Thursday, May 31, 2012

Today, I sold the remainder of my TIPS position.  Real yields for the 30 yr have dipped below 0.5% which I find to be expensive.  That said, clearly we are in an environment where return expectations have to be ratcheted DOWN.  While US 10yr rates have dipped below 1.6%, it is not the lowest in the world as Japan has been at 1% for a long time and Germany is at 1.2%.  I can certainly see a scenario where US rates go lower.  As I mentioned a few days ago I was going to touch on scenario analysis and what it looks like.  This is an example where it can be helpful.

In the investment world (well, in everything, really) events are probabilistic.  What I mean by that is that to any activity, there is a probability that it happens or not.  The method consists of coming up with all the POSSIBLE outcomes and weighting these outcomes by the probability they occur.  So in this case, I try to come up with possibilities for interest rates and the results.

Scenario                                                Probability             10yr Rate outcome
Global growth increases                             10%                           +1%
Global growth resumes at lower rate          60%                            -0.10%
Global growth declines                               30%                            -0.50%

Expected outcome                                     100%                           -0.11%

Admittedly, the probabilities and outcomes are subjective and flawed but they provide a framework of thinking about the markets.

I look at these results and think, where are the risks to my predictions?  Maybe rates don't go too much lower even in a decline growth market.  Maybe rates go up further if we start getting some growth at some point?  I think this is a possibility and 10year rates can go up 2% or more and that would impact the overall outcome.  Given that I feel this is the case, I am looking to bail on my long term bonds temporarily and see how the balance of risks plays out in the near future.

My big concern right now (and the flip side opportunity)  is about the exodus from equity.  Allocations to equity by large institutions is going down and the public is disenchanted by equities.  The problem is that the more bonds we put in our allocations, then the higher the savings rate must go up and therefore consumption goes down.

So there is a negative feedback loop that impacts equities.  As much as I like them here, it will be important not to fall so much in love that you lose flexibility.  Keep some powder dry for opportunities.

Friday, May 25, 2012

Asset allocation study

A while back I had alluded to some retirement calculations where I estimated what kind of return was necessary to provide a good chance of maintaining a certain lifestyle (as measured by current expenditure as a percent of total assets) and not bleed your assets to levels that would be uncomfortable as you get older.  The numbers I had come up with were 2% return over inflation coupled with an expense rate of 1.6% would yield an excellent profile for retirement.  There are many other parameters and the full details I will disclose over time once I figure out a good way to present them.

So, that's all well and good if you can get 2% over inflation.  But, today, the long term TIPS are yielding 0.5% over inflation!  That's a far cry from 2%.  Of course, taking risk should yield higher real returns over time, but the difference is large enough that I figured I would run the numbers again.  Using a 0.5% real return, our expense rate would have to drop to 1% to have a similar profile for retirement.

The conclusion, as I have mentioned is that it is critical that we keep our costs to reasonable levels when we are trying to finance our retirement with an investment portfolio.  Costs tend to be certain whereas returns have volatility.  In addition, the first few years are crucial to the results.  If you started investing a few years back, and had a big amount in equity, you may be in a big hole right now and the only sure way to dig out is to work longer and control costs.

An excellent article that sums up my thoughts of what has been happening in the last few years.

The key points are that bonds have gained favor due to their lower risk parameters in addition to a systemic (regulatory) appetite for bonds and away from equity from large investors.   The feeling that the equity game is rigged against the small investor does not help either.

That said, I still feel that for long term investors, equities provide uncommon value these days.  So long as you can bring yourself to believe that our (basically) capitalist system will survive, then stocks will provide superior returns over the next decade.  There will be volatility, so we need to position ourselves be "nimble" i.e. buying on dips and also being willing to sell a little bit if things get a bit too positive.  But, predominantly it is buying on sell offs.  Use your time to examine stocks where you like the business, there are barriers to entry, good and stable management teams, dividend payment discipline or at the very least an active investment in their and other businesses.

Once you have your list, you can watch them and be ready to invest when the opportunity arises.

Wednesday, May 23, 2012

Big turn around today.  Again, I think back to the concept of reading the tape and trying to listen to what the market is telling you.  It is showing resilience and that should not be discounted.

The gyrations are not for the squeamish and at this point, we have had some nice pullbacks in core stocks.  I am not messing around too much with speculative plays.  Yes, they can have some good rallies from here, but given that I am trying to build a long term portfolio, I find the speculative plays which I would not allocate much money to anyway to be a distraction.

I reduced my position in BBY on the good earnings announcement yesterday and am looking at TEF and wondering why on earth I am in that stock.  It is a pure cyclical play on latin american growth and is probably a black hole.  That said, I think there will be a good opportunity to bet on Latin America or other developing areas, but it should be done in a diversified manner, for example an ETF for Brazil.

Germany 30yr bonds trading below 2% yields is an interesting development.  Ours are in the 2.8% area and in my view look like there is not much upside (lower yields) but looking at Germany gives me pause. If we go into a complete capitulation of taking risk (non zero probability) then we could see US rates even lower!

I try to think about markets in scenarios and then attach probabilities to each scenario.  In that way I can come up with my own expected value of outcomes in the near future.

More on this tomorrow.

Monday, May 21, 2012

A virtuous day, apparently.  All is well in the world as long as China supports growth.

We have been on a very negative track and as I posted on my last entry, it was starting to look a little less interesting for bond buyers which would ultimately prove to be good for stocks.  I do not know if today is the start of that turnaround, but at the minimum it is a breather from the relentless selling of the last few days.

I sold out of at least one of my specs -BAC- trying to make sure I heed my own advice of not holding on to bad ideas too long.  I fall prey to it like many people and it is a struggle.  It is one reason why many people trade with stops.  I am not the biggest fan of stops because in my career, stops gave too much information to my broker counterparties.  Of course, I should not have nearly the same misgivings when trading at the individual level, but I guess I am an old dog these days.

I still retain my speculative positions in AVP and BBY and TEF.  All out of favor positions which I should be out of for all purposes, but I am not.  I have them on the short leash as I had mentioned and can pull out in disgust any time.  Today would probably be a good day (up days are great to sell into) but hope springs eternal!

My core positions are doing ok except for CAT which has been blasted, but I trust that China speaking about growth would help the industrials.  I think it is a good long term buy.

My bond trading has been better than my stock picking.  Today I sold out of my 7 year TIPS bonds.  With real yields at -1% or so, I just don't see much upside.  Instead I will be looking to add to my 2040 TIPS on a pullback.  Currently they are trading at 0.5% real yield.  No great shakes, but still positive.

Muni's have done well.  MHN has been a good position that I have added to.  I think NY will be in good position overall in terms of municipal financing.  No place is perfect, but NY has a lot of support and this fund yields over 6% tax free.

I also like Bank loans and I recently added to VVR which is like a high yield bond bet, but with senior securities which have floating rates.  So if we get some growth surprise (hope springs eternal...) these notes should do well.


Friday, May 18, 2012

Aside from temporarily hating all stocks, I see is one small silver lining.  Stocks are down and yet, bonds (in particular the 10yr) are down!  This is potentially huge.  I blogged yesterday about watching when the market does not do the expected and this classifies in that heading.  Bonds and Stocks have less than a -70% correlation.  If we see that breaking down, that could signal that the "flight to safety" that it represents is breaking down a bit.  At some level of stock valuation, the market will not want to hold bonds.  Of course it could also mean the decline of the US led world - but, I do not think that is the case :)

Just a data point, but let's keep an eye on it.

Thursday, May 17, 2012

High yield bonds taking a bit of a beating as are high grade corporates.  I think this is part of the aftermath of JP Morgan attempting to get out of the trade.  This may continue for a while.  I had recently reduced my exposure to corporates arguing that the expected return was not high enough.  At least that was a good call (wiping my brow).  The stocks I have purchased have not been so kind.  But, I will hold to my thesis that stocks offer better value over the long term.  If we see a pull back to where high yield bonds are offering 7-8% over treasuries, probably about  a 15% price correction in HYG, then I would change my mind.

Full, but orderly retreat from stocks.  No real places to hide except for long term government bonds and commodities.  I am not a big buyer of the commodity story as Gold doesn't really do anything for me.  I missed that boat early on and, just like 10 year govt bonds, it does not feel like it holds much value up here.

Buffett was recently said to have been cheering the market lower so he could buy his stocks more cheaply - picture me with an expressionless face here.  It never feels good to lose money, but I guess the point is that as long as you are not forced to sell then you don't have to book a loss.  Enter here a random diatribe  against leverage.  Don't borrow to get long stocks and you would avoid the majority of problems that investors (including professional ones) get into.

CAT is one stock that is not only going down but is underperforming the market as well.  I believe this to be happening because there is a global slowdown thesis being played out in the market.  This will probably continue until we get some evidence to the contrary.

Probably one of the simplest and most underrated indicators of market performance is how the market absorbs news.  If you have been in the market for any amount of time, you have borne witness to the odd phenomena when good news is met with a bad stock price movement and vice versa.  These are important signals.  It has been my experience that turning points come when bad news no longer hits stocks and the converse is true when good news fails to give stocks a further boost.  I'd say right now we are in a neutral to negative environment as the messages are mixed and the stocks keep going down.  When we get a bad piece of news and stocks stop reacting, then it will be time to build up some more stock longs.  Right now, unless you are very underinvested, then stay on the sidelines.

Wednesday, May 16, 2012

A great piece of news with housing starts surprising on the upside.  For better or worse, the housing market is the 800 pound gorilla in the US market.  Any good news in that area will immediately lift spirits and help cyclical companies in particular.

I added a little bit to some of my weaker core equity names, KO, GE and even added a bit to my speculative position in BAC.  In addition, I am looking to add to my NY Muni fund- MHN.  I think this is a great long term holding for those in the NY area.  No state or federal taxes and it yielding over 6%.  It is NOT risk free, however.  Aside from the NY risk (heavily dependent on the financial industry) the fund borrows in the short term to buy long term securities to the tune of 40% of the portfolio.  This juices up the yield, but introduces the risk that if short term interest rates rise, then borrowing costs go up and the fund will not be able to provide extra yield and may lose money liquidating securities to repay the borrowing.

I still like the name because I do not think short term interest rates are going anywhere for years and in case I am wrong, I have bought options that will hedge this risk a bit (these are options on Eurodollar futures and if anyone is truly interested in this, send me a comment and I will elaborate).

Tuesday, May 15, 2012

AVP and other stuff

Well Cody is taking the high road insisting that the deadline was firm and pulled their bid for the company.  Lumps taken.  From here, I have the stock on a very tight leash.  My expected downside was lower than the 18.5 price right now, so I will probably sell if it breaks 18 but I will try to hold onto it as I do not believe the deal to be truly dead.  Time will tell.

More talk on the tape about the low growth scenario I have been mentioning in this blog.  We will be in a low rate environment for a long time and an investment portfolio should have stock exposure in companies that will pay some dividends.

For my own portfolio I now have about 46% in stocks of which 7% I would consider speculative (not dividend type stocks).  I am putting all those 7% on a short leash (AVP is one of them).

The risk of inflation down the road is present and T.I.P.S will help in planning for that eventuality.  But don't load the boat on them as 1) the real yields are quite low and 2) the feds decide what constitutes the CPI and can change their mind mid-stream.

Monday, May 14, 2012


Feeling a bit better about the prospects of a successful buyout of Avon Products.  The stock is up to 21.15 which is still a significant discount to the current bid of 24.75.  There is also a chance another bidder emerges.  Downside is limited here, I think, but it is still a speculative bet and should only occupy a small piece of the portfolio.

Stocks in general feel pretty ugly.  JP Morgan's disclosure should come as no surprise that big bets are still being taken.  What could be new information is that Dimon was an influential voice for deregulation which has now been impugned.  Further evidence that bank valuations are unclear and on a downward path.

Europe is not helping matters, but they are not alone.  There is an overall feeling that developed nations are on an unsustainable spending path and that debt loads are too high.  Restructuring is painful and necessary.  Companies have been dealing with efficiency far longer than the government has and are much better at it.  There will be volatility, but try to take advantage of it by buying companies you believe in when prices dip.

Where the rubber meets the pavement is interest rates.  Companies need a liquid fixed income market to operate smoothly.  That can only happen when the government financing operations are smooth as well.  This is the big risk (the "black swan" in current parlance) to my scenario.  If governments become unstable and in turn their fixed income markets untradeable, then companies will have issues.

I must say I am nervous.  However, I still place a low enough probability on that type of event that it makes sense to buy on dips.  As always we are susceptible to some larger negative event - which by definition is unforseeable and therefore unavoidable except by being out of the markets completely.

For what it's worth, options markets are not going crazy over these moves and do not indicate an over-elevated level of risk.

Thursday, May 10, 2012

Speculative Bet

Just as an FYI, I think AVP is a reasonable bet here.  There is a hostile bid at 24.75 with reasonable backing.  AVP is going through a restructuring to increase shareholder value.  Cody really wants Avon and with the proper backing can still go up in price.  My guess is they could go up to the 27 range.  Given that AVP was trading at below 17 a few weeks ago, this is a spec for sure, but I think there are some tailwinds in your favor.

With hostile bids in merger arb, it makes sense to put a little money out there (key word small) and see how things develop. We will see some action in the next few days.
Simplify, simplify.

Portfolios evolve over time.  You buy a little of this and sell a little of that and if you are not careful, you end up with a portfolio that perhaps does not look like what you set out to create.

In my case, I have fallen too much in love with the idea of shorting the 10yr treasuries.  I stand firm with my idea that government bond yields are too low to be interesting investments, BUT, that is different from saying they are going to go up any time soon.  I am a firm believer that we are in a slow growth environment for a long time to come.  The Fed has told us they will be keeping rates low for the foreseeable future (2014 is well beyond my foresight, anyway).  We have high unemployment and overcapacity in the manufacturing sector.  It will take time for our workforce to "retrain" into the high tech sector that the U.S. will thrive in later on down the road.  I have no doubt the U.S. will get there.  Other countries are making outstanding improvements, but ultimately, this is still the country that provides the safest and best opportunity for bright people.

In the meantime, there is no evidence to suggest that rates are going to go up anytime soon.  QEx is NOT dead.  The Fed will continue to prime the pump on weak news.  In addition,  the turmoil in Europe will cause shocks that will push our bonds higher.

So, I maintain that while in the long run I see bond yields going up, I do not see them going up in the next 6-12 months, so I am reducing my short position in the 10 year area.

That said, I do believe that rates are too low to compensate for risk.  Government bonds will have a place in a portfolio as a method to reduce portfolio risk and for that purpose I have long term T.I.P.S.  (All the pump priming will eventually lead to some inflation so everyone needs some protection. Stocks will provide some protection as well).  But, aside from T.I.P.S, I can't see owning 10year bonds at 1.9% being a great investment.  Nor do I see corporate bonds at 4% as a great buy when you can build a high quality dividend paying stock portfolio yielding over 3%.  I think high yield bonds can be another story and do provide some protection if rates go higher, so I will keep my (smallish) position in them.

Selling the high grade corporate bonds(LQD and CSJ) will raise cash that I can use to purchase stocks on dips.

Tuesday, May 8, 2012

There are always persuasive stories for any viewpoint in the market.  Hence why the networks can always trot out a talking head for both a pro and con for any given situation.  While I think it is important not to be a polly ana and believe everything is ok, it is equally important not to try to invest for the end of the world.  The reality is if there is financial armageddon, there will be no safe place to hide as it would likely even be difficult to withdraw from the financial system.

Given that, it is key to not get too carried away with negative views and consider that most likely, the sun will rise tomorrow and if it doesn't then what difference did it make that you were all in cash!

With this perspective in mind, let's review the current situation:

Global growth is slow so that will impact future earnings, ok, but we are still growing overall.

There is too much debt, perhaps, but the market tends to adjust for this by demanding a higher return when the risk of non-repayment is higher.

I'd say the most interesting risk is the relationship between stocks and bonds.  It is certainly true that if rates go up, then stocks will be less valuable because the discounted value of future cash flows (i.e. the theoretical stock price) will be lower.  However, rates will only go up for three reasons:

Higher growth  - win for stocks
Higher inflation - generally a win for stocks over time as they ultimately have some pricing power
Higher assessment of required risk premium (i.e. higher real return) - no real winner here as bonds and stocks both go down.

As always, I would recommend not making any rash moves - always be incremental with your core portfolio.  If you want to make speculative bets, that is fine.  Just make sure speculation is kept to lower dollar amounts and try to decide ahead of time what your risk tolerance is.

I know a weakness of mine is to let losers run on too long.  It is easy to fall into this trap since if you loved a stock at 20, you REALLY love it at 15, right?  Well, perhaps, but remember that the market can stay irrational longer that you can stay solvent. So try to keep that activity to a minimum.  But if you find a company you can believe in and treats its investors well, then try to stick with it and build a position over time on weakness.

Monday, May 7, 2012

Hi all,

I posted results for my portfolio for  April.  The month started out on a downward path and recovered at the end to finish in positive territory.  My negative view on government bonds (specifically in the 10 year maturity) has been a bad mark on my portfolio.  Over the course of the month, I increased my stock bets taking advantage of some pullbacks to add to quality dividend payers.

My stock exposure is 40.5% which is a lot closer to my benchmark of 45%.  I will be looking to get a bit above the benchmark on pullbacks.  My credit exposure is about 31.7% but my overall bond bet is only 4% because I have sold government bonds in the 10 year maturity.

This weekend's election results in Greece and France while worrisome for fiscal conservatives will ultimately be good for equities and, someday, bad for government bonds.  US bonds will benefit short term from investors seeking a safe haven.  There is a higher chance now that the euro fails in the future, than there was last week.

I have believed that we are in a slow growth period and will be for some time.  While, I still believe US government bonds are not a good investment, I am moderating a bit on whether I should have such a large negative bet against them.  I may look to moderate that in the coming month.

In addition, I think we will get opportunities to buy equities cheaply.  Keep your eye on the prize.  The prize here is building a portfolio of good companies to be held for the long term.  You can always allocate a small part of your portfolio to speculation to keep you interested, but keep your core portfolio in mind.

I am no stock picker, but some of my favorites are:


On the speculative side, I like AMZN because they are so disruptive of the retail model.