Hyman Minsky & the Economic Profession/Savings Bonds/Correlation of Asset Classes/Sold CYB

1. Hyman Minsky: Minsky and Robert Schiller are two of the very few economists worth reading. The rest are consumed with mathematical models and absurd, even laughable constructs based on the "Rational Man" The Death of 'Rational Mans- washingtonpost.com Rational man | The Economist

For those unfamiliar with Minsky, here is a link to an introductory article in Wikipedia. A ten page paper written by Minsky titled "The Financial Instability Hypothesis" is worth a read: www.levy.org/pubs/wp74.pdf The stark failure of mainstream economists is due in part to ignoring Minsky, a point recently made by Floyd Norris in his NYT column. This is a link to Pimco's Paul McCulley discussing Minsky and his relevance to understanding the recent financial crisis: pimco-global.com/pdfs For the most part, I would have the same reverence for economists as I do the Masters of Disaster, and I would wholeheartedly agree with Hayek's remark that economists have "made a mess of things". Friedrich August von Hayek - Nobel Prize Lecture Unfortunately, nothing has changed since that remark by Hayek many moons ago.

2. Savings Bonds: For anyone interested in determining the value of their savings bonds, the treasury department has a calculator: Calculate the Value of Your Paper Savings Bond(s) Some might say that this is a staid investment. In 1992, the treasury sold some EE with a guarantee of 7.5% until the bond reached its face or par value, and 4% thereafter until maturity. The maximum face amount was $10,000, bought for $5000. A $10,000 face amount savings bond bought in 1992 for $5,000 would now be worth $12,392. It would currently be accruing interest at a rate higher than the 10 year Treasury bond. This is a link to the table of that shows the current rates by issue data: www.treasurydirect..pdf The current rate for newly issued bonds is just 1.2%: Individual - EE/E Savings Bonds If I had to buy a savings bond today, it would be the "I" series: Individual - I Savings Bonds & Individual - I Savings Bonds Rates & Terms (the last link shows how the treasury calculates interest for its inflation linked I Savings Bonds)

On tax issues for I bond holders, see IRS publication 550 at the bottom of page 7: www.irs.gov/pub/irs-pdf/p550.pdf The coupon rate for the I bonds is very low now at .3%. But, there is always the option after five years to redeem the bond without penalty and then invest in an new one. Since the investor can redeem after 5 years, receive their principal and accrued interest at that time, I view them as comparable to the 5 year TIP bond. Bloomberg reports that the current coupon yield on the 5 year TIP as of 12/24/09 is .41%. There are no penalties for redemption after a five year holding period: Individual - I Savings Bonds

If the coupon payable on the I Bond moved up substantially from its current low rate, it might make sense to redeem the old one with say a .3% coupon for a new one with a 3% coupon, for example, both having the same inflation adjustment component. But this kind of investment is not the path many will choose, because the upside is so limited, even when the coupon was over 3% from 9/1/98 to 5/1/2001. Individual - I Savings Bonds Rates & Terms The last link contains the historic coupon rates of the I savings bond, and illustrates a point that I have made several times about TIPs. The coupon rate will fluctuate with changes in inflation and inflation expectations.

3. Asset Correlation: I occasionally will look at historical charts that contain information on how one asset class correlates with another. Positive correlation simply means the asset classes move in the same direction, both up and down. If positive correlation is stated at 1, the correlation is perfect. I would view anything over .7 to be a high positive correlation. Negative correlation indicates that the asset classes move in different directions. A recent example of negative correlation was the movement of the S & P 500 and treasury bond prices between September 2008 and early March 2009.

For historical data, I turn to the charts contained in David Darst's book "Mastering the Art of Asset Allocation". This book contains data up to 2004. I am most interested in the rolling 10 year periods. Looking at the data starting in 1970 showing correlations with the S & P 500, I see very high positive correlations with the Wishire 5000 index. The positive correlations are mostly .99 or .98. The asset classes with negative correlations with the S & P 500, or small positive correlations, for significant periods of time were gold, silver, REITs and TIPs. The 10 year treasury note had positive correlation in every ten year rolling period starting in 1970 and ending in 2004, with a large number of low or modest positive correlation. I would call 1 to 30 a low positive correlation, 31 to 69 modest, and over 70 as high. Generally, for the purposes of evaluating diversity, I would want some assets with low positive correlations and some that would historically be negative, more often than not. (see the comments of Gary Gordon in this article: ETF Trends )

And it always needs to be emphasized that correlations between asset classes can be volatile. This article shows how the commodity index was negatively correlated with the DJIA for most of the 1970s and early 1980s, and then turned toward more positive correlation numbers in rolling five year periods after 1985 with only one negative correlation five year period: Seeking Alpha But even that picture can be a little deceiving by arbitrarily focusing on specific five year periods, rather than rolling five year periods, and comparing stocks to the broad commodity index which is weighted in energy. So oil prices were rising in the 1970s and stocks were going nowhere for the decade. I would expect a negative correlation between oil and stocks in the 1970s, but I expected positive correlation between that broad commodity index and stocks in 2008. So, the analysis has to be specific for the particular time at issue. The broad commodity index is running with stocks now. The Ishares ETF for the GSCI Commodity index was at 23.1 in early March and has risen to $31.11 as of 12/24: GSG Fund Charts - iShares S&P GSCI Commodity Indexed Trust Fund Charts You can also see looking at that one year chart the positive correlation in the first quarter of 2009 between GSG and stocks, both moving down.

For agricultural commodities, 2009 has not been exactly been stellar. Just compare DBA, a ETF for agricultural commodities to the S & P 500.S&P 500 INDEX,RTH Index Chart DBA is flat. But if I include a chart with data from last year's stock debacle, DBA would have suffered less in losses than the S & P 500.

Some of the more detailed posts on this subject include the following:

instability & volatility in asset correlations

Emerging Market Currencies and Bonds as Non-Correlated Asset Classes

Treasury Inflation Protected Securities as a Non-Correlated Asset

Total Bond Market Index (BND) and IEF as Non-Correlated Assets to Stocks

More on International Bonds as a Non-correlated Asset

Examples of Dynamic Asset Allocation over the Past Two Years

Static v. Dynamic Asset Allocation

4. Lions Gate (LGF) (owned LT category): Precious is still playing in 1003 theatres. Over the past 7 weeks, the film has an estimated gross of about 40 million. Another LGF release, Brothers, is up to 22.349 million in 3 weeks. top films

5. Dividends and Interest: One of the securities that I own, PFK, goes ex interest on Tuesday for its monthly interest payment. PFK is a senior bond whose interest rate is calculated based on a 2.4% spread to CPI. The calculation is explained in earlier posts. / CPI and CPI Floaters OSM and PFK The rate for the January payment is $.0231. I expect that rate to increase over the coming months (see the calculations below).

Two of the Trust Certificates (TCs) containing a junior Aon trust preferred (TP), KTN and KVW, go ex interest for their semi-annual payment also on the 29th of December. I own both of those, with KTN bought at $14 or less per share, now trading over $25. Other securities that go ex dividend or interest that I own and have discussed in this blog include Winstream; the U.S. Bancorp equity preferred floater ( USB.PRH); two synthetic floaters-GJT & GJN; Sysco; a BDC, Prospect Capital (PSEC); PMA Capital Senior note (PMK); Wilshire Bancorp; two Odyssey Re equity preferred stocks, one a floater and the other a fixed coupon; IDG an ING hybrid; IAE, IGD, GCS, CSQ, PSY- Closed End Investment funds (CEFs); GRT & GRTPRF (a cumulative REIT preferred stock); EHL, A FIRST MORTGAGE BOND issued by Entergy Louisiana; Enerplus, a Canadian energy trust; LXPPRD (cumulative equity REIT preferred stock); SIVBO (a TP from SVB Financial); & CVB Financial. So, that is a diverse lot of securities. The income orientation is clear.

I will summarize the method used to calculate the interest payment for the Prudential CPI floater (a senior bond maturing in 2018 at a $25 par value) which goes ex tomorrow with a payment in January. The CPI calculation covers a 12 month period with a 3 month lag. The non-seasonally adjusted CPI is used:

Pricing Supplement No. 122 dated March 31, 2006

NSA CPI September 2009: 215.969

NSA CPI September 2008: 218.783

Difference: -2.814

Divided by 218.783= -.01286

Add Spread: .024= .0111 x $25 par value= $.2775

Divide by 12 months= .0231 cents which is what is shown on the WSJ dividend page.

As shown, this rate for January 2010 is still being adversely impacted by the negative CPI numbers from 4th quarter of 2008.

This is the calculation for the payment in February 2010, as one negative CPI number from 2008 is eliminated:

NSA CPI October 2009: 216.177

NSA CPI October 2008: 216.573

Difference: -.395

Divide -.395 by 216.573= -.0018

Add Spread .024 to -0018238= .0222 x. $25 par value= $.555

Divide by 12= $.04625

And for the March 2010 payment, another 2008 negative CPI number is eliminated, and I can now calculate the penny rate:

NSA CPI November 2009 216.330

NSA CPI November 2008 212.425

Difference 3.905

Divide by 212.425= + .0184

Add Spread .024= .0424 x. $25=$1.06

Divide by 12 months= $.0883

I can not do the April 2010 payment until the December CPI number is released in mid January 2010. But let's make an assumption of an increase from 216.330 to say just 216.5 in that December CPI number. I calculated the penny rate based on that assumption at $.1121.

This is the data series that has to be used: http://research.stlouisfed.org/fred2/data/CPIAUCNS.txt As the negative numbers from 2008 are eliminated Bureau of Labor Statistics Data, the penny rate moves up. LB had a deer in the headlights look when PFK was at $12.5, unable to push the buy button, then hit the buy button several times in the $17.83 to $18.94 range.

6. Inflation Adjusted Stock Market Returns: While the rally in 2009 has taken the DJIA to 1999 levels, an article in the WSJ highlights the obvious, the inflation adjusted number is worse. For the DJIA to return to return to the 1999 highs adjusted for inflation, the DJIA would now have to be at 13460. This does not take into account dividends, but dividends are not what they use to be either.

The moneychimp site has a calculator that lets you adjust stock returns for any period of time: S&P 500 I did a calculation of the S & P 500 return with dividends and adjusted for inflation, starting on 1/1/99 to 12/31/2008. The annualized return was a -3.89. I tried another bad period, with inflation, between 1/1/1969 to 12/31/1981, and the annualized return was -2.07. But if I take a longer period, starting on 1/1/1982 to 12/31/2008, the return is positive at 7.43% annualized.

7. Sold 100 CYB for a Small Loss ( see disclaimer): I went to the Wisdomtree website this morning, and checked to see whether CYB paid an annual dividend in 2009. No dividend was paid. WisdomTree - WisdomTree Dreyfus Chinese Yuan Fund (CYB) I also read a story this morning, where the Chinese premier insisted that China would not be presurred to unpeg the yuan to the dollar. CNBC Those two new facts caused me to reconsider holding the currency ETF for the Chinese Yuan, and I decided to sell my position this morning. Instead of owning the Yuan in a very indirect through this ETF, I will increase my holdings in Canadian dollars which will be used to buy high yielding Canadian stocks. The position was bought at $25.36 in November: BOUGHT 100 CYB at $25.36

8. Australian Dollars: I mentioned in an earlier post that I would be buying some Australian dollars at some point, rather than buying back the currency ETF for the Australian dollar, FXA. I have changed my mind on that one. The only reason for me to convert my U.S. dollars in the Aussie currency directly is to buy stocks on the Australian exchange. I have decided to refrain from doing that due to the brokerage commission being too high at 32 Australian dollars (currently about $28 U.S.Currency Converter ). If the Australian dollar falls significantly, say to $20 U.S., I may choose to buy a stock on the Australian exchange and convert my dollars then. In the meantime, I may buy back my shares in FXA: Sold FXA My trades in FXA, and other currency ETFs, in 2008 were one of the few positive events from that year.

9. RB Receives a Reward While LB Is Given Awards: Headknocker is generous to a fault, which goes without saying. While the RB in this operation is frequently maligned by the Nerd LB, HK recognizes that the vision thing can sometimes play a role in advancing the HK's capital position. So, to show his generosity, HK will allow the RB to buy five Lottery Tickets today and tomorrow on the condition that any loss be realized before it turns into a long term loss next year.

For LB, HK will thank the NERD for preserving HK's capital during the trying times in 2008. To show HK's gratitude, HK hereby grants to LB the follow awards: Best Macro Economic Analysis in 2009 at HQ; Best Market Historian in 2009 at HQ; Best Stock Researcher in 2009 at HQ; Best Numbers Cruncher in 2009 at HQ; and Best Technician in 2009 at HQ. Of course, LB is the only candidate for those awards here at HQ.

Medtronic/Managing Large Gain In a Bond Position/Bill Tedford's Inflation Prediction & His Sell of TIPs

1. Medtronic (owned): In the follow-up section in this week's Barrons, there is an upbeat assessment of Medtronic's prospects. I do not have access to the report from Credit Suisse referenced in this article, titled "The Sleeping Giant is Awakening". Kristine Stewart, the CS analyst, argues that MDT's new product launches over the next 12 to 18 months will sustain double digit earnings growth. She has a target of $49. I arrived several weeks ago at a target for Medtronic of $49.35, in a manner that would be viewed as simplistic by Wall Street. I took the then current, forward earnings estimate, multiplied it by 15, which seemed reasonable, and came up with $49.35. Item # 6 Added to Medtronic (post dated 9/18/2009). Medtronic was the first stock bought by RB during its March frolic, near the 52 week low at below $26 on 3/4/09. (on 3/6/09, 3/9 & 3/10, the buying began in earnest with buys of NYX, CPB, the TC MJH, the TC PJZ, the TC KSA, DIS, IR, DD, SYY, the TP JWF, KO, the TC JZV, & HNZ). I do not plan to do anything now with my MDT shares. If the price approaches $49, I will make a decision then.

2. Managing Large Unrealized Gains in a Bond Position: One of the hardest decisions to make is whether or not to pare a bond or a preferred stock bought at an extremely favorable price, where the yield at the investor's cost is just phenomenal. What would you do now, assuming you were a reader of this blog, and bought say 2000 shares of AEB, the hybrid from Aegon, at $4.5 earlier in the year? The shares are now trading at over $17. The security pays the greater of 4% or 7/8% above the 3 month LIBOR, calculated on a $25 par value. www.sec.gov It is a perpetual security that can be called at Aegon's option after 12/15/2010. It is certainly possible that it will never be called. At the guarantee, the yield at that $4.5 cost is around 22% annually, currently taxed as a qualified dividend for a U.S. taxpayer. If LIBOR rose to 5% during the applicable computation period, the yield would soar to 32.6% annualized. Eight percent 3 month LIBOR would result in a 49.3% annualized yield at that $4.5 cost! It would be hard to give any of those yields up. And, if the investor sold some shares, the proceeds might be invested in another security that would lose value, and almost certainly have a lower yield. I view this issue in a different way for common stocks. If I owned 2000 shares of a common stock that went from $4.5 to $17, I would view it as foolish not to pare or schnitzel as Cramer would say. Booyah Breakdown. It would only be a question of how foolish, measured in part by the size of the position in the portfolio, so that the greater the size-the greater the foolishness. AEB however is a junior bond, which is treated as equity capital for regulatory purposes. And it is a bond paying that buyer at $4.5 a lot to hold onto it. That is the rub. Some of my readers have done better than me with some of these securities. I bought 50 shares of AEB at 4.8 in February, more at $5.5 and at $8. But, I am a tortoise, not a hare, a plodder not a leaper.

Of course, a lot would depend on an individual's particular circumstances, risk tolerance, the size and balance of the overall portfolio, the percentage weight of AEB in that portfolio, and several other factors. There is no cookie cutter answer for this kind of issue. I would start by evaluating Aegon's credit risk. The logical & analytical side wants to know about the risks first and foremost. In assessing those risks, I am not searching for information that confirms my decision to buy the security, or that makes me feel pleased with myself for continuing to own it. I want to search for information that would highlight the risks and identify what can go wrong.

For Aegon, I would have been very focused on the European Commission's burden sharing policy, the long term impact of that policy, and the relevance of the Mandatory Payment events in the AEB prospectus under current circumstances. Those topics are discussed briefly in Aegon Hybrids: Gateway Post and the posts linked therein. Although it is at best an imperfect process, I am trying to evaluate a number of factors to balance risk and reward, the likelihood of a dividend deferral, the consequences of a deferral, and the circumstances that must first exist for a deferral to be legal. After doing that analysis with Aegon, I concluded that I would take the risk of holding all of the Aegon hybrids which I owned, and even added 100 of AEF.

Back to that hypothetical investor holding 2000 of Aegon bought at $4.5. If it was me, and it is not me, I would harvest some of those profits, just in case an unexpected event devastated my unrealized profits. I would generally, though not always, work toward a position of playing with the house's money, taking into account dividends and profits realized on the shares. So, just speaking for myself, I would probably sell 1/3 and keep the rest. I might split that 1/3 into two batches, one to be sold at the beginning of 2010 and another sold at say a couple of bucks higher.

This kind of problem does not lend itself to a right or wrong answer, because the future is unknowable and the yield of the bond at the $4.5 cost is just fantastic. The yield and the nature of the security, being a bond, are the primary impediments to paring the position. Part of the problem is what happens to the funds realized from the pare. The investor could take the funds realized from selling some shares and then buy shares in what turns out to be the next Enron or Lehman, while AEB moves higher and continues paying its quarterly dividend until the investor is long gone. All of this assumes that the investment would be a minimal part of a portfolio. For me, when the value of all securities from a single issuer exceed 1% of my investable portfolio, I am already thinking about paring.

[ I have not sold any of the 350 shares that I own. My total exposure to Aegon hybrids is around $7500 at current prices (far less at cost) and I recently bought 50 shares of the common as a Lottery Ticket. At most I may sell 50 shares of AEB at some point, and I am in no hurry to do that. It is a Rule Violation for me to devote more than $10,000 in initial outlays to the securities of one firm, and that includes bonds, preferred and common stock. ]

Still, and this may be psychological, I would still do a pare of those hypothetical 2000 shares until I became comfortable, moving toward that goal of playing with the house's money, when I am likely to let it ride until something really spooks me about the company. This means that Aegon would have to monitored for as long as I held those AEB shares. After each major event such as an earnings release, I would have to ask myself whether or not I want to continue holding this security, based on an evaluation of the likelihood of continued payments of the dividend. That is why I engaged in often lengthy nerdy discussions of Mandatory Payment Events after the EC announced its burden sharing policy for owners of European hybrid securities like AEB.

I mentioned in an earlier post that I sold LEHPRG, a Lehman equity preferred floater in late 2007, after getting spooked: A RISK OF PREFERRED STOCKS (LEHPRG REMEMBERED) So, once I am spooked, and I view that response as rational under the circumstance, then there would be much more than a pare as a response, either an elimination or a substantial reduction in exposure. We are now near the end of 2009 and HK would horse whip a HT who took another gain this year.

3. Is the Fed Right About Inflation: The Fed keeps saying that inflation is not a problem and it will keep the federal funds rate at 0 to .25% for "an extended period". CPI has already turned up. The cash inflation number, which includes price levels of actual transactions, as opposed to hypothetical ones, is already turning hot. /Agricultural ETFs/What is the Real Cash Inflation Number? A repeat of the 1970s is one possibility given the degree and duration of the fiscal and monetary stimulus on top of the gigantic budget deficits-guns and butter on steroids.

I was interested in an article in the WSJ summarizing the views of Bill Tedford, a bond manager for more than 20 years, who has beaten his benchmark. I had never heard of the guy until I read this article. The model that he has been using to predict inflation is currently signaling CPI accelerating to 3 or 4% by the end of 2010 and hitting 5% to 6% in 2011. This would not surprise me at all. It just seems to me that the government is now repeating the mistakes of the late 1960s and 1970s, and I am having difficulty understanding why the result will be much different.

Tedford sold his TIPs for the same reason that I recently liquidated my entire position in the TIP ETF. /Sold All Shares TIP ETF/Started Hedge for Corporate Bonds This is what I said at the time of that transaction on 11/10/09:

"What precipitated the sell yesterday was that the real yield was falling to about 1.25% on the ten year TIP, the maturity that I use for evaluating the TIP ETF. This ETF has a weighted average maturity of 8.91 years-currently according to its sponsor. iShares Barclays TIPS Bond Fund (TIP): Overview I would not buy a 10 year TIP with a coupon of 1.25%, so I sold the remaining TIP ETF shares that I own a good profit for this kind of investment."

This is the relevant part of my discussion in the gateway post on TIPs:

"Currently the real yield on the 10 TIP is less than 2%. In an inflationary environment, investors may demand more of a real yield for the TIP, and the breakeven point may also increase, in order for the investors to be comfortable that they would actually be receiving a real yield. If there was 6% inflation two years from now, I would expect an older TIP, with a 1.8% real yield and a 1.9% breakeven, to fall in price to make it equivalent to a new TIP offering in real yield and breakeven spread. The accretion to the principal due to the increased inflation may not make up for the fall in price." Advantages and Disadvantages of Treasury Inflation Protected Securities:

That post, like many of the major gateway posts was written over a period of weeks in May and June 2009. Subsequently they were grouped together under a common date, 9/25/2009, so that I could find them more easily.

A few weeks ago, the coupon for the 10 year TIP was barely above 1%. The TIP bonds have fallen in price since late November and the real yield (coupon rate) is back up to 1.43%, better than the 1.25% when I eliminated the TIP ETF, but not yet enticing to me. Bloomberg.com: Government Bonds Why? If inflation increases, the real yield for newly issued TIP securities will rise, as investor demand a higher coupon to compensate for the increased inflation risks. The older TIP bonds would then have to fall in price to equalize the real yield. I agree with that argument. The question for each individual to decide for themselves is how accurate is the market predicting inflation in the pricing of the current TIP.

The recent decline in TIP can be seen looking at the historical prices for the TIP ETF, moving from $106.57 on 11/30 to $103.78 on 12/24. TIP: Historical Prices for ISHARES BARCLAYS TIP

Tedford is apparently telling his clients according to the WSJ to invest in assets that have historically done well in an inflationary environment, such as agricultural commodities, timber, oil and natural gas, and metals.

It goes without saying that many economists do not agree with that assessment. The WSJ article quotes some economists who argue that the velocity of money is more important than the monetary base. The velocity that money is exchanging hands is still down. All of this falls within a category of what I will label as "unknowable". The possibility of inflation becoming a problem has been mentioned as significant enough for me to take proactive measures starting last October, when it was possible to buy assets providing some inflation protection such as floating rate bonds with guarantees at very attractive prices.

I have already started to branch out into agricultural commodities, and have started to increase my common stock position in oil and natural gas firms, with recent buys of 100 shares each in Exxon, Marathon Oil, and Enerplus. I also added IGE at what I viewed as a favorable price a few months ago (BOUGHT 100 IGE at $27.85), and started to increase my holdings in GCS, a CEF investing in natural resource companies. I have also initiated positions in the broader commodity index by buying RJI, and I still own some RJZ for metal exposure. My main metal exposure is gold and silver bullion stored in a lock box.

I would call what I have done to be proactive and sensible until I have more information on which set of experts may be right on the inflation issue. I would describe what I have done is to tilt a little toward accepting Tedford's view. The floaters with guarantees were important in this effort since the purchases were so favorable that they provide now protection in both inflation and deflation (or low inflation) scenarios. The main decision now is for how long do I hold onto some of the fixed coupon bonds with maturity dates ten or more years from now. They will fair poorly if Tedford's inflation forecast comes to pass.

Bought 100 MRO at 31.68/Took Tax Loss-BAC Common shares/Zions WPCS SYY/Japanese Yen

1. Bought 100 Marathon Oil at $31.68 Thursday (see Disclaimer) Kurt Wulff calculated the net present value of MRO at $53 recently in a Seeking Alpha article. Cramer referred to MRO as the best oil company in the U.S. now on Wednesday, (12/3/09) -- Seeking Alpha. The analyst reports that I recently viewed are a mixed bag. Morningstar has it rated 4 stars with a $44 fair value. S & P also has MRO rated at 4 stars with a $38 price target. Barclays believes Exxon and Chevron are better values and MRO is rated equal weight with a $33 price target.

The dividend yield for MRO at my cost is around 3%. Looking at a five year price chart, the stock price peaked at close to $62 in May 2007 and bottomed in February near $23. MRO Stock Charts Based on the data at Marketwatch, the consensus estimate for 2010 is $3.47, which would give MRO a forward P/E of 9.11 or so assuming of course that estimate turned into a fact next year. Analyst Estimates for Marathon Oil Corp The data at Reuters has the 2010 number slightly higher at $3.57. There can be huge swings at MRO based on refining margins and the prices realized from oil and natural gas sales. As a result, MRO earned from continuing operations last quarter $.55 compared to $2.82 in the year ago quarter. form10q2009sept30.htm

The current price is near MRO's book value.

Marathon has finished recently an upgrade to its refinery in Garyville Louisiana, making it the fourth largest in the U.S. Part of the recent problems are tied to its refining operations. Garyville Refinery Expansion Production has increased in 2009 for the first three quarters by about 11% compared to last year. Marathon is anticipating 6% production growth in 2010: Marathon to grow production by 6% in 2010 - MarketWatch

A lot of the negativity surrounding Marathon now has to do with its large refining operation. An article in the NYTimes last Wednesday points out the already well known problems in the American refining industry, and I would not want to downplay some of the negative factors. But, I would not be looking primarily in the rear view mirror, as that NYT columnist. Instead, I would tend to be more focused about the future since the negative news seems to be priced into the refining stocks. Several refineries have been shuttered in the U.S. and gasoline demand has been weak due to the recession. If 2010 shapes up a positive one for the economy, distillate demand could perk up, improving margins provided the input costs for refiners do not take off again, meaning the prices for crude. Some of the positive factors are discussed in this video previously linked in my discussion about Valero: Top 2010 Stocks: VLO

2. Goldman Sachs: For the sake of argument and to avoid a charge of engaging in hyperbole, I will postulate the hypothetical existence of an investment banker who is interested in furthering the interests of their client, and who will not place their own personal greed ahead of the client's interest. My only point would be why would anyone trust an investment banker.

The article in Wednesday's edition of NYT is just the last salvo that undermines trust in the Masters of Disaster, who are after all on a singular mission to advance their personal interests to the exclusion of all matters. It should not be surprising that the Masters of Disaster will throw their clients under the train when so many of them even wrecked their own firms in furtherance of their personal greed. I have previously linked some of the articles in The Reckoning series that goes into more detail. I thought that I would just link the article with the firm in this post:

AIG: Insurer’s Crisis, Blind Eye to a Web of Risk

Citigroup: Citigroup Saw No Red Flags

Merrill Lynch: How Merrill Lynch Faltered and Fell

Washington Mutual: WaMu Built an Empire on Bad Loans

But there are literally thousands of examples over the past decade. Never before in the history of civilization has so many been paid such outrageous sums to do so much harm and perform so miserably.

The most recent disclosure in the NYT was how Goldman and others packaged the toxic CDOs sold to their clients in such a way as to improve Goldman's profits in betting against those securities sold to its customers. NYTimes.com One thing that is always fascinating to me is that the customers keep coming back for more, must be some kind of sadistic or masochistic streak, or maybe those customers have a total inability to learn from past experience.

One basic characteristic of a Master of Disaster is the ability to land on their feet after blowing something up, like the world's economic system. You almost have to respect that ability. It must be nice to become filthy rich, never be held accountable for the disasters created by your actions, and to be able to walk away nonchalantly allowing others to pay for the consequences of your actions.

Headknocker is not bitter, really, maybe he sounds a tad weary since a lot of what happened during the 2002 to 2007 period reminds him of the corrupt business practices of the S & L wheeler dealers who precipitated the recession in 1990-1991 and required a massive government bailout. HK has seen this picture many times before, the plots and endings are basically the same, but the names do change. Most of the S & L perpetrators kept their booty, and the taxpayers paid about 130 billion dollars to clean up their messes, with a total cost of one-half trillion according to the G.A.O. In today's dollars, the cost of the S & L bailout would be about 250 billion to the taxpayers. US Banker

LB was just grateful to the Masters of Disaster for giving it an opportunity to work in real time on its trading rules, the ones for a disaster phase of a bear market. Maybe HK is used to cleaning up other people's messes. But, he is becoming weary of Uncle Ben's Jihad against the savers and other responsible persons in the U.S.

3. Sold BAC common for a TAX Loss (see disclaimer): At least our new HT obeyed the Headknocker and sold a position to take a tax loss which will offset some of the gains realized in 2009. I may buy back some of the BAC shares after waiting more than 30 days to avoid the wash sale rule. I have previously discussed that I view holding BAC throughout 2008 to be my worse mistake on an individual security for that year. /Bank of America BAC Raising Capital & Another Way the Past Finds a Way to Live in the Present-MJH Purchase and Baggage from the Past Once I made the mistake on the common, I was not inclined to buy other securities issued by BAC when they became attractively priced, such as MJH. As explained in that last linked post, I only bought 50 shares of MJH at $7.51, rather than say 200 shares, because I did not want more exposure to, or losses from Bank of America. So, I lost the opportunity of gaining more with MJH, which subsequently rose to $21.8 as of Thursday's close, and is paying me almost 25% per year until 2026. Buy of 50 MJH at $7.51 So I lost some of that opportunity due to the baggage that I was carrying from the past that day and I still have my loss in the BAC common. Best to move on, since this is depressing to even remember. I did extract some value from the common by selling some shares and thereby reduced my 2009 tax bill. I do not have any carry forward losses, and I had book already a lot of short term gains in 2009.

4. Zions and ZBPRA: Zions announced the other day the results for its offer to exchange common stock for ZBPRA: Zions Bancorporation Announces Preliminary Results of Its Series A Preferred Stock Exchange Offer This was Zions second attempt in 2009 to "redeem" the ZBPRA on the cheap. Zions reported that 51.29% of the ZBPRA was tendered for exchange into the common. Zions issued 2,816,834 shares of common stock for this floating rate equity preferred stock, representing about 1.96% of its common stock outstanding as of 11/30. I still own my 100 shares of ZBPRA bought at $7.8. This will result in an approximate 70 million bump in Zions tangible common equity. Zions In that last linked article, David George, an analyst at Robert W. Baird Company, commented that Zions still needed to raise 450 to 650 million in capital. I have seen several estimates in that range. So far, Zions has resisted selling a large amount of common stock at one time, preferring to do it in dribbles. Of the original 240 million face value of ZBPRA outstanding, only 70 million remains as Zions successfully reduced the amount outstanding on the cheap. I recently did an analysis of ZBPRA compared to ZBPRC, another equity preferred issue from Zions: Analysis of Prior Question: ZBPRA vs. ZBPRC OR ZBPRB/

5. Drinking Water: I was not exactly reassured by a NYT article about the safety of tap water in the U.S. The article points out that the EPA only regulates 91 potential contaminants in drinking water. There are hundreds of contaminants which are not regulated that could potentially be hazardous, especially when consumed over long periods of time. I personally do not trust the government to act in the best interests of its citizens. I would look at W's claims justifying the Iraq invasion in the same skeptical manner as I would view the EPA's assertions about the safety of tap water. So, for water, I will filter tap water used for drinking, hoping to remove some contaminants and have for years. HK is too cheap to buy bottled water. And since the LB does not permit the consumption of alcohol, and HK is too cheap to drink many soft drinks, about 98% of the liquid refreshments consumed consists of tap water.

6. WPCS International (WPCS)( owned Lottery Ticket category): This one has not done well since I bought it at $3.53: Bought 50 WPCS as LT/Bought 50 PSEC/ Sold 100 VIMC at $3.53/Bought 50 of the Floaters USBPRH & BMLPRH/ Sold 100 GJK at $24.6/Sold a Mutual Fund in IRA WPCS reported earnings for its fiscal 2010 2nd quarter of five cents and revenues of 24.3 million. The company reaffirmed 2010 earnings guidance in a range of $.31 to $.34. The backlog at the end of the quarter was 28 million, and its bids for contracts "increased substantially to $245 million which is an indication" of a more robust level of activity according to the WPCS CEO. WPCS Reports FY2010 Second Quarter At the end of October, the company had 8.511 million in cash and no debt. WPCS is a mini micro cap with a market cap at the current price of $2.76 of about 19 million. Price to book is .32 and price to sales is .18. WPCS: Key Statistics for WPCS International Incorporated WPCS' fiscal year ends in April. The one analyst who covers the firm estimates FY 2011 earnings at .49, WPCS: Analyst Estimates for WPCS It probably did not help that Merriman downgraded WPCS from buy to neutral after this earnings release. StreetInsider

7. Sysco (SYY) (owned): Morningstar has a favorable article about Sysco after attending an analyst day. The focus is on how SYY has improved efficiency and lowered operating costs during the recession. I am in a long term holding pattern with the shares bought at $19.46 in March. Buys of CPB LQD SYY XKK This stock has historically had excellent dividend growth: Item # 4 Sysco

8. Japanese Yen: I can at least understand why the Australian and Canadian dollars have increased in value against the U.S. dollar since March. I simply scratch my head when looking at the strength of the Yen and the Euro. I thought that this article made an interesting bearish case for the Yen. Japan's Titanic The currency ETF for the Japanese Yen, FXY, rose from around $100 in early March to $115 on 11/30: CRNCYSHRS JPN YEN TR ETF Chart To an untrained eye, and I certainly have no training in technical analysis, this chart looks like a double top formation, with the 115 level previously providing resistance in mid-December 2008 (closed at 114.61 0n 12/17/08 FXY) Once FXY hit 115.40 intraday on 11/30/09 (FXY: Historical Prices), it quickly retreated to its closing price last Thursday of $108.32. I currently do not have a position in the Yen, though I did consider buying the double short ETF for the Yen when FXY approached 115.

Yahoo/Dynamic Asset Allocation

1. Yahoo (owned): RB just said that the Nerd better not sell the RB's Yahoo for a $50 profit. Bought 100 Yahoo at Open/Bought 50 ETF PIQ at $19.81/Added 50 ABWPRA at $19.42 LB only hopes that no one read the No Wit's explanation for why it bought YHOO. LB noted that the RB was allowed recently to buy shares in this non-dividend paying stock as a sop, sort of like giving a baby a pacifier to keep it quiet.

Morgan Stanley resumed coverage of Yahoo with an overweight rating. The analyst is Mary Meeker. She is expecting material sequential revenue growth in the 4th quarter after several negligible or negative sequential revenues growth.

The LB will impose Order. Chaos only appears to exist.

2. Static vs. Dynamic Asset Allocation: Possibly the most important decision an investor will make in their lifetime is whether to follow a static or dynamic asset allocation model. Some investors never make a coherent decision one way or the other. Instead, they just jump back and forth, moving assets from one hot asset class to another only after a large move. An example of that phenomenon now would be the herd movement by individuals into bond funds and out of stocks. Other investors never have an asset allocation plan, or anything that would resemble a plan, as distinguished from moment to moment decisions on which hot mutual fund or individual stock to buy.

Sometime next year I will try to gather my thoughts into one post about asset allocation issues. For now, I have collected a number of posts on this topic into two Gateway Posts: Time for a Paradigm Shift in Asset Allocation Theory: Need Dynamism, Better Assessment of All Forms of Risk, and Due Regard to Volatility Patterns & More on Failures of Standard Asset Allocation Models and Target Funds/Use of Volatility in an Asset Class to Make Adjustments to an Asset Allocation

In that later linked post, I show how using the VIX Asset Allocation model, which is one tool in my Dynamic Asset Allocation process, would have substantially improved historical returns in a simple asset allocation scheme using just two ETFs, one for stocks and the other for bonds. The reader could plug in numbers for a broader stock ETF, such as IYY, a total stock market ETF. I used SPY and IEF since those ETFs had been around long enough to use from 2002 to the present. BND, Vanguard's ETF for the total bond market, is a newer product.

There is a reason for bringing this subject up at the end of this year. The most important issue for dynamic asset allocation in the next decade will be the decision on the amount of exposure to bonds, irrespective of an individuals age, as well as the kind of bonds or bond like investments that would need to be over-weighted or under-weighted.

In a static asset allocation model, there is no adjustment made based on what is happening in the real world. The central theme for that model is that allocation is based on circumstances unique to the individual, as if the world revolves around you at the center of the universe. This kind of model may be adequate during a long term secular bull market in the two major asset classes. As seen over the past decade, the static model does not work well when one of the two major asset classes fail. Bonds have done just fine over the past decade, and I would argue that bonds have been in a long term secular bull market since 1982. As a result of that bull move, yields are very low now particularly on government bonds from virtually all developed nations. The asset class that has failed over the past decade is of course stocks. And by failure, I am just referring to my standard definition of a long term bear market, a movement up and down over a 10 to 15 year period, that ultimately ends up going nowhere. The static model would not have made any adjustment in exposure to stocks based on external reality.

When I started to think about investments, I was a teenager. At that time, stocks were in the final phase of a long term secular bull market starting in 1950. Bonds had not kept up. In fact, I have mentioned in prior blogs Roger Gibson's statement that long term treasury bonds had actually started a long term secular bear market around 1946: For BND: Is it Safe is not the Right Question. Instead Ask What are the Risks & Rewards/Assume Lost of Principal Possible How reasonable is a prediction of a 2% 10 year treasury yield and 475 on the S & P 500 I have bought his book Asset Allocation but have not had a chance to read. I would add this comment now. During the inflationary period starting in the mid to late 1960s and ending in the early 1980s, both bonds and stocks failed as an asset class. There can be no dispute about that statement. If someone had retired in 1965 depending on a target fund to fund their retirement, they would be in a world of hurt. Only a dynamic asset allocation, which is admittedly more difficult to implement, would have worked during long term bear markets in a major asset class.

Contrary to the opinions of many financial advisors, adding foreign stocks and commodities (or more esoteric asset classes) will not cushion the fall, but may only add to it. This would especially be the case where there is a high positive correlation between asset classes during a bull move, and then some external event causes a major shift downward for all of those positively correlated asset classes. I generally discuss this type of topic using the words positive or negative correlation, or just "non-correlated". So anyone interested in that topic could use the google search box at the top right hand corner, and enter a search term. I just entered "emerging market non-correlated" and came up with this post: Emerging Market Currencies and Bonds as Non-Correlated Asset Classes/Links to Performance Data on Target Funds & More on Their Many Failures & a more general discussion at Instability & Volatility in Asset Correlations

The dynamic asset allocation process does take into account the individual's age, risk tolerance, and financial needs. The key difference with the static asset allocation model is that the dynamic process has to adjust based on what is actually happening in the real world.

When making asset allocation decisions, I am dealing with a large number of variables, planning for future contingencies, and constantly evaluating new information and how it may impact allocation decisions. It is a constantly evolving process. For example, I ask myself what would happen over the next decade if I weighted bonds based on my age, used primarily a total bond market index fund that pays me around 4% and some of the TIP ETF, at a time when the 10 year TIP coupon is hovering just over 1%. Would that achieve my goals over the next 10 years? While the future is unknown of course, I still have to plan now using possible and more probable than not scenarios. This is just my opinion, but I believe the bond asset class will soon begin a period where prices fall and yields rise, and the fixed coupon bond class will at best maintain a stable value after adding back interest payments starting today and ending 10 years from now. I have sold all of my bond ETFs, TIP, WIP, BWX, BND, SHY, BSV, etc. and have started to prepare last October for what I believe will be the most likely scenario for the upcoming decade, falling bond prices and rising yields. This has meant buying individual bond issues when they fell to substantial discounts to par value starting in October 2008 and to emphasize more floating rate bonds and equity preferred stocks. At some point, when I view the risk/reward tilted back more in my favor, I will start to buy the 10 year TIP again in my retirement account. I doubt that I will be adding a security like BND at anytime in the next five years. But, as new information is digested, I will have to adjust what I am planning for now, and that is the essence of dynamic asset allocation.

Even over the past few months, I have made adjustments. For example, I noted in a post from last December that I would not be buying a stock ETF until I received a green light from my Vix Asset Allocation model. A FEW MORE COMMENTS ON DYNAMIC ASSET ALLOCATION I later made an adjustment and decided to go ahead an add a few low cost stock ETFs when prices were still low, and then later sell some stock mutual funds after a prolonged bull move. This adjustment was discussed in March 2009 and in several posts thereafter: A Good Month But Another Awful Quarter I later added several stock ETFs such as VEU, VTI and VV from Vanguard.

I may not have another post until next Monday. In the meantime, Headknocker is going to have to find a Head Trader willing to take some tax losses to offset at least some of the gains this year. HK has reminded all HTs that it is only necessary to wait more than 30 days, and the position can be bought back. Using FIFO accounting, this may be an opportunity to lower HK's tax bill in 2009 and lower the cost basis of some of the positions. Most likely, 2009 will be the best year ever at HQ, with the trading operation up 42% year to date with almost 30% in cash now earning next to nothing. Having cash, however, did provide the psychological cushion for buying stocks in March, even though the cash allocation was not the primary source of funds for those purchases. A liquidation of virtually the entire position in individual short term bonds maturing in less than five years provided most though not all of the funds. In retrospect, it would have been better to keep those bonds, and to use part of the cash stash. But, sometimes, even for a highly developed LB, psychological issues and a security blanket have some influence. The kind of results experienced in 2009 will most likely never be repeated again. The buying opportunity in floating rate securities, bonds, and stocks was just one of those rare shoot the fish in a barrel opportunities.