on this topic.
I view this P/E ratio as having many flaws. For one, it incorporates 10 years of past earnings while the market is attempting to price future earnings. The prior ten years also includes the worst recession since the Great Depression that is still having some lingering negative impacts on important industries. New housing starts are hovering new the 1974 recession lows as an example:
Long Term Chart: Housing Starts: Total: New Privately Owned Housing Units Started
{In garden variety recessions, automobiles and housing lead the way out. It is not surprising that new housing starts have been anemic during the current recovery considering that it was the housing bubble, and everything related to it, that created the Near Depression. There are fundamental reasons supporting a pickup in new housing contraction, including household formations, the destruction of houses abandoned after foreclosure, and the low number of new homes built since 2007. There are many reason for future optimism for new home construction, and everything that goes with it, starting to contribute to GDP growth.}
The forward 12 month P/E for the S & P 500 is reasonable at slightly over 15. Markets Data Center - WSJ.com
The market is after all more interested in the future than the past 10 years.
Liz Ann Sonders sums up some of the criticisms of Shiller's P/E 10. Variety of Price-Earnings Ratios
Other criticisms can be found in these SA articles:
"A Cautionary Note About Robert Shiller's CAPE"
"Shortcomings Of The Shiller PE10 Ratio"
Shiller PE Continues To Mislead Investors,
See also, CAPE says equities too pricey, but they’re not - MarketWatch
However, long term readers know that I try to present a balanced view in this blog, and the CAPE ratio is troubling given historical precedent.
Historically, as noted by Meban Faber in a 2012 paper, the S & P 500 will frequently have negative real rates of return over a 10 year period when the CAPE ratio exceeds 20.
See Meban Faber: "Global Value: Building Trading Models with the 10 Year Cape" (Free Download from SSRN)
He makes the same point in his recent book: Shareholder Yield: A Better Approach to Dividend Investing: Mebane Faber (Amazon)
The Shiller P/E 10 ratio, as known as the CAPE Ratio, is calculated by dividing the S & P 500's price by the index's average real reported earnings over the prior ten years. The average historical CAPE ratio is 16.5.
As of 7/31/13, using the S & P 500 monthly close of 1685.73, the CAPE ratio was calculated by Doug Short at 23.7: Cheap? The market is far from cheap using the CAPE ratio and is 25% above Short's regression line.
This blog, P/E10 Ratio Research Catalog, links a large number of articles written on this topic.
I view this P/E ratio as having many flaws. For one, it incorporates 10 years of past earnings while the market is attempting to price future earnings. The prior ten years also includes the worst recession since the Great Depression that is still having some lingering negative impacts on important industries. New housing starts are hovering new the 1974 recession lows as an example:
Long Term Chart: Housing Starts: Total: New Privately Owned Housing Units Started
{In garden variety recessions, automobiles and housing lead the way out. It is not surprising that new housing starts have been anemic during the current recovery considering that it was the housing bubble, and everything related to it, that created the Near Depression. There are fundamental reasons supporting a pickup in new housing contraction, including household formations, the destruction of houses abandoned after foreclosure, and the low number of new homes built since 2007. There are many reason for future optimism for new home construction, and everything that goes with it, starting to contribute to GDP growth.}
The forward 12 month P/E for the S & P 500 is reasonable at slightly over 15. Markets Data Center - WSJ.com
The market is after all more interested in the future than the past 10 years.
Liz Ann Sonders sums up some of the criticisms of Shiller's P/E 10. Variety of Price-Earnings Ratios
Other criticisms can be found in these SA articles:
"A Cautionary Note About Robert Shiller's CAPE"
"Shortcomings Of The Shiller PE10 Ratio"
Shiller PE Continues To Mislead Investors,
See also, CAPE says equities too pricey, but they’re not - MarketWatch
However, long term readers know that I try to present a balanced view in this blog, and the CAPE ratio is troubling given historical precedent.
Historically, as noted by Meban Faber in a 2012 paper, the S & P 500 will frequently have negative real rates of return over a 10 year period when the CAPE ratio exceeds 20.
See Meban Faber: "Global Value: Building Trading Models with the 10 Year Cape" (Free Download from SSRN)
He makes the same point in his recent book: Shareholder Yield: A Better Approach to Dividend Investing: Mebane Faber (Amazon)
The past can be prologue. This time may not be different. The level of the CAPE ratio and the anemic GDP and jobs growth signal to me at least the need for caution.
In this blog, I am attempting to present a balanced view. The Shiller P/E 10 is just one of the negatives.
Other valuation measures, such as the Q Ratio, also have the market in expensive territory (see Doug Short's discussion at Market Valuation)
Just for clarity, it is my opinion, based on the weight of the evidence, that the U.S. stock market is currently in a long term secular bull market, rather than a cyclical bull within the confines of a long term secular bear market.
I also believe that the market has moved too far, too fast based on economic fundamentals and valuations. It would be healthy at this point for the market to correct by at least 10% and then move sideways for 6-12 months or until there is a validation of the market's move in the real world. The S & P 500 has moved from 1100 to almost 1700 over the past two years. S&P 500 Index Chart
In this blog, I am attempting to present a balanced view. The Shiller P/E 10 is just one of the negatives.
Other valuation measures, such as the Q Ratio, also have the market in expensive territory (see Doug Short's discussion at Market Valuation)
Just for clarity, it is my opinion, based on the weight of the evidence, that the U.S. stock market is currently in a long term secular bull market, rather than a cyclical bull within the confines of a long term secular bear market.
I also believe that the market has moved too far, too fast based on economic fundamentals and valuations. It would be healthy at this point for the market to correct by at least 10% and then move sideways for 6-12 months or until there is a validation of the market's move in the real world. The S & P 500 has moved from 1100 to almost 1700 over the past two years. S&P 500 Index Chart
************
Interest Rates and Stock Prices:
On a daily basis, I read opinions stated as facts by the Commentariat at SeekingAlpha. Among those souls predisposed to bearishness, and possibly having a profound psychological need to justify missing the robust stock market rally since March 2009, one common theme is that stocks will decline when interest rates rise.
When the brain ossifies and opinions become immutable, it becomes impossible to learn anything from current events.
What is the recent history about how stocks perform when rates go up?
The ten year treasury yield was 1.66% on 5/1/2013 and is hovering near 2.6% now. Daily Treasury Yield Curve Rates For anyone owning bonds over the past three months, it has been painful.
As interest rates for intermediate and long term bonds spiked up, the S & P 500 gained almost 7%, having closed at 1,582.70 on 5/1: Historical Prices | S&P 500
It is just a fact that every major bull move in the stock market since 1982 has occurred with the ten year treasury yielding over 4%.
The robust move between 1991-1999 took place with the ten year treasury yield moving mostly between 5% to 7.5%.
Rates were even higher for the powerful stock market move between August 1982 to October 1987, the first leg in what turned out to be a long term secular bull market in stocks that returned over 14% annualized for an investment in the S & P 500, adjusted for inflation and with reinvestment of dividends. That long term secular bull market started in 1982 when the average 30 year mortgage rate for the year was 16.04% with two points. Primary Mortgage Market Survey Archives - 30 Year Fixed Rate Mortgages - Freddie Mac
And, the robust stock rally between 2004 to October 2007 occurred when the ten year treasury was moving mostly between 4% to 5%.
There are positives associated with a 4% average rate on "risk free" savings. There is almost $7 trillion stuck in savings accounts earning nothing now. Add money market funds, CD holdings, and low yielding treasury bill and short term notes, the number is just staggering. Just slap a 4% interest rate on $10 trillion ($400 BILLION PER YEAR) and run the result through any econometric model on the impact. It would have a huge positive impact on the economy and jobs: The Big Picture.
The FED knows about the substantial negative impacts. It is constantly updating the amounts held in those "risk free" instruments earning nothing for all practical purposes. Federal Reserve Statistical Release H.6
Total Savings Deposits at all Depository Institutions
The past may not predict the future of course. But the past three decades, including the past three months, does not provide any support for those fretting about another 1% to 1.5% rise in the ten year rate over the next 12 to 18 months.
***********
CEF General American Investors (own):
 |
| GAM as of 8/8/13 (2 Dividend Reinvestments)-Average Cost Per Share=$29.52 |
I always find it interesting to see how a small difference in performance mounts up over time. The annualized GAM net asset value return over 20 years is 10.6% compared to the S & P 500 at 8.6%, both with dividends reinvested and to 6/30/13. General American Investors: Annualized Results The difference in the value of a $10,000 investment shows up in a long term chart: General American Investors: Twenty-Year Results
I reviewed the most recent shareholder report, and I am fine with most of the fund's investments.
SEC General American Investors Shareholder Report for the Period ending June 30, 2013.
Website: General American Investors
Website: General American Investors
Item # 3 Bought 100 of the Stock CEF $29.52 (September 2012)
I am reinvesting the dividends.
GAM has a tendency to hold positions for a long time.
Friday's Closing Price: GAM: $33.43 -0.05 (-0.15%)
***************
Adams Express (ADX) (own close to 900 shares):
I noticed that ADX no longer had a page in its shareholder reports listing buys and sells during the quarter. The fund did specify in its most recent quarterly report that it had realized capital gains of $26+M during the first six months or $.29 per share. ADAMS EXPRESS COMPANY - SEC FORM N-CSRS - JUNE 30, 2013
I found a list of transactions for the second quarter at ADX's website that shows an unusual amount of activity for this fund. adx_quarterlychanges_063013.pdf This data is now accessible at Adams Express Company | Quarterly Changes in Portfolio Securities The fund has also started buying some stock ETFs.
Links to Some Prior Trades: Item # 2 Bought ADX at $8.34 (May 2009); Item # 5 Added To CEF ADX at $9.98 (November 2009); Item # 1Bought 200 ADX @ 9.99 (October 2010); Item # 2 Added 50 ADX at $10.95 (June 2011); Item # 1Added 50 of the Stock CEF ADX at $9.77 (December 2011); Item # 4 Bought 100 ADX at $10.14 (November 2012)
ADX pays a managed distribution of at least 6% annually. Most of that distribution will be capital gains paid during the 4th quarter. The quarterly income dividend is relatively small. (Dividend history since 1956: ADX_Div_Payments.pdf)
I have quit reinvesting the dividend after acquiring a significant number of shares between September 2008 and December 2012. If and when the shares rise to the $13-$13.5 range, I may lighten up by selling 200 shares and then look to buy those shares back at below my current average cost per share. I am in no hurry to buy or to sell. I simply do not want to buy more shares at the current price. If the price fell below $10, I would consider using the cash dividends to buy more shares at that time.
Closing Price 8/8/13: ADX: $12.49 +0.04 (+0.32%)
ADX Page at Morningstar
ADX Page at CEFConnect
***************
I am reinvesting the dividends.
GAM has a tendency to hold positions for a long time.
Friday's Closing Price: GAM: $33.43 -0.05 (-0.15%)
***************
Adams Express (ADX) (own close to 900 shares):
 |
| ADX as of 8/8/2013/Average Cost Per Share $10.67 |
I found a list of transactions for the second quarter at ADX's website that shows an unusual amount of activity for this fund. adx_quarterlychanges_063013.pdf This data is now accessible at Adams Express Company | Quarterly Changes in Portfolio Securities The fund has also started buying some stock ETFs.
Links to Some Prior Trades: Item # 2 Bought ADX at $8.34 (May 2009); Item # 5 Added To CEF ADX at $9.98 (November 2009); Item # 1Bought 200 ADX @ 9.99 (October 2010); Item # 2 Added 50 ADX at $10.95 (June 2011); Item # 1Added 50 of the Stock CEF ADX at $9.77 (December 2011); Item # 4 Bought 100 ADX at $10.14 (November 2012)
ADX pays a managed distribution of at least 6% annually. Most of that distribution will be capital gains paid during the 4th quarter. The quarterly income dividend is relatively small. (Dividend history since 1956: ADX_Div_Payments.pdf)
I have quit reinvesting the dividend after acquiring a significant number of shares between September 2008 and December 2012. If and when the shares rise to the $13-$13.5 range, I may lighten up by selling 200 shares and then look to buy those shares back at below my current average cost per share. I am in no hurry to buy or to sell. I simply do not want to buy more shares at the current price. If the price fell below $10, I would consider using the cash dividends to buy more shares at that time.
Closing Price 8/8/13: ADX: $12.49 +0.04 (+0.32%)
ADX Page at Morningstar
ADX Page at CEFConnect
***************
Recent Economic Reports:
The ISM's July PMI index for U.S. services rose to 56 from 52.2 in June. The consensus estimate was for a 53. The new orders component rose to 57.7 from 50.8. The employment index decreased by 1.5% to 53.2. The business activity index increased to 60.4. According to Brian Wesbury, the business activity index has a "stronger correlation with economic growth than the overall index". ftportfolios.com/Commentary.PDF
The HSBC/Markit PMI index for China's service sector was reported at 51.3 in July. markiteconomics
The ISM's July PMI index for U.S. services rose to 56 from 52.2 in June. The consensus estimate was for a 53. The new orders component rose to 57.7 from 50.8. The employment index decreased by 1.5% to 53.2. The business activity index increased to 60.4. According to Brian Wesbury, the business activity index has a "stronger correlation with economic growth than the overall index". ftportfolios.com/Commentary.PDF
The HSBC/Markit PMI index for China's service sector was reported at 51.3 in July. markiteconomics
CoreLogic reported that home prices increased by 11.9% Y-O-Y in June. With the latest rise, home prices are still 19% below their June 2006 peak. Calculated Risk Blog; Reuters; MarketWatch
The rapid return of home prices toward trendline growth is one of the most important economic developments over the past year. As noted earlier, the rise in home prices last year enabled millions of households to refinance their mortgages at abnormally low rates, Bloomberg, and that is continuing into 2013.
Home equity is the primary repository of household wealth for most Americans. The FED reported that household net worth increased by almost $3 trillion in the 2013 first quarter, due largely to increases in home prices and stocks. Z.1 release.pdf
Household net worth exceeded $70 trillion in the first quarter and is certainly higher now: Chart Net Worth- St. Louis Fed
I only recently learned that I could create my own graphs using the data available at the St. Louis Federal Reserve. This chart shows the serious decline in household net worth during the Near Depression period and the ensuing snapback:
Rising home prices will also contribute to increased consumer confidence about the future.
The Commerce Department reported that the nation's trade deficit was $34.2B in June, down from $44.1B in May. census.gov.pdf
This shrinkage in the trade deficit may boost the government's next estimate of second quarter GDP. Reuters In the first estimate, the government estimated that the trade sector had a .8 drag on GDP. Brian Wesbury noted in his blog that the impact was probably zero based on this latest trade number. He is estimating now a revision in 2nd quarter real GDP to 2.5% from 1.7%. Wesbury.PDF
The Fed's July survey of senior loan officers had eased their lending policies and reportedly experienced stronger demand over the past three months. FRB: Senior Loan Officer Opinion Survey: July 2013
For the week ending 8/3, the four week moving average of initial unemployment claims fell to the lowest level since November 2007.
The Mortgage delinquency rate for residential units decreased to 6.96% of all loans outstanding, the lowest level since mid-2008. The serious delinquent rate which are more than 90 days past due, was at 5.88%.
Singapore raised its 2013 growth forecast to 2.5%-3.5%, up from the previous estimate of 1% to 3%.
The WSJ published yesterday an article about one of China's ghost cities.
For whatever it may be worth, China's National Bureau of Statistics has started to publish some favorable data about China's economy as of late. Late last week, China's industrial production was reported to have increased 9.7% Y-O-Y in July, better than the consensus 9% forecast. Retail sales reportedly increased by 13.2%. These reports had a positive impact on commodity prices last Friday.
*******************
Nashville Area ETF (NASH):
I may have to invest in this one at some point. I am after all a Nashvillian, and have observed for decades the entrepreneurial culture here. My first investment was in HCA back in the late 1960s when it owned one small hospital across from the Parthenon.
Still, a geographic centric is probably not the best investment concept and may be more indicative of ETF proliferation.
Without even looking, I knew that this new ETF had to have a concentration in healthcare companies. Fund Holdings - LocalShares
Sponsor's Website: Nashville & Its Companies - LocalShares
Nashville ETF - Zacks.com
Friday's Closing Price: NASH: $25.00 -0.04 (-0.16%) : Nashville Area ETF
***************
TLT vs. 5 Randomly Selected Blue Chip Common Stocks: Two Peas from the Same Pod-Davy Levy and David Rosenberg
Back in August 2010, David Rosenberg was touting again buying ten and thirty year treasuries that were yielding 2.5% and 3.6% at the time. Barrons was giving him a pass again on his errant forecasts about the stock market, as always, presenting Rosenberg as some kind of modern day oracle. Well, I knew differently.
Rosenberg was predicting doom and gloom in the March 9, 2009 Barrons' issue, published the day before the S & P 500 started its 150+% ascent. That same issue featured another ghoul, David Levy, spouting gloom and doom in an article tilted "No Doom, Just Gloom".
Levy was again featured in the 8/5/13 issue, given a pass again by the same Barron's interviewer, Lawrence Strauss, as he touted treasuries again in an article titled "Another U.S. Recession Is Coming". Okay, maybe that is prescient, recessions do come along with some regularity. Maybe I will become a well known guru by making this statement: The US. will experience a recession in the future. I am now ready to form my own consulting firm, hire a few dozen MIT pets, and start charging the deaf, dumb and blind $100,000 a year for Wrong Way Forecasts.
I will have more to say about Levy in just a moment. Back to Barron's Market Oracle In Residence David Rosenberg.
It was Rosenberg who was predicting in April 2009 that the S & P 500 was going to "gravitate in a 475-650 range for an extended period of time". Business Insider Well, he is just one of those bears who can not see.
I was fed up with his negativity when reading that August 2010 article so I decided to conduct a test that is summarized in this post: More on Barron's and David Rosenberg (8/23/2010 Post). I took a snapshot of a portfolio that had invested $50,000 in TLT, the 20+ year treasury ETF, and another $50,000 evenly divided among 5 randomly selected blue chip dividend stocks from a list of 10, spending less than 30 seconds in compiling the list. The stocks had an aggregate dividend yield in excess of TLT.
Last Thursday, I took a snapshot comparing the performance of TLT vs. the 5 Blue Chips to see how Rosenberg's anti-stock bias has held up against his unswerving affection for treasuries.
Rosenberg is up $495.6 on his $50,000 TLT investment or less than 1%, while the monkey is up $24,537.25 or almost 50%. Both performance numbers exclude dividend payments.
Back to David Levy. As noted in the recent Barron's article, Levy is concerned about the level of consumer debt to disposable income which has come down from 128% to around 104% now. This is a chart showing that ratio:
Households and Nonprofit Organizations; Credit Market Instruments; Liability, Level (CMDEBT)/Disposable Personal Income (DPI)
Relying on that data series simply confirms his bias in my opinion. What does he omit in his analysis? It should be obvious to long time readers of this blog and any fair minded and informed investor.
Levy fails to take into account the service cost of that debt! Levy may even be aware that millions of mortgages, the main debt obligation of American households, have been refinanced at abnormally low rates. Debt has declined, but debt service costs have plunged, as Levy undoubtedly knows. The debt service payment to disposable income ratio has fallen to levels last seen in 1980:
Household Debt Service Payments as a Percent of Disposable Personal Income
That is one important omission.
Yet, he relies on one number without mentioning the other. Why? The DSR ratio undermines his bearish position on that issue.
Please note that both charts show trouble brewing between 1995-2007, as both the total debt to disposable income and the debt service costs rising well outside of historical ranges.
The first chart is important, but so is the second. Both charts also need to be weighted and evaluated with this thought in mind. Almost 1/3rd of homes are owned free and clear in the U.S. according to the Census Bureau. If the government separated out those folks from these charts altogether, we would see the problem starkly in the 1995-2007 period.
I never pay any attention to so called experts who constantly demonstrate a lack of balance. To be successful as an investor, balance is essential. It is important to avoid predispositions to consider only positive or negative data, and any opinion needs to be constantly challenged with new data without interference from one's ego, as if someone else had first formulated the opinion.
*************
The rapid return of home prices toward trendline growth is one of the most important economic developments over the past year. As noted earlier, the rise in home prices last year enabled millions of households to refinance their mortgages at abnormally low rates, Bloomberg, and that is continuing into 2013.
Home equity is the primary repository of household wealth for most Americans. The FED reported that household net worth increased by almost $3 trillion in the 2013 first quarter, due largely to increases in home prices and stocks. Z.1 release.pdf
Household net worth exceeded $70 trillion in the first quarter and is certainly higher now: Chart Net Worth- St. Louis Fed
I only recently learned that I could create my own graphs using the data available at the St. Louis Federal Reserve. This chart shows the serious decline in household net worth during the Near Depression period and the ensuing snapback:
 |
| Household Net Worth Percent Change From A Year Ago |
The Commerce Department reported that the nation's trade deficit was $34.2B in June, down from $44.1B in May. census.gov.pdf
This shrinkage in the trade deficit may boost the government's next estimate of second quarter GDP. Reuters In the first estimate, the government estimated that the trade sector had a .8 drag on GDP. Brian Wesbury noted in his blog that the impact was probably zero based on this latest trade number. He is estimating now a revision in 2nd quarter real GDP to 2.5% from 1.7%. Wesbury.PDF
The Fed's July survey of senior loan officers had eased their lending policies and reportedly experienced stronger demand over the past three months. FRB: Senior Loan Officer Opinion Survey: July 2013
For the week ending 8/3, the four week moving average of initial unemployment claims fell to the lowest level since November 2007.
The Mortgage delinquency rate for residential units decreased to 6.96% of all loans outstanding, the lowest level since mid-2008. The serious delinquent rate which are more than 90 days past due, was at 5.88%.
Singapore raised its 2013 growth forecast to 2.5%-3.5%, up from the previous estimate of 1% to 3%.
The WSJ published yesterday an article about one of China's ghost cities.
For whatever it may be worth, China's National Bureau of Statistics has started to publish some favorable data about China's economy as of late. Late last week, China's industrial production was reported to have increased 9.7% Y-O-Y in July, better than the consensus 9% forecast. Retail sales reportedly increased by 13.2%. These reports had a positive impact on commodity prices last Friday.
*******************
Nashville Area ETF (NASH):
I may have to invest in this one at some point. I am after all a Nashvillian, and have observed for decades the entrepreneurial culture here. My first investment was in HCA back in the late 1960s when it owned one small hospital across from the Parthenon.
Still, a geographic centric is probably not the best investment concept and may be more indicative of ETF proliferation.
Without even looking, I knew that this new ETF had to have a concentration in healthcare companies. Fund Holdings - LocalShares
Sponsor's Website: Nashville & Its Companies - LocalShares
Nashville ETF - Zacks.com
Friday's Closing Price: NASH: $25.00 -0.04 (-0.16%) : Nashville Area ETF
***************
TLT vs. 5 Randomly Selected Blue Chip Common Stocks: Two Peas from the Same Pod-Davy Levy and David Rosenberg
Back in August 2010, David Rosenberg was touting again buying ten and thirty year treasuries that were yielding 2.5% and 3.6% at the time. Barrons was giving him a pass again on his errant forecasts about the stock market, as always, presenting Rosenberg as some kind of modern day oracle. Well, I knew differently.
Rosenberg was predicting doom and gloom in the March 9, 2009 Barrons' issue, published the day before the S & P 500 started its 150+% ascent. That same issue featured another ghoul, David Levy, spouting gloom and doom in an article tilted "No Doom, Just Gloom".
Levy was again featured in the 8/5/13 issue, given a pass again by the same Barron's interviewer, Lawrence Strauss, as he touted treasuries again in an article titled "Another U.S. Recession Is Coming". Okay, maybe that is prescient, recessions do come along with some regularity. Maybe I will become a well known guru by making this statement: The US. will experience a recession in the future. I am now ready to form my own consulting firm, hire a few dozen MIT pets, and start charging the deaf, dumb and blind $100,000 a year for Wrong Way Forecasts.
I will have more to say about Levy in just a moment. Back to Barron's Market Oracle In Residence David Rosenberg.
It was Rosenberg who was predicting in April 2009 that the S & P 500 was going to "gravitate in a 475-650 range for an extended period of time". Business Insider Well, he is just one of those bears who can not see.
I was fed up with his negativity when reading that August 2010 article so I decided to conduct a test that is summarized in this post: More on Barron's and David Rosenberg (8/23/2010 Post). I took a snapshot of a portfolio that had invested $50,000 in TLT, the 20+ year treasury ETF, and another $50,000 evenly divided among 5 randomly selected blue chip dividend stocks from a list of 10, spending less than 30 seconds in compiling the list. The stocks had an aggregate dividend yield in excess of TLT.
Last Thursday, I took a snapshot comparing the performance of TLT vs. the 5 Blue Chips to see how Rosenberg's anti-stock bias has held up against his unswerving affection for treasuries.
 |
| TLT vs. 5 Blue Chips Selected at Random As of Thursday 8/8/13 |
Back to David Levy. As noted in the recent Barron's article, Levy is concerned about the level of consumer debt to disposable income which has come down from 128% to around 104% now. This is a chart showing that ratio:
Households and Nonprofit Organizations; Credit Market Instruments; Liability, Level (CMDEBT)/Disposable Personal Income (DPI)
Relying on that data series simply confirms his bias in my opinion. What does he omit in his analysis? It should be obvious to long time readers of this blog and any fair minded and informed investor.
Levy fails to take into account the service cost of that debt! Levy may even be aware that millions of mortgages, the main debt obligation of American households, have been refinanced at abnormally low rates. Debt has declined, but debt service costs have plunged, as Levy undoubtedly knows. The debt service payment to disposable income ratio has fallen to levels last seen in 1980:
 |
| FED's DSR Ratio |
That is one important omission.
Yet, he relies on one number without mentioning the other. Why? The DSR ratio undermines his bearish position on that issue.
Please note that both charts show trouble brewing between 1995-2007, as both the total debt to disposable income and the debt service costs rising well outside of historical ranges.
The first chart is important, but so is the second. Both charts also need to be weighted and evaluated with this thought in mind. Almost 1/3rd of homes are owned free and clear in the U.S. according to the Census Bureau. If the government separated out those folks from these charts altogether, we would see the problem starkly in the 1995-2007 period.
I never pay any attention to so called experts who constantly demonstrate a lack of balance. To be successful as an investor, balance is essential. It is important to avoid predispositions to consider only positive or negative data, and any opinion needs to be constantly challenged with new data without interference from one's ego, as if someone else had first formulated the opinion.
*************
1. Sold 104+ PEO at $27.06 (see Disclaimer): The Petroleum & Resources Corp. (PEO) is a stock closed end fund that owns natural resource stocks, primarily those in the energy industry. Petroleum & Resources Corp. | Investments in Global Energy and Natural Resources Exxon and Chevron account for 29.4% of net assets as of 6/30/13: Top Ten Holdings
I also own the stock CEF Adams Express that has PEO as its largest portfolio position: Adams Express Top Ten Holdings
PEO Page at Morningstar
CEFConnect Page on PEO
Last SEC Filed Shareholder Report: PETROLEUM & RESOURCES CORPORATION - FORM N-CSRS - JUNE 30, 2013
I also own the stock CEF Adams Express that has PEO as its largest portfolio position: Adams Express Top Ten Holdings
PEO Page at Morningstar
CEFConnect Page on PEO
Last SEC Filed Shareholder Report: PETROLEUM & RESOURCES CORPORATION - FORM N-CSRS - JUNE 30, 2013
Snapshot of Trade:
Snapshot of Profit:
As noted in that snapshot, I reinvested two dividends totaling $105.86 and another $44.98 was taken in cash.
Total Dividends: $150.84
Total Share Profit: $205.94
Total $ Return: $356.78
% Return on Original $2,505.64 Investment Made on 8/6/12: 14.24%
Item # 3 Bought 100 of the Stock CEF PEO at $24.98 (August 2012)
Rationale: The primary reasons for this sell are profit taking and an ongoing effort to reduce my stock allocation due to valuation concerns. I selected PEO primarily due to its sector focus, and I am already an involuntary long term holder in another CEF, BCF, in that sector.
There were several reasons that would support keeping the shares or buying them back when and if the price corrects more than 10%.
Countervailing Considerations for a Hold or a New Buy:
A. The discount to net asset value per share was -14.65% as of 8/1/13: CEFConnect
On the flip side, this fund normally sells at a large discount.
B. Many of the top holdings are selling near 10 times earnings.
XOM Key Statistics | Exxon Mobil
CVX Key Statistics | Chevron
OXY Key Statistics | Occidental Petroleum
PSX Key Statistics | Phillips 66
HES Key Statistics | Hess Corporation
NOV Key Statistics | National Oilwell Varco
On the flip side, cyclical stocks, with erratic earnings, will frequently sell at below market multiples. The second quarter earnings reports from both Exxon and Royal Dutch (own) were disappointing. Exxon-SEC Filed Earnings Press Release; Royal Dutch-SEC Filed Earnings Press Release
C. The fund is paying a 6% managed distribution that is not supported by a return of capital. The five year distribution rate has averaged 6.9%, based on the total distributions divided by the average month-end market price for the fund's shares.
The dividend is mostly supported by long term capital gains paid in the 4th quarter. The fund will also source some of the dividend from income and short term capital gains.
On the flip side, the managed distribution policy would likely be eliminated when and if the unrealized capital gains evaporated due to a severe downturn in this sector and/or market. A recent example of such a downturn is still fresh in the OG's memory bank.
Future Buy: I am looking for a re-entry at below $25. I am in no hurry.
Friday's Closing Price: PEO: $26.82 -0.05 (-0.19%)
2. Sold 405+ of the Stock CEF EOI at 12.3513 (see Disclaimer): This sell is part of my ongoing stock allocation pare.
Snapshot of Trade:
Data as of 8/5/13:
Closing Net Asset Value Per Share: $13.59
Closing Market Price: $13.34
Discount: -9.2
Average 3 Yr. Discount: -10.3%
Snapshot of "Profit":
I have apparently only discussed two purchases made in the main taxable account:
Item # 1 Bought 100 of the CEF EOI at $12.78 (September 2010); Item # 3 Added 100 of the Stock CEF EOI at $10.27 (November 2011).
My last add was a 50 share buy in January 2013:
Most of this profit is artificial and represents nothing more than a downward adjustment of the cost basis to reflect return of capital (ROC). I would expect the profit to be adjusted up some when the fund reports the precise amount of its ROC next year. A significant number of shares were bought with the monthly dividend. I am predisposed to own CEFs like Adams Express and Swiss Helvetia that support their dividends with earnings rather than a ROC and who managed to navigate the recent Near Depression without incurring capital loss carryforwards.
Rationale: I have not been pleased with the performance of this stock CEF. I have had no trouble whatsoever beating the managers of this fund as an individual investor working without the resources available to them. I therefore fired the managers of this fund.
Over the past five year period ending 8/2/13, the annualized total return which would include reinvested dividends was 4.72% based on net asset value and 4.94% at the market price. CEFConnect I have smashed that annualized return using a balanced asset allocation with a large cash allocation, and would not regard my performance as particularly noteworthy. And I work for free.
Another negative is that the fund supports its dividend distribution heavily with a ROC.
When looking for something to sell when I am reducing my stock allocation, a fund like EOI is certainly at the top of my list.
Sponsor's Page: Enhanced Equity Income Fund | Eaton Vance
Morningstar Page: EOI (rated 3 stars)
Eaton Vance Enhanced Equity Income Fund (SEC Filed Shareholder Report for the Period Ending 3/31/13: Capital Loss Carryforward of $132+M and Deferred Capital Losses of $12+M as noted in note D at page 13)
Future Buys: I have given up on Eaton Vance stock CEFs. While it is just my opinion, there needs to be a restructuring of their "talent" pool.
Friday's Closing Price: EOI: $12.26 -0.04 (-0.33%)
3. Added 50 of the Synthetic Floater GYB at $19.6-Roth IRA (see Disclaimer)
Snapshot of Purchase:
This last purchase was an add to an existing position in the ROTH IRA:
I transferred the Roth IRA to Vanguard in January 2011 after Fidelity started prohibiting the purchase of this type of security and many others.
Snapshot of my GYB ROTH IRA history since January 5, 2011:
Security Description: The Corporate Asset Backed Corp. CABCO Series 2004-101 Trust Goldman Sachs Capital I Float. Rate Call Ctfs (GYB) is a Synthetic Floater in the Trust Certificate form of ownership, a category of Exchange Traded Bonds.
GYB makes quarterly interest payments at the greater of 3.25% or .85% above the three month Libor rate on a $25 par value. As with other exchange traded synthetic floaters, there is a maximum coupon. For GYB, the maximum is 8.25%: Prospectus
The underlying bond owned by the trust is a trust preferred issue from Goldman Sachs Capital I maturing on 2/15/2034 with a 6.345% fixed rate coupon. (Underlying Bond: FINRA) In effect, the underlying security is a junior bond from GS. That rate will not be received by the owners of GYB unless the swap agreement terminates.
It is the swap agreement with a brokerage company that creates the rate paid by this security. The trustee receives the interest payments from Goldman Sachs for the 6.345% fixed coupon securities owned by it and then swaps that amount with the brokerage firm for the amount due the owners of GYB.
The owners of GYB will be entitled to receive $25 per trust certificate on 2/15/2034, assuming GS survives of course. If GS goes bankrupt, I would expect this security to be worthless.
Prior Trades: I have repeatedly bought and sold this security, as well as the functionally equivalent PYT, repeatedly in retirement accounts:
Links to Prior GYB Trades:
Bought 100 GYB at 10.95 /Will Hold Synthetic Floaters In Retirement Account (April 2009); Sold 100 GYB at 18.09 (May 2010); Bought 70 GYB at 18.49 in Regular IRA (March 2010); Added 30 GYB in IRA at $17.97 (July 2010); Sold 100 GYB @ $19.4 (October 2010); Bought 50 GYB @ $19.07 (October 2010); Bought 50 GYB at 18.63 in the Roth IRA (January 2011); Sold 100 GYB at $19.7 in Roth IRA (May 2011); Bought 50 GYB at $16.95 in Roth IRA August 2011; Added 50 of the Synthetic Floater GYB at $15.56-ROTH IRA (December 2011); Sold 100 GYB at $17.09 January 2012-Roth IRA; Bought Back 100 of GYB at 17.2-Roth IRA March 2012; Sold 100 of 150 GYB at $18.03 December 2012-Roth IRA
The largest gain originated from my first buy in the regular IRA:
On one of those two 100 share lots, I realized a $691.71 gain.
The remaining trades have involved small gains and clips of the interest payments:
Total Realized Gains: $1,233.71
Rationale: I will just copy and edit some of a prior discussion on this security:
Based on a total cost of $19.6, the minimum current yield would be about 4.15%. The float would become the applicable rate when the three month LIBOR exceeded 2.4%, during the relevant computation period.
The maximum coupon of 8.25% would result in a current yield of 10.52% based on a total cost of $19.6. The current yield is likely to remain at the bottom end of that range for a couple of more years due to the FED's Jihad against the Savings Class that is keeping short term rates artificially low.
The YTM would be higher for an investor holding the security to maturity, since the yield to maturity includes the additional yield realized by capturing the spread between $25 and the purchase cost.
For example, assume that the average coupon per year until February 2034 was 5%. The coupon is now 3.25%, but the FED's Jihad Against the Saving Class is not likely to last for another 21 years hopefully. There will likely be periods when the maximum coupon of 8.25% is in effect. A five per cent coupon or higher coupon can be hit whenever the three month Libor equals or exceeds, as the case may be, 4.15% which is probably close to a normal rate historically. Chart: 3-Month London Interbank Offered Rate (LIBOR), based on U.S. Dollar; Historical Data: research.stlouisfed.org
There will be a range of coupons between 3.25% to 8.25% during the remaining life of this security. With a reasonable assumption of 5% as the average going forward, the YTM would be around 7.27% using the Morningstar Bond Calculator. That hypothetical return would depend on the future average rate which could be higher or lower than 5%. (at 6%=8.55%; at 4%=6.01%).
Due to complicated tax issues associated with the swap agreement, I will own synthetic floaters only in retirement accounts.
Risks: This security has historically been volatile in price, as shown by my purchases listed above and by a long term chart. GYB Stock Chart (set to 1 decade)
Part of the problem in 2008-2009 involved the identity of the issuer and the low status of a trust preferred security in the capital structure. The TP is in effect a junior bond, senior to common and equity preferred stocks, but is likely to become worthless in the event of a BK due to abundance of more senior securities fighting over the crumbs.
Another problem with the synthetics arose in the outrageous actions of WFC in redeeming GJN after JPM redeemed the underlying TP without making a make whole payment, relying on a purported escape hatch in the prospectus relating to the phasing out of TPs as Tier 1 equity as part of the Dodd-Frank law. JPM was allowed to avoid a make whole payment by electing to redeem the TP within a narrow time frame after a "capital treatment event", and the passage of Dodd Frank was such an event.
The underlying TP owned by the GYB trust does not contain a similar escape hatch as I discussed in an earlier blog. Sold 50 JBK at $22.75/Reassessment of Current Synthetic Floater Positions; Item # 3 GJN Redemption (near the end of that post). The GS 2034 TP has a make whole provision for an early redemption by GS.
For the reasons discussed in several prior posts, I am surprised that no one sued JPM and WFC, at least to my knowledge, given the amount of money involved for the owners of GJN and the institutional owners of the 2035 JPM TP. Turkle Trust v. Wells Fargo; District Court Decision in Turkle Trust v. Wells Fargo (N.D. Cal)/Summary of Argument: JPM Potential Obligation to Pay Make Whole for its Recent 2035 TP Redemption/Other JPM Capital Trust Preferred Securities: Language on Make Whole Payment and Capital Treatment Event; The Egregious Swap Termination Fee Paid to the GJN Swap Counterparty
Long time readers may remember that I brought this GJN hosing to the attention of the NYT: GJN-Wells Fargo-New York Times
Lastly, the FED is likely to continue its Jihad Against the Saving Class for at least another two years, unless there is an unexpected and sustained spike in inflation well in excess of 2%. I would not anticipate see an increase in the minimum coupon due to the activation of the Libor float until at least 2016.
Friday's Closing Price: GYB: $19.40 -0.11 (-0.56%)
4. Bought Back 100 of the Stock CEF IF at $11.23 (see Disclaimer):
Snapshot of Trade:
Security Description: The Aberdeen Indonesia Fund (IF) is a stock closed end fund.
CEFConnect Page for IF
IF Page at Morningstar (not rated; fund paid a $2.1603 per share long term capital gain distribution last December)
Data for Friday 8/2/13:
Closing Net Asset Value Per Share: $12.8
Closing Market Price: $11.32
Discount: -11.53
Data for Monday 8/5/13:
Closing Net Asset Value Per Share: $12.78
Closing Market Price: $11.23
Discount: -11.97%
Sponsor's Website: Indonesia Fund, Aberdeen Asset Management
SEC Form N-Q (holdings as of 3/31/12: cost $66M+; value $132M+)
Last SEC Filed Shareholder Report
Prior Trade:
Item # 5 Sold 100 IF at $12.91 (April 2013); Bought 100 of IF at $11.64.
Rationale: I will just copy my earlier discussion and make some changes to bring that earlier discussion up to date.
(1) Super Cycle-Middle Class Consumers in Emerging Markets: I have already explained this rationale in a recent post. Item # 3 Bought 50 of the Stock ETF EELV at $27.2 (11/29/12). The importance of that super cycle has been masked by governments and consumer develeraging in developed markets, particularly the U.S. and Europe.
It is not difficult to do a google search about Indonesia's growth and come up with a host of recent informative articles about Indonesia's place in this Super Cycle. I just took a sample:
A recent report by the Boston Consulting Group estimated that Indonesia's "middle and affluent class" will "likely" double to 141M within the next seven years. WSJ
Middle-Class Consumption Soars - Bloomberg (May 2012)
Indonesia: The newest BRIC? CNN Money (October 2012)(7th largest economy by 2030)
Middle-Class Money Powers Indonesia's Rising Cities-CNBC (October 2012)
GDP grew at a 5.81% annual rate in the 2013 2nd quarter and by 2.61% from the 2013 first quarter. This was below expectations. Inflation is accelerating and the Indonesian central bank has raised interest rates in its two past meetings. Bloomberg; Indonesia GDP
(2) According to CEFConnect, this fund has an an annualized performance of 13.9% over 5 years and 22.16% over ten years, based on net asset value, through 8/2/13.
Needless to say, that is excellent and the future may be quit different. I would be pleased with a ten year annualized return of 10% going forward in just about any investment.
Risks: Emerging market stocks have traditionally been more volatile than U.S. stocks with a higher beta. In the coming years, as more investors become confident about the emerging market story, that traditional pattern could change. Any fund focused on a specific country will have country risks (e.g. political upheaval) and currency risks for a U.S. investor. CEFs have their own unique risks including the expansion of the discount to net asset value subsequent to the purchase. The normal risks associated with stocks are of course present.
When I bought the Indonesia Fund, the Jakarta Composite Index (JKSE) was sitting just a slither above its 200 day SMA and had already pierced its 50 day SMA to the downside. The JKSE closed at 4640.78 on 8/2/13 after hitting a high at 5,214.98 on 5/20/13: JKSE Historical Prices So the technical picture from this perspective looks dicey.
The currency risk is significant. The USD has been gaining value against the Indonesian Rupiah:
USD/IDR Currency Conversion Chart (1/1/2012: 1 USD buys 9,110 IDRs; 8/5/13: 1 USD buys 10,289 IDRs)
When I sold this CEF on 4/18/13, 1 USD would buy 9,680.9 IDRs or 608.1 fewer IDRS.
The USD has gained 6.28% against the Indonesian Rupiah between 4/18 to 8/05. The USD has risen against emerging market currencies since U.S. interest rates started to rise back in May.
The currency decline would be reflected in IF's net asset value and would required a gain in its holdings of an equivalent amount for the net asset value to remain the same.
That has not happened. The net asset value per share was $14.22 on 4/18/13 which represents a -12.78% decline, so the currency conversion issue has contributed to about 1/2 of the decline.
When I assume the risk of a foreign currency, I want the currency to rise against the USD after I make my purchase. The purchase on 8/5 missed the 6.28% decline in the Rupiah's value since 4/18/13, but will be subject to the risk of further declines going forward. Ideally, I would want the stocks owned by this fund to gain in value and for the Rupiah to gain back some of its recent losses.
The double whammy would be for the Rupiah to continue to lose value against the USD and for the ordinary shares owned by IF to go down in value on the Indonesian exchange.
Friday's Closing Price: IF: $11.07 -0.02 (-0.18%)
5. Added 50 NPI at $12.16 (see Disclaimer): Randall Forsyth noted in his recent Barrons that CEF bond funds were "on sale". He then followed up with another article pointing out that municipal bonds were yielding more than corporate bonds with the same credit ratings. Barrons.com Those observations are easy to make as a journalist. For those of us on the front lines, bond CEFs may be "on sale", provided interest rates do not go up another 1%, but buying them now requires a measure of intestinal fortitude.
Bond CEFs are falling knives at the moment, a characterization that is not a matter for debate. My current approach is to nibble once a week, investing up to $1,000. I missed last week. I may miss next week.
{I did manage to lighten up before the swan dive by either eliminating or reducing some bond CEF positions at much higher prices, but then re-entered one of those, GDO, at higher prices than prevailing now (e.g. eliminated 1,000 MMT-no longer own; eliminated GDO before starting to buy back at lower prices; eliminated NBD; and reduced VGI: Sold 100 of 250 of the Bond CEF VGI at $19.48 (May 2013); Sold 100 NBD at $21.86-Roth IRA (May 2013); Sold 300 of the Bond CEF MMT at $7.57-ROTH IRA (April 2013-Last of 1,000 Shares); Sold 100 GDO at $20.79; Sold 120 GDO at $20.73 (February 2013-Last Lot Then Held)}
I have some cash available in the Regular IRA to make the next six buys. I would buy only taxable CEF bonds in that account. That account may be the best place for those purchases given my age. I will eventually transfer everything in that account into a Roth IRA anyway. If a bond CEF declines more than 10% over the coming months after purchase, I could just go ahead and transfer the security into the ROTH IRA, and save some on taxes given the lower market value.
I will focus in the coming weeks on taxable bond CEF purchases that have shorter durations than the typical municipal bond CEF.
It is cost effective from a tax standpoint to make a ROTH IRA conversion when the security being transferred has fallen in value. The market value at the time of transfer has to be included in taxable income. I did my first Roth Conversion in October 2008, which was an ideal time to implement this kind of strategy.
Snapshot of Purchase:
The Nuveen Premium Income Municipal Fund (NPI) is a leveraged municipal bond closed end fund.
I have previously discussed this municipal bond CEF. Item # 5 Bought 58 NPI at $13.4 & 42 at $13.17 (6/15/13 Post); Item # 3 Added 50 NPI at $12.45 (7/27/13 Post)
A recent analysis by Fitch, summarized at Barrons.com, estimated the potential net asset value per shares loss due to interest rate rises (.5%, 1%, 1.5%) based on a municipal bond fund's duration. As I have noted, a general rule of thumb is to multiply the duration by the percentage increase in rates.
Duration—What an Interest Rate Hike Could Do to Your Bond Portfolio - FINRA
Get to know your bond fund: Duration| Vanguard
NPI has a leverage adjusted effective duration of 15.38 years; and a "modified duration" of 6.98 years. NPI - Nuveen Premium Income Municipal Fund Consequently, NPI carries a great deal of interest rate risk. On top of that risk, selling pressure has been so intense over the past several weeks that the market price has declined at a significantly higher percentage rate than the decline in net asset value per share, thereby amplifying the losses. The 1 year chart looks like a water slide: NPI Interactive Chart In January 2013, the price hit $15.79.
Leverage amplifies sensitivity to interest rates and increases both the risks and the potential benefits. It does not help to use even low cost borrowed funds to buy an asset that declines in value.
I have nothing more to add to those discussions other than the price has declined and the discount to net asset value has expanded since those recent purchases.
Data on Day Before Purchase (Tuesday 8/7/13):
Closing Net Asset Value Per Share: $13.78
Closing Market Price: $12.21
Discount: -11.39%
Yield: 7.08%
Equivalent Yield at 35% Marginal Federal Tax Rate= 10.89%
Data on Day of Purchase (Wednesday 8/8/13)
Closing Net Asset Value Per Share: $13.79
Closing Market Price Per Share: $12.23
Discount: -11.31
Discount at $12.16 Price: -11.82%
Yield: 7.07%
Tax Equivalent Yield: 10.88%
Average 5 Year Discount: -3.88%
Average 3 Year Discount: -2.73%
CEFConnect Page for NPI (discount as of 8/9/13= -11.46; NAV at $13.79)
Nuveen Premium Income Municipal Fund Inc. Stock Price
Sponsor's Webpage: NPI - Nuveen Premium Income Municipal Fund
NPI Page at Morningstar
The next ex dividend date is 8/13/13: Nuveen Closed-End Funds Declare Monthly Distributions
This fund is weighted in municipal bonds rated "A" or better.
I am reinvesting the monthly dividend to buy more shares and will continue to do so as long as the discount to net asset value per share exceeds the five year average of -3.88%. My average cost per share is $12.97 currently.
Friday's Closing Price: NPI: $12.21 -0.02 (-0.16%)
6. Added 100 PSEC at $10.85 (See Disclaimer):
Snapshot of Trade:
Prospect Capital Corp. is a Business Development Corporation that pays monthly dividends. The current yield at a $10.85 total cost per share is about 12.19%. PSEC has been raising the dividend in insignificant amounts each month.
Prospect Capital Declares Four Additional Monthly Cash Dividends to Shareholders Through December 2013, Discloses Benefits From Rising Interest Rates
I will probably sell my 100 PSEC shares, held in the Roth IRA, when and if the price exceeds $11. I have been flipping PSEC in the ROTH while holding a position in a taxable account where I am reinvesting the dividend to buy additional shares, at least until the price routinely exceeds a 5% premium to book value per share.
Needless to say, there is no free lunches in investing and there are abundant risks associated with any security paying 12%. I discuss some of the risks in prior posts. The most extensive discussion can be found in Item # 3 Bought 100 PSEC @ $10.2-Roth IRA (November 2012 Post). I also recently added 50 shares in a taxable account: Item # 2 Added 50 PSEC at $10.15 (June 2013).
In the last SEC Filed Annual Report, it takes the company 22 single space pages to discuss the risks (pp. 29-51: sec.gov) An investor needs to read and understand that discussion.
I do not expect much capital appreciation. The primary reason for buying any BDC is to generate income and hopefully exit the position without losing anything on the stock.
Prospect Capital Profile Page at Reuters
Prospect Capital Key Developments Page at Reuters
Prospect Capital Corporation: Company Website
Recent Investor Presentation (7/10/13): www.prospectstreet.com (one of many things that worry me is shown at page 5 of that presentation, a rise in the portfolio size from just $136M in 2006 to over $3.7B, financed with a continuous stream of equity and debt offerings; yet net asset value per share has been trending down over that period. Who benefits from that vast increase in size: shareholders or management? With that vast increase in new investments, the potential for unpleasant surprises would seem to increase, and all of the foregoing makes the OG nervous and uncomfortable).
Closing Price Last Friday: PSEC: $10.86 -0.01 (-0.09%)
*********
This post is long enough. I wii discuss two trades made last week in the next post.
 |
| 2013 PEO 104+ Shares +$205.94 |
Total Dividends: $150.84
Total Share Profit: $205.94
Total $ Return: $356.78
% Return on Original $2,505.64 Investment Made on 8/6/12: 14.24%
Item # 3 Bought 100 of the Stock CEF PEO at $24.98 (August 2012)
Rationale: The primary reasons for this sell are profit taking and an ongoing effort to reduce my stock allocation due to valuation concerns. I selected PEO primarily due to its sector focus, and I am already an involuntary long term holder in another CEF, BCF, in that sector.
There were several reasons that would support keeping the shares or buying them back when and if the price corrects more than 10%.
Countervailing Considerations for a Hold or a New Buy:
A. The discount to net asset value per share was -14.65% as of 8/1/13: CEFConnect
On the flip side, this fund normally sells at a large discount.
B. Many of the top holdings are selling near 10 times earnings.
XOM Key Statistics | Exxon Mobil
CVX Key Statistics | Chevron
OXY Key Statistics | Occidental Petroleum
PSX Key Statistics | Phillips 66
HES Key Statistics | Hess Corporation
NOV Key Statistics | National Oilwell Varco
On the flip side, cyclical stocks, with erratic earnings, will frequently sell at below market multiples. The second quarter earnings reports from both Exxon and Royal Dutch (own) were disappointing. Exxon-SEC Filed Earnings Press Release; Royal Dutch-SEC Filed Earnings Press Release
C. The fund is paying a 6% managed distribution that is not supported by a return of capital. The five year distribution rate has averaged 6.9%, based on the total distributions divided by the average month-end market price for the fund's shares.
On the flip side, the managed distribution policy would likely be eliminated when and if the unrealized capital gains evaporated due to a severe downturn in this sector and/or market. A recent example of such a downturn is still fresh in the OG's memory bank.
Future Buy: I am looking for a re-entry at below $25. I am in no hurry.
Friday's Closing Price: PEO: $26.82 -0.05 (-0.19%)
2. Sold 405+ of the Stock CEF EOI at 12.3513 (see Disclaimer): This sell is part of my ongoing stock allocation pare.
Snapshot of Trade:
 |
| 2013 Sold 405+ EOI at $12.3513 |
Data as of 8/5/13:
Closing Net Asset Value Per Share: $13.59
Closing Market Price: $13.34
Discount: -9.2
Average 3 Yr. Discount: -10.3%
Snapshot of "Profit":
+.jpg){kind=small} |
| 2013 EOI 405+ Shares +$467.31 ($+74.92 ST; +$392.39 LT) |
I have apparently only discussed two purchases made in the main taxable account:
Item # 1 Bought 100 of the CEF EOI at $12.78 (September 2010); Item # 3 Added 100 of the Stock CEF EOI at $10.27 (November 2011).
My last add was a 50 share buy in January 2013:
 |
| 2013 Bought 50 EOI at $11.21 |
Rationale: I have not been pleased with the performance of this stock CEF. I have had no trouble whatsoever beating the managers of this fund as an individual investor working without the resources available to them. I therefore fired the managers of this fund.
Over the past five year period ending 8/2/13, the annualized total return which would include reinvested dividends was 4.72% based on net asset value and 4.94% at the market price. CEFConnect I have smashed that annualized return using a balanced asset allocation with a large cash allocation, and would not regard my performance as particularly noteworthy. And I work for free.
Another negative is that the fund supports its dividend distribution heavily with a ROC.
When looking for something to sell when I am reducing my stock allocation, a fund like EOI is certainly at the top of my list.
Sponsor's Page: Enhanced Equity Income Fund | Eaton Vance
Morningstar Page: EOI (rated 3 stars)
Eaton Vance Enhanced Equity Income Fund (SEC Filed Shareholder Report for the Period Ending 3/31/13: Capital Loss Carryforward of $132+M and Deferred Capital Losses of $12+M as noted in note D at page 13)
Future Buys: I have given up on Eaton Vance stock CEFs. While it is just my opinion, there needs to be a restructuring of their "talent" pool.
Friday's Closing Price: EOI: $12.26 -0.04 (-0.33%)
3. Added 50 of the Synthetic Floater GYB at $19.6-Roth IRA (see Disclaimer)
Snapshot of Purchase:
This last purchase was an add to an existing position in the ROTH IRA:
I transferred the Roth IRA to Vanguard in January 2011 after Fidelity started prohibiting the purchase of this type of security and many others.
Snapshot of my GYB ROTH IRA history since January 5, 2011:
Security Description: The Corporate Asset Backed Corp. CABCO Series 2004-101 Trust Goldman Sachs Capital I Float. Rate Call Ctfs (GYB) is a Synthetic Floater in the Trust Certificate form of ownership, a category of Exchange Traded Bonds.
GYB makes quarterly interest payments at the greater of 3.25% or .85% above the three month Libor rate on a $25 par value. As with other exchange traded synthetic floaters, there is a maximum coupon. For GYB, the maximum is 8.25%: Prospectus
The underlying bond owned by the trust is a trust preferred issue from Goldman Sachs Capital I maturing on 2/15/2034 with a 6.345% fixed rate coupon. (Underlying Bond: FINRA) In effect, the underlying security is a junior bond from GS. That rate will not be received by the owners of GYB unless the swap agreement terminates.
It is the swap agreement with a brokerage company that creates the rate paid by this security. The trustee receives the interest payments from Goldman Sachs for the 6.345% fixed coupon securities owned by it and then swaps that amount with the brokerage firm for the amount due the owners of GYB.
The owners of GYB will be entitled to receive $25 per trust certificate on 2/15/2034, assuming GS survives of course. If GS goes bankrupt, I would expect this security to be worthless.
Prior Trades: I have repeatedly bought and sold this security, as well as the functionally equivalent PYT, repeatedly in retirement accounts:
Links to Prior GYB Trades:
Bought 100 GYB at 10.95 /Will Hold Synthetic Floaters In Retirement Account (April 2009); Sold 100 GYB at 18.09 (May 2010); Bought 70 GYB at 18.49 in Regular IRA (March 2010); Added 30 GYB in IRA at $17.97 (July 2010); Sold 100 GYB @ $19.4 (October 2010); Bought 50 GYB @ $19.07 (October 2010); Bought 50 GYB at 18.63 in the Roth IRA (January 2011); Sold 100 GYB at $19.7 in Roth IRA (May 2011); Bought 50 GYB at $16.95 in Roth IRA August 2011; Added 50 of the Synthetic Floater GYB at $15.56-ROTH IRA (December 2011); Sold 100 GYB at $17.09 January 2012-Roth IRA; Bought Back 100 of GYB at 17.2-Roth IRA March 2012; Sold 100 of 150 GYB at $18.03 December 2012-Roth IRA
The largest gain originated from my first buy in the regular IRA:
 |
| 2010 Regular IRA +$774.42 (2 100 Shares) |
The remaining trades have involved small gains and clips of the interest payments:
 |
| 2009 Roth IRA 50 Shares +$183.98 |
 |
| 2010 Roth IRA 100 Shares +$76.06 |
 |
| 2011 Roth IRA +$68.97 (two 50 share lots) |
 |
| 2012 ROTH IRA +$130.28 |
Rationale: I will just copy and edit some of a prior discussion on this security:
Based on a total cost of $19.6, the minimum current yield would be about 4.15%. The float would become the applicable rate when the three month LIBOR exceeded 2.4%, during the relevant computation period.
The maximum coupon of 8.25% would result in a current yield of 10.52% based on a total cost of $19.6. The current yield is likely to remain at the bottom end of that range for a couple of more years due to the FED's Jihad against the Savings Class that is keeping short term rates artificially low.
The YTM would be higher for an investor holding the security to maturity, since the yield to maturity includes the additional yield realized by capturing the spread between $25 and the purchase cost.
For example, assume that the average coupon per year until February 2034 was 5%. The coupon is now 3.25%, but the FED's Jihad Against the Saving Class is not likely to last for another 21 years hopefully. There will likely be periods when the maximum coupon of 8.25% is in effect. A five per cent coupon or higher coupon can be hit whenever the three month Libor equals or exceeds, as the case may be, 4.15% which is probably close to a normal rate historically. Chart: 3-Month London Interbank Offered Rate (LIBOR), based on U.S. Dollar; Historical Data: research.stlouisfed.org
There will be a range of coupons between 3.25% to 8.25% during the remaining life of this security. With a reasonable assumption of 5% as the average going forward, the YTM would be around 7.27% using the Morningstar Bond Calculator. That hypothetical return would depend on the future average rate which could be higher or lower than 5%. (at 6%=8.55%; at 4%=6.01%).
Due to complicated tax issues associated with the swap agreement, I will own synthetic floaters only in retirement accounts.
Part of the problem in 2008-2009 involved the identity of the issuer and the low status of a trust preferred security in the capital structure. The TP is in effect a junior bond, senior to common and equity preferred stocks, but is likely to become worthless in the event of a BK due to abundance of more senior securities fighting over the crumbs.
Another problem with the synthetics arose in the outrageous actions of WFC in redeeming GJN after JPM redeemed the underlying TP without making a make whole payment, relying on a purported escape hatch in the prospectus relating to the phasing out of TPs as Tier 1 equity as part of the Dodd-Frank law. JPM was allowed to avoid a make whole payment by electing to redeem the TP within a narrow time frame after a "capital treatment event", and the passage of Dodd Frank was such an event.
The underlying TP owned by the GYB trust does not contain a similar escape hatch as I discussed in an earlier blog. Sold 50 JBK at $22.75/Reassessment of Current Synthetic Floater Positions; Item # 3 GJN Redemption (near the end of that post). The GS 2034 TP has a make whole provision for an early redemption by GS.
For the reasons discussed in several prior posts, I am surprised that no one sued JPM and WFC, at least to my knowledge, given the amount of money involved for the owners of GJN and the institutional owners of the 2035 JPM TP. Turkle Trust v. Wells Fargo; District Court Decision in Turkle Trust v. Wells Fargo (N.D. Cal)/Summary of Argument: JPM Potential Obligation to Pay Make Whole for its Recent 2035 TP Redemption/Other JPM Capital Trust Preferred Securities: Language on Make Whole Payment and Capital Treatment Event; The Egregious Swap Termination Fee Paid to the GJN Swap Counterparty
Long time readers may remember that I brought this GJN hosing to the attention of the NYT: GJN-Wells Fargo-New York Times
Lastly, the FED is likely to continue its Jihad Against the Saving Class for at least another two years, unless there is an unexpected and sustained spike in inflation well in excess of 2%. I would not anticipate see an increase in the minimum coupon due to the activation of the Libor float until at least 2016.
Friday's Closing Price: GYB: $19.40 -0.11 (-0.56%)
4. Bought Back 100 of the Stock CEF IF at $11.23 (see Disclaimer):
Snapshot of Trade:
Security Description: The Aberdeen Indonesia Fund (IF) is a stock closed end fund.
CEFConnect Page for IF
IF Page at Morningstar (not rated; fund paid a $2.1603 per share long term capital gain distribution last December)
Data for Friday 8/2/13:
Closing Net Asset Value Per Share: $12.8
Closing Market Price: $11.32
Discount: -11.53
Data for Monday 8/5/13:
Closing Net Asset Value Per Share: $12.78
Closing Market Price: $11.23
Discount: -11.97%
Sponsor's Website: Indonesia Fund, Aberdeen Asset Management
SEC Form N-Q (holdings as of 3/31/12: cost $66M+; value $132M+)
Last SEC Filed Shareholder Report
Prior Trade:
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| 2013 Sold 100 IF $110.77 |
Rationale: I will just copy my earlier discussion and make some changes to bring that earlier discussion up to date.
(1) Super Cycle-Middle Class Consumers in Emerging Markets: I have already explained this rationale in a recent post. Item # 3 Bought 50 of the Stock ETF EELV at $27.2 (11/29/12). The importance of that super cycle has been masked by governments and consumer develeraging in developed markets, particularly the U.S. and Europe.
It is not difficult to do a google search about Indonesia's growth and come up with a host of recent informative articles about Indonesia's place in this Super Cycle. I just took a sample:
A recent report by the Boston Consulting Group estimated that Indonesia's "middle and affluent class" will "likely" double to 141M within the next seven years. WSJ
Middle-Class Consumption Soars - Bloomberg (May 2012)
Indonesia: The newest BRIC? CNN Money (October 2012)(7th largest economy by 2030)
Middle-Class Money Powers Indonesia's Rising Cities-CNBC (October 2012)
GDP grew at a 5.81% annual rate in the 2013 2nd quarter and by 2.61% from the 2013 first quarter. This was below expectations. Inflation is accelerating and the Indonesian central bank has raised interest rates in its two past meetings. Bloomberg; Indonesia GDP
(2) According to CEFConnect, this fund has an an annualized performance of 13.9% over 5 years and 22.16% over ten years, based on net asset value, through 8/2/13.
Needless to say, that is excellent and the future may be quit different. I would be pleased with a ten year annualized return of 10% going forward in just about any investment.
Risks: Emerging market stocks have traditionally been more volatile than U.S. stocks with a higher beta. In the coming years, as more investors become confident about the emerging market story, that traditional pattern could change. Any fund focused on a specific country will have country risks (e.g. political upheaval) and currency risks for a U.S. investor. CEFs have their own unique risks including the expansion of the discount to net asset value subsequent to the purchase. The normal risks associated with stocks are of course present.
When I bought the Indonesia Fund, the Jakarta Composite Index (JKSE) was sitting just a slither above its 200 day SMA and had already pierced its 50 day SMA to the downside. The JKSE closed at 4640.78 on 8/2/13 after hitting a high at 5,214.98 on 5/20/13: JKSE Historical Prices So the technical picture from this perspective looks dicey.
The currency risk is significant. The USD has been gaining value against the Indonesian Rupiah:
USD/IDR Currency Conversion Chart (1/1/2012: 1 USD buys 9,110 IDRs; 8/5/13: 1 USD buys 10,289 IDRs)
When I sold this CEF on 4/18/13, 1 USD would buy 9,680.9 IDRs or 608.1 fewer IDRS.
The USD has gained 6.28% against the Indonesian Rupiah between 4/18 to 8/05. The USD has risen against emerging market currencies since U.S. interest rates started to rise back in May.
The currency decline would be reflected in IF's net asset value and would required a gain in its holdings of an equivalent amount for the net asset value to remain the same.
That has not happened. The net asset value per share was $14.22 on 4/18/13 which represents a -12.78% decline, so the currency conversion issue has contributed to about 1/2 of the decline.
When I assume the risk of a foreign currency, I want the currency to rise against the USD after I make my purchase. The purchase on 8/5 missed the 6.28% decline in the Rupiah's value since 4/18/13, but will be subject to the risk of further declines going forward. Ideally, I would want the stocks owned by this fund to gain in value and for the Rupiah to gain back some of its recent losses.
The double whammy would be for the Rupiah to continue to lose value against the USD and for the ordinary shares owned by IF to go down in value on the Indonesian exchange.
Friday's Closing Price: IF: $11.07 -0.02 (-0.18%)
5. Added 50 NPI at $12.16 (see Disclaimer): Randall Forsyth noted in his recent Barrons that CEF bond funds were "on sale". He then followed up with another article pointing out that municipal bonds were yielding more than corporate bonds with the same credit ratings. Barrons.com Those observations are easy to make as a journalist. For those of us on the front lines, bond CEFs may be "on sale", provided interest rates do not go up another 1%, but buying them now requires a measure of intestinal fortitude.
Bond CEFs are falling knives at the moment, a characterization that is not a matter for debate. My current approach is to nibble once a week, investing up to $1,000. I missed last week. I may miss next week.
{I did manage to lighten up before the swan dive by either eliminating or reducing some bond CEF positions at much higher prices, but then re-entered one of those, GDO, at higher prices than prevailing now (e.g. eliminated 1,000 MMT-no longer own; eliminated GDO before starting to buy back at lower prices; eliminated NBD; and reduced VGI: Sold 100 of 250 of the Bond CEF VGI at $19.48 (May 2013); Sold 100 NBD at $21.86-Roth IRA (May 2013); Sold 300 of the Bond CEF MMT at $7.57-ROTH IRA (April 2013-Last of 1,000 Shares); Sold 100 GDO at $20.79; Sold 120 GDO at $20.73 (February 2013-Last Lot Then Held)}
I have some cash available in the Regular IRA to make the next six buys. I would buy only taxable CEF bonds in that account. That account may be the best place for those purchases given my age. I will eventually transfer everything in that account into a Roth IRA anyway. If a bond CEF declines more than 10% over the coming months after purchase, I could just go ahead and transfer the security into the ROTH IRA, and save some on taxes given the lower market value.
I will focus in the coming weeks on taxable bond CEF purchases that have shorter durations than the typical municipal bond CEF.
It is cost effective from a tax standpoint to make a ROTH IRA conversion when the security being transferred has fallen in value. The market value at the time of transfer has to be included in taxable income. I did my first Roth Conversion in October 2008, which was an ideal time to implement this kind of strategy.
Snapshot of Purchase:
The Nuveen Premium Income Municipal Fund (NPI) is a leveraged municipal bond closed end fund.
I have previously discussed this municipal bond CEF. Item # 5 Bought 58 NPI at $13.4 & 42 at $13.17 (6/15/13 Post); Item # 3 Added 50 NPI at $12.45 (7/27/13 Post)
A recent analysis by Fitch, summarized at Barrons.com, estimated the potential net asset value per shares loss due to interest rate rises (.5%, 1%, 1.5%) based on a municipal bond fund's duration. As I have noted, a general rule of thumb is to multiply the duration by the percentage increase in rates.
Duration—What an Interest Rate Hike Could Do to Your Bond Portfolio - FINRA
Get to know your bond fund: Duration| Vanguard
NPI has a leverage adjusted effective duration of 15.38 years; and a "modified duration" of 6.98 years. NPI - Nuveen Premium Income Municipal Fund Consequently, NPI carries a great deal of interest rate risk. On top of that risk, selling pressure has been so intense over the past several weeks that the market price has declined at a significantly higher percentage rate than the decline in net asset value per share, thereby amplifying the losses. The 1 year chart looks like a water slide: NPI Interactive Chart In January 2013, the price hit $15.79.
Leverage amplifies sensitivity to interest rates and increases both the risks and the potential benefits. It does not help to use even low cost borrowed funds to buy an asset that declines in value.
I have nothing more to add to those discussions other than the price has declined and the discount to net asset value has expanded since those recent purchases.
Data on Day Before Purchase (Tuesday 8/7/13):
Closing Net Asset Value Per Share: $13.78
Closing Market Price: $12.21
Discount: -11.39%
Yield: 7.08%
Equivalent Yield at 35% Marginal Federal Tax Rate= 10.89%
Data on Day of Purchase (Wednesday 8/8/13)
Closing Net Asset Value Per Share: $13.79
Closing Market Price Per Share: $12.23
Discount: -11.31
Discount at $12.16 Price: -11.82%
Yield: 7.07%
Tax Equivalent Yield: 10.88%
Average 5 Year Discount: -3.88%
Average 3 Year Discount: -2.73%
CEFConnect Page for NPI (discount as of 8/9/13= -11.46; NAV at $13.79)
Nuveen Premium Income Municipal Fund Inc. Stock Price
Sponsor's Webpage: NPI - Nuveen Premium Income Municipal Fund
NPI Page at Morningstar
The next ex dividend date is 8/13/13: Nuveen Closed-End Funds Declare Monthly Distributions
This fund is weighted in municipal bonds rated "A" or better.
I am reinvesting the monthly dividend to buy more shares and will continue to do so as long as the discount to net asset value per share exceeds the five year average of -3.88%. My average cost per share is $12.97 currently.
Friday's Closing Price: NPI: $12.21 -0.02 (-0.16%)
6. Added 100 PSEC at $10.85 (See Disclaimer):
Snapshot of Trade:
Prospect Capital Corp. is a Business Development Corporation that pays monthly dividends. The current yield at a $10.85 total cost per share is about 12.19%. PSEC has been raising the dividend in insignificant amounts each month.
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| Dividend Declarations September-December 2013 |
I will probably sell my 100 PSEC shares, held in the Roth IRA, when and if the price exceeds $11. I have been flipping PSEC in the ROTH while holding a position in a taxable account where I am reinvesting the dividend to buy additional shares, at least until the price routinely exceeds a 5% premium to book value per share.
Needless to say, there is no free lunches in investing and there are abundant risks associated with any security paying 12%. I discuss some of the risks in prior posts. The most extensive discussion can be found in Item # 3 Bought 100 PSEC @ $10.2-Roth IRA (November 2012 Post). I also recently added 50 shares in a taxable account: Item # 2 Added 50 PSEC at $10.15 (June 2013).
In the last SEC Filed Annual Report, it takes the company 22 single space pages to discuss the risks (pp. 29-51: sec.gov) An investor needs to read and understand that discussion.
I do not expect much capital appreciation. The primary reason for buying any BDC is to generate income and hopefully exit the position without losing anything on the stock.
Prospect Capital Profile Page at Reuters
Prospect Capital Key Developments Page at Reuters
Prospect Capital Corporation: Company Website
Recent Investor Presentation (7/10/13): www.prospectstreet.com (one of many things that worry me is shown at page 5 of that presentation, a rise in the portfolio size from just $136M in 2006 to over $3.7B, financed with a continuous stream of equity and debt offerings; yet net asset value per share has been trending down over that period. Who benefits from that vast increase in size: shareholders or management? With that vast increase in new investments, the potential for unpleasant surprises would seem to increase, and all of the foregoing makes the OG nervous and uncomfortable).
Closing Price Last Friday: PSEC: $10.86 -0.01 (-0.09%)
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This post is long enough. I wii discuss two trades made last week in the next post.
"If the government separated out those folks from these charts altogether, we would the problem starkly in the 1995-2007 period."
ReplyDeleteDid you mean to write "...we would [see] the problem [even more] starkly..."?
Overall another excellent column. I do appreciate your striving to present a balanced view, and read your blog regularly.
Cathie: Thanks for pointing that garbled sentence out. That resulted from a communication problem between the OG's mush of a brain and his finger tips.
ReplyDeleteThe point made in this sentence is that the parabolic rise in consumer debt, starting around 1985 and reaching a crescendo in 2007, was concentrated in one population segment.
If you strip out those households who have no mortgage debt, the rise in debt to disposable income during that period would have demonstrated the potential problem, which imploded in 2008, to virtually anyone looking at the chart. There were a large number of households that went well over 200% and even 300% in the household debt to DPI ratio. The households with no mortgage debt actually skewed the household liability to DPI chart down significantly and masked the emerging problem.
Oddly, one of the highest household debt to DPI ratios can be found in Denmark where the ratio is over 300%.