Big Picture: No Change
Stable Vix Pattern (Bullish):
Recent Developments:
The December ISM services was reported at 56.2%, down from 59.3% in November.
The ten year treasury is currently trading below 2%. 10_YEAR Bond Quote The German 10 year bond is trading below a .5% yield. DE 10Y
In early trading today, WTI has now crashed below $50 per barrel. Crude Oil Futures Quotes - CME Group
The VIX is declining some in early trading today, and is below the 20 marker.
**********************
The underlying theme in the two trades discussed in this post is the persistent decline in intermediate and longer term rates.
If bond investors are being rational, and are exercising sound judgment based on available data, their future predictions are becoming more ominous for stock investors. European ten year sovereign yields from Germany, the Netherlands, Belgium, France and even Spain, are consistent only with the onset of the Japan scenario, a long term stagnant growth cycle interrupted frequently by recessions and marked by periodic episodes of deflation with occasional low inflation numbers.
I do not believe that it is possible to explain a 10 year German government bond with a .5% yield in another cogent or convincing manner.
Several European governments are currently enjoying negative interest rates on their two year notes. Global Government Bonds-WSJ.com
There are several European sovereign ten year bonds that have never been so low in yield, and their histories go back for centuries. Bloomberg; MarketWatch; FT.com
While the U.S. treasuries are not sending yet the same deflation and recessionary to stagnant growth signals, the trend is in that direction. It will be difficult for stocks to maintain their current elevated multiples with inflation trending below 1% or into mild deflation for even brief periods. Earnings growth would be difficult, and emerging markets might not adequately compensate for the lack of pricing power and sluggish revenue growth due to their own slowing economies.
Bond investors are far from omniscient. If they were actually capable of predicting future inflation rates, they would not have priced 30 year treasuries at 15%+ in 1981. A 15% thirty year treasury rate assumed that inflation would remain problematic for decades, a patently incorrect future prediction based on what actually happened thereafter and even irrational based on the then apparent successful efforts of the Volcker led FED to slay the inflation bogeyman.
It is a common characteristic of humans to rely too heavily on the present to predict the future, and even the bond ghouls are human, more or less. The reality is no one can predict the future and everyone is just guessing.
I have now sold my two bank ETFs. I unloaded KRE a few days ago and discussed that sell in a previous post. In this post, I will briefly mention selling the Fidelity Financial ETF FNCL.
Assuming bond investors have correctly predicted the future, which is always a debatable assumption, it is entirely possible that the net interest margin of regional banks could be squeezed even further, particularly if the FED raises the FF rate this year in two .25% increments. Those rate increases will result in higher deposit costs for banks which are now paying their depositors nothing or close to it. If intermediate and longer term rates continue to trend down, the interest rates on many loans and bank investments will follow, causing some additional net interest margin contraction which has already been a problem for the banks and could become worse under this type of scenario.
Net Interest Margin for all U.S. Banks-St. Louis Fed
I am not predicting the future here. If and when I believe that I can predict the future, then I would have clearly lost my marbles and would need my family to appoint a guardian or conservator to manage my money.
I can only assign probabilities to future economic scenarios based on information that is currently available to me.
The bond ghouls are causing me to upgrade some the possibility of a non-temporary worldwide stagnant growth cycle with alternating periods of low inflation to mild deflation, or what I call the Japan Scenario.
In the Japan Scenario, most stocks are not going to work. The primary beneficiary would be high quality, long term bonds.
I simply can not accept the yields available for the highest quality bonds, so I will have to settle for BBB where I can still find at least some yield.
1. Bought 300 JTP at $8.18 (see Disclaimer):
Snapshot of Trade:
Prior Trade: I have one prior round trip trade:
Sold Roth IRA: 200 JTP at $8.38 (7/5/14 Post)(snapshot of profit=$154.9 with a total return of $248.5 or 16.42%)-Bought 200 JTP at $7.53-Regular IRA (10/14/13 Post)
Security Description: The Nuveen Quality Preferred Income Fund (JTP ) is a leveraged closed end fund that invests in preferred stocks and bonds. "predominantly" in securities rated investment grade by at least one rating agency.
Sponsor's website: JTP-Nuveen Quality Preferred Income Fund (as of 11/28/14, leverage at 27.96% with an annualized cost based on the latest month of 1.01%; 211 holdings; average effective duration was 5.66 years; average leverage adjusted duration was 7.86 years).
"Duration—What an Interest Rate Hike Could Do to Your Bond Portfolio"-FINRA
Data From Date of Trade 1/5/15:
Closing Net Asset Value Per Share: $9.2
Closing Market Price: $8.25
Discount at Closing Price: -10.33%
Discount at $8.18: -11.09%
Average Historical Discounts
1 Year: -10.19%
3 Years: -6.18%
5 Years: -5.88%
The current discount is well above the 3 and 5 year averages. I prefer to buy closed end funds when the discount is substantially higher than the historical averages.
JTP Page at Morningstar (rated 2 stars; no analyst report)
The fund is weighted in investment grade securities:
SEC Form N-Q: Holdings as of 10/31/14 (cost $776.676+M vs. value at $828.373+M)
Last SEC Filed Shareholder Report: Period Ending 7/31/14
SEC Filings for JTP
JTP Quarterly Fact Sheet
JTP: Commentary Third Quarter 2014
Dividend: The monthly distribution rate was $.052 per share through the November 2014 payment. The fund increased that rate to $.053 in December and then to $.055 for January 2015. Nuveen Closed-End Funds Declare Monthly Distributions The fund also paid out an additional distribution of $.0905 per share last December. Nuveen Quality Preferred Income Fun Dividend Date & History
Rationale and Risks: The primary reason for owning a leveraged bond CEF is to generate current income. Based on the current monthly distribution rate of $.055 per share ($.66 annually), and assuming a total cost per share of $8.18, the dividend yield is about 8.07%.
Since I view the stock market's valuations as stretched, and bonds to be relatively unattractive given their current yields and risks, I currently have an above average cash allocation, close to 25% of investable assets. My Canadian Dollar position is unusually high after selling several securities on the Toronto exchange last year.
I am currently increasing my cash flow without materially changing that cash allocation, which is accomplished simply by selling some lower yielding investments and substituting higher yielding ones in their place. The cash allocation will be drawn down, as it was in March 2009, when and if I see better values in the stock and bond markets than I do now.
This fund generated substantial realized losses on investments during the Near Depression period. As of 7/31/14, the fund had a loss carryforward of $340.839+M and used $11.57+M of the loss carryforward during its F/Y ending 7/31/14 to shelter long term capital gains from taxation.
The loss carryforward is somewhat advantageous to a new owner who buys this security in a taxable account, assuming the investor views tax efficiency as a benefit. I personally do not view large capital gain distributions favorably when paid into a taxable account. The net asset value per share is adjusted down by the amount of the distribution, and I have a tax obligation even though my wealth was not increased by the distribution.
I did not own this CEF prior to a small purchase made in October 2013. I looked at the fund's portfolio prior to the Near Depression, and there was then no loss carryforwards. Instead, the fund had an unrealized gain of $21.55+M. (page 39-shareholder report for the period ending 12/31/2006). The fund had then a weighting in investment grade securities.
The problem was that many of these securities were issued by banks and REITs, and the prices of those securities were smashed in 2008 and into 2009. In many cases, the price of a $25 par value security went into single digits. If the fund had no leverage, it could have waited until the prices recovered, which happened fairly quickly thereafter. Buying those smashed securities in 2008-2009 was a major profit center for me.
However, given the magnitude of the price declines and the size of the leverage, I suspect that the fund had no choice but to sell positions at the worst possible time in order to reduce leverage. As of 12/31/2006, JTP had investments valued at $1.336+B with a cost of $1.313+B, and the last shareholder report showed that the investments were then valued at $828+M.
Whatever the cause, the foregoing history highlights risks even when the fund has a weighting in investment grade securities. During times of economic distress, those securities can be downgraded into junk status, which happened to securities issued by several financial institutions, and investors will frequently price those securities as if a bankruptcy is likely to happen when the odds are actually substantially less.
The fund summarizes risks starting at page 11 of its last SEC filed shareholder report.
I would emphasize what I call normal CEF risks. The market price is determined by the frequently irrational decisions of investors and may consequently stray a considerable distance from net asset value per share, either above or below.
It is entirely possible for a fund's net asset value per share to go up with the market price declining, or for the market price to decline at a significantly greater percentage rate than the net asset value per share during periods of market stress.
All that I can say now is that the discount to net asset value per share is significantly higher than the historical 3 and 5 year averages. I am consequently playing the possibility that the net asset value per share will increase and the discount will narrow after my purchase. The converse may actually happen, appropriately called the Double Whammy, where the discount widens after my purchase as the net asset value per share declines.
Another risk is that the FED will start to raise short term rates this year. This will increase the cost of borrowed funds for leveraged CEFs and consequently narrow the income spread between that cost and the yields generated by longer term securities bought with those borrowed funds. I do not currently expect more than a .5% increase in the federal funds rate this year, and any additional increases are likely to be slow and measured thereafter. An increase in short term borrowing costs will erode the income advantage of leveraged bond funds. They are able to generate more income for their investors than an unleveraged fund owning the same securities due to that spread.
It remains to be seen whether intermediate and longer term rates will increase or decrease during the next FED tightening cycle. Many bond investors now believe that the yield curve will flatten, as longer term rates continue to move down while short rates increase due to the FED ending ZIRP. It would obviously be unfavorable for leveraged bond funds for their short term borrowing costs to increase and for the securities bought with those borrowed funds to go down in value.
So, there are abundant risks when an investor reaches for an 8% yield in a world without yield in risk free instruments.
2. Sold 60 FNCL at $28.75 (see Disclaimer)
Snapshot of Trade:
Snapshot of Profit:
Item # 7 Bought 50 FNCL at $26.57 (4/1/14 Post)
Security Description: The Fidelity MSCI Financials Index ETF (FNCL) is a low cost financial sector ETF that can be bought by Fidelity customers commission free. When a brokerage commission is eliminated, the investor can buy in small increments without worrying about the impact of a commission on the average cost per share. I bought this position in a 50 and 10 share lot.
This ETF will own banks, credit card and insurance companies, REITs and Berkshire Hathaway.
Expense Ratio: .12%
FNCL | ETF Snapshot - Fidelity
The dividend yield is currently low. The sponsor reported that the distribution yield was just 1.73% as of 11/30/14. A number of large financial institutions cut their dividends to 1 cent per share during the financial crisis and are still well below pre-2008 dividend levels. Some of them, like Citigroup and Bank of America, are unlikely to return to their pre-2008 dividend levels in my lifetime.
Citigroup Dividend History
Bank of America Dividend History
Rationale: I explained the rationale for dumping this position in the introduction. If there is a correction in regional bank stocks, I will consider later in the year using the proceeds from selling both KRE and FNCL to buy higher yielding individual bank stocks.
The December ISM services was reported at 56.2%, down from 59.3% in November.
The ten year treasury is currently trading below 2%. 10_YEAR Bond Quote The German 10 year bond is trading below a .5% yield. DE 10Y
In early trading today, WTI has now crashed below $50 per barrel. Crude Oil Futures Quotes - CME Group
The VIX is declining some in early trading today, and is below the 20 marker.
**********************
The underlying theme in the two trades discussed in this post is the persistent decline in intermediate and longer term rates.
If bond investors are being rational, and are exercising sound judgment based on available data, their future predictions are becoming more ominous for stock investors. European ten year sovereign yields from Germany, the Netherlands, Belgium, France and even Spain, are consistent only with the onset of the Japan scenario, a long term stagnant growth cycle interrupted frequently by recessions and marked by periodic episodes of deflation with occasional low inflation numbers.
I do not believe that it is possible to explain a 10 year German government bond with a .5% yield in another cogent or convincing manner.
Several European governments are currently enjoying negative interest rates on their two year notes. Global Government Bonds-WSJ.com
There are several European sovereign ten year bonds that have never been so low in yield, and their histories go back for centuries. Bloomberg; MarketWatch; FT.com
While the U.S. treasuries are not sending yet the same deflation and recessionary to stagnant growth signals, the trend is in that direction. It will be difficult for stocks to maintain their current elevated multiples with inflation trending below 1% or into mild deflation for even brief periods. Earnings growth would be difficult, and emerging markets might not adequately compensate for the lack of pricing power and sluggish revenue growth due to their own slowing economies.
Bond investors are far from omniscient. If they were actually capable of predicting future inflation rates, they would not have priced 30 year treasuries at 15%+ in 1981. A 15% thirty year treasury rate assumed that inflation would remain problematic for decades, a patently incorrect future prediction based on what actually happened thereafter and even irrational based on the then apparent successful efforts of the Volcker led FED to slay the inflation bogeyman.
It is a common characteristic of humans to rely too heavily on the present to predict the future, and even the bond ghouls are human, more or less. The reality is no one can predict the future and everyone is just guessing.
I have now sold my two bank ETFs. I unloaded KRE a few days ago and discussed that sell in a previous post. In this post, I will briefly mention selling the Fidelity Financial ETF FNCL.
Assuming bond investors have correctly predicted the future, which is always a debatable assumption, it is entirely possible that the net interest margin of regional banks could be squeezed even further, particularly if the FED raises the FF rate this year in two .25% increments. Those rate increases will result in higher deposit costs for banks which are now paying their depositors nothing or close to it. If intermediate and longer term rates continue to trend down, the interest rates on many loans and bank investments will follow, causing some additional net interest margin contraction which has already been a problem for the banks and could become worse under this type of scenario.
Net Interest Margin for all U.S. Banks-St. Louis Fed
I am not predicting the future here. If and when I believe that I can predict the future, then I would have clearly lost my marbles and would need my family to appoint a guardian or conservator to manage my money.
I can only assign probabilities to future economic scenarios based on information that is currently available to me.
The bond ghouls are causing me to upgrade some the possibility of a non-temporary worldwide stagnant growth cycle with alternating periods of low inflation to mild deflation, or what I call the Japan Scenario.
In the Japan Scenario, most stocks are not going to work. The primary beneficiary would be high quality, long term bonds.
I simply can not accept the yields available for the highest quality bonds, so I will have to settle for BBB where I can still find at least some yield.
1. Bought 300 JTP at $8.18 (see Disclaimer):
Snapshot of Trade:
Prior Trade: I have one prior round trip trade:
Sold Roth IRA: 200 JTP at $8.38 (7/5/14 Post)(snapshot of profit=$154.9 with a total return of $248.5 or 16.42%)-Bought 200 JTP at $7.53-Regular IRA (10/14/13 Post)
Security Description: The Nuveen Quality Preferred Income Fund (JTP ) is a leveraged closed end fund that invests in preferred stocks and bonds. "predominantly" in securities rated investment grade by at least one rating agency.
Sponsor's website: JTP-Nuveen Quality Preferred Income Fund (as of 11/28/14, leverage at 27.96% with an annualized cost based on the latest month of 1.01%; 211 holdings; average effective duration was 5.66 years; average leverage adjusted duration was 7.86 years).
"Duration—What an Interest Rate Hike Could Do to Your Bond Portfolio"-FINRA
Data From Date of Trade 1/5/15:
Closing Net Asset Value Per Share: $9.2
Closing Market Price: $8.25
Discount at Closing Price: -10.33%
Discount at $8.18: -11.09%
Average Historical Discounts
1 Year: -10.19%
3 Years: -6.18%
5 Years: -5.88%
The current discount is well above the 3 and 5 year averages. I prefer to buy closed end funds when the discount is substantially higher than the historical averages.
JTP Page at Morningstar (rated 2 stars; no analyst report)
The fund is weighted in investment grade securities:
SEC Form N-Q: Holdings as of 10/31/14 (cost $776.676+M vs. value at $828.373+M)
Last SEC Filed Shareholder Report: Period Ending 7/31/14
SEC Filings for JTP
JTP Quarterly Fact Sheet
JTP: Commentary Third Quarter 2014
Dividend: The monthly distribution rate was $.052 per share through the November 2014 payment. The fund increased that rate to $.053 in December and then to $.055 for January 2015. Nuveen Closed-End Funds Declare Monthly Distributions The fund also paid out an additional distribution of $.0905 per share last December. Nuveen Quality Preferred Income Fun Dividend Date & History
Rationale and Risks: The primary reason for owning a leveraged bond CEF is to generate current income. Based on the current monthly distribution rate of $.055 per share ($.66 annually), and assuming a total cost per share of $8.18, the dividend yield is about 8.07%.
Since I view the stock market's valuations as stretched, and bonds to be relatively unattractive given their current yields and risks, I currently have an above average cash allocation, close to 25% of investable assets. My Canadian Dollar position is unusually high after selling several securities on the Toronto exchange last year.
I am currently increasing my cash flow without materially changing that cash allocation, which is accomplished simply by selling some lower yielding investments and substituting higher yielding ones in their place. The cash allocation will be drawn down, as it was in March 2009, when and if I see better values in the stock and bond markets than I do now.
This fund generated substantial realized losses on investments during the Near Depression period. As of 7/31/14, the fund had a loss carryforward of $340.839+M and used $11.57+M of the loss carryforward during its F/Y ending 7/31/14 to shelter long term capital gains from taxation.
The loss carryforward is somewhat advantageous to a new owner who buys this security in a taxable account, assuming the investor views tax efficiency as a benefit. I personally do not view large capital gain distributions favorably when paid into a taxable account. The net asset value per share is adjusted down by the amount of the distribution, and I have a tax obligation even though my wealth was not increased by the distribution.
I did not own this CEF prior to a small purchase made in October 2013. I looked at the fund's portfolio prior to the Near Depression, and there was then no loss carryforwards. Instead, the fund had an unrealized gain of $21.55+M. (page 39-shareholder report for the period ending 12/31/2006). The fund had then a weighting in investment grade securities.
The problem was that many of these securities were issued by banks and REITs, and the prices of those securities were smashed in 2008 and into 2009. In many cases, the price of a $25 par value security went into single digits. If the fund had no leverage, it could have waited until the prices recovered, which happened fairly quickly thereafter. Buying those smashed securities in 2008-2009 was a major profit center for me.
However, given the magnitude of the price declines and the size of the leverage, I suspect that the fund had no choice but to sell positions at the worst possible time in order to reduce leverage. As of 12/31/2006, JTP had investments valued at $1.336+B with a cost of $1.313+B, and the last shareholder report showed that the investments were then valued at $828+M.
Whatever the cause, the foregoing history highlights risks even when the fund has a weighting in investment grade securities. During times of economic distress, those securities can be downgraded into junk status, which happened to securities issued by several financial institutions, and investors will frequently price those securities as if a bankruptcy is likely to happen when the odds are actually substantially less.
The fund summarizes risks starting at page 11 of its last SEC filed shareholder report.
I would emphasize what I call normal CEF risks. The market price is determined by the frequently irrational decisions of investors and may consequently stray a considerable distance from net asset value per share, either above or below.
It is entirely possible for a fund's net asset value per share to go up with the market price declining, or for the market price to decline at a significantly greater percentage rate than the net asset value per share during periods of market stress.
All that I can say now is that the discount to net asset value per share is significantly higher than the historical 3 and 5 year averages. I am consequently playing the possibility that the net asset value per share will increase and the discount will narrow after my purchase. The converse may actually happen, appropriately called the Double Whammy, where the discount widens after my purchase as the net asset value per share declines.
Another risk is that the FED will start to raise short term rates this year. This will increase the cost of borrowed funds for leveraged CEFs and consequently narrow the income spread between that cost and the yields generated by longer term securities bought with those borrowed funds. I do not currently expect more than a .5% increase in the federal funds rate this year, and any additional increases are likely to be slow and measured thereafter. An increase in short term borrowing costs will erode the income advantage of leveraged bond funds. They are able to generate more income for their investors than an unleveraged fund owning the same securities due to that spread.
It remains to be seen whether intermediate and longer term rates will increase or decrease during the next FED tightening cycle. Many bond investors now believe that the yield curve will flatten, as longer term rates continue to move down while short rates increase due to the FED ending ZIRP. It would obviously be unfavorable for leveraged bond funds for their short term borrowing costs to increase and for the securities bought with those borrowed funds to go down in value.
So, there are abundant risks when an investor reaches for an 8% yield in a world without yield in risk free instruments.
2. Sold 60 FNCL at $28.75 (see Disclaimer)
Snapshot of Trade:
Snapshot of Profit:
 |
| 2015 Sold 60 FNCL +$135.71 |
Security Description: The Fidelity MSCI Financials Index ETF (FNCL) is a low cost financial sector ETF that can be bought by Fidelity customers commission free. When a brokerage commission is eliminated, the investor can buy in small increments without worrying about the impact of a commission on the average cost per share. I bought this position in a 50 and 10 share lot.
This ETF will own banks, credit card and insurance companies, REITs and Berkshire Hathaway.
Expense Ratio: .12%
FNCL | ETF Snapshot - Fidelity
The dividend yield is currently low. The sponsor reported that the distribution yield was just 1.73% as of 11/30/14. A number of large financial institutions cut their dividends to 1 cent per share during the financial crisis and are still well below pre-2008 dividend levels. Some of them, like Citigroup and Bank of America, are unlikely to return to their pre-2008 dividend levels in my lifetime.
Citigroup Dividend History
Bank of America Dividend History
Rationale: I explained the rationale for dumping this position in the introduction. If there is a correction in regional bank stocks, I will consider later in the year using the proceeds from selling both KRE and FNCL to buy higher yielding individual bank stocks.
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