Friday, December 20, 2013

Reviewing the current state of valuation:

10 yr Treasury:  2.94%
S&P 500 PE 15  (forward earnings $120, index level around 1810)
E/P is 6.66%

S&P 600 (small cap) has a PE of around 18.
E/P is 5.55%

Small cap E/P tends to be smaller because the growth expectations are larger.

So with the S&P 500 spread of earnings yield  to 10 yr treasuries of 3.7%, that puts us in a favorable range for stocks going forward.  Anything below 2.5% and I would increase my bond weighting.  Right now, the indicator is pointing to increased equity, though it is now the lowest in the last few years.  But still a huge positive versus where we saw the indicator in 2007 and 2008 (around 0% risk premium for stocks).

Thursday, December 19, 2013

Today, I am buying some VWO.  Emerging markets getting hit as investors reassess whether China will keep growing.  That is always a question and we know that it is a managed economy, a monumental change and subject to many potential issues.  But, that is why it is called investing.

MHN has made some recovery, but it is still cheap.  I was able to buy a bit more of the preferred stock ETF's but haven't sold anything yet.

I am looking at the problem with a buy first and wait to sell mentality.

Wednesday, December 18, 2013

The Fed's decision to start reducing it's purchase rate, while notable, obscures the fact of the overall indebtedness being taken on in the name of trying to jump start the economy.

I guess any movement towards a more normal policy is welcome but I still come away with a lot of uneasiness.  Jim Grant, most lately, and others have been discussing the asset inflation that is the result of the Fed's activities.  If a small percentage own the lion's share of the assets and the fed is trying to push asset values up by lowering the rate at which cash flows are discounted then it stands to reason that the wealthy are obviously getting more so.  He points out that records are being set in purchases of rare automobiles and art.  All true, and all signs that inequality in economic outcomes is increasing and to me this is depressing.  I would hope that the rising tide lifts all boats, but I fear that many are left behind.

But, as investors, we need to invest based on the information in front of us and not what we might hope it would be.  I do not see anything currently standing in the way of asset prices continuing to go up.  My equity allocations are going to be going up.  But, and I think this is important, I will be reducing my corporate fixed income exposure.  I have written about PFF recently and it is clear to me that these instruments are sub-optimal for a growth portfolio and even for an income portfolio as I have been trying to build.  Right now, we need to invest for growth and that means equities.

But hold your horses! We do need some balance.  Usually fixed income is the way to balance a portfolio, but I would posit that we should only consider government bonds.  Further, because of the future potential dangers of the Fed's path and it's implications for the US dollar, it will be important to mix in global equities and perhaps global government bonds (the only real alternative in my eyes are German or Swiss bonds).

For now, enjoy the upswell and use it to sell any positions that are not your favorites in particular on the fixed income side.  I still like JPS, MHN and VTA but largely because they are at such massive discounts to net asset value (NAV).  But, reviewing my holdings, while I think T is a bit cheap versus VZ, it is not a favorite and I would rather hold a bit more emerging markets equity VWO.

Thursday, December 12, 2013

A lot of good thoughts here in this article:

In particular the thinking behind not holding cash.  In practice of course, we should hold at least some percentage in order to be able to react to any bargains out there.  That said, there should always be a competition in one's portfolio.  No investment should have a locked spot.  Of course, there can (and should) be factors other than pure value (diversification is an obvious one).

I do like the idea of not getting caught being too macro in thinking.  The reality is that none of us know the future, so we make the best decision we can with the information we have.  Solid companies that are managed well, in a growing market are probably good long term bets and short run swings should not dissuade us.  As I've said before, we can't invest for the end of the world (well, you can, but it's a bit extreme IMHO).  I fall prey to this thinking as well, but playing too defensively is not a good long term recipe for success.

MHN has gotten to a fairly large discount to NAV (-10%).  I am buying some more here.  Even with Puerto Rico and other muni risk, I think it's a good reward/risk ratio.

I ave also bought some TLT using Jan 2015 options (a 1x3 risk reversal if you care).  This will give me some exposure if we get a downdraft in growth expectations.

In addition, I am buying some VWO and other international exposure.  Emerging markets have not done well this year , but if growth prospects improve globally, they should reward investors handsomely.

Wednesday, December 11, 2013

I think this is an excellent synopsis of the "risk" case to the current market.

In particular, there are 2 graphs that I find telling - the job #'s from Russell 2000 companies and the the gap in loans versus bank assets.  It is frustrating to say the least that the stimulus is not finding it's way into the economy.

To me, it is clear it is pushing up asset prices - and here I am not talking about only the bond purchases, but the low rate environment.

It is a very thorny problem.  Does one go to cash to protect their position and potentially miss out on a continuation of the bull market?  It is very difficult to stand on the sidelines and watch the market go up every day and not participate.

No easy answer here.  I am uneasy, but also look at the objective numbers and find nothing wrong about the valuations, but that is relative to where interest rates are.  Recall that I look at earnings yield relative to 10 year bonds.  Right now, we stand at about 6.25% versus the 10 year at 2.75, so the spread at 3.5% would have me in stocks.  But, what if rates were at a more "normal" level?  say 4% (growth of 2% plus inflation 2%).  Well, that would put stocks at a not so cheap level.  To normalize to the current 3.5% spread, that would put the multiple at 13.33 and with earnings around 110, then the index at 1466 (or about 20% lower).

Unfortunately, this type of analysis can make one a chicken little.  Markets can stay irrational longer than one thinks.

So do we ride the wave?  Or batten down the hatches?

Thursday, December 5, 2013

Great growth number today.  Yet, the market is down.  Perhaps the market is looking through and seeing that the big growth is mainly from a growth in inventories and if the final consumption doesn't come through then it won't create a virtuous cycle.

I think that is trying to get a bit too cute.  I would look at it as a positive sign of optimism from businesses.  I will buy some equities here.

Wednesday, December 4, 2013

Is down about 5% today.  I think it's because they own about 41% of El Paso which is down about 10%.

EPB is down about 10% because it has guided dividend growth of about 2% which is apparently too low for MLP's.

I don't know about EPB, but it's not too terrible in my eyes and KMI has indicated about 10% dividend growth for 2014 - and given that they own 41% of EPB I would assume they knew that EPB was going to guide lower.  So, I think KMI is taking this into account in it's numbers.  I think this is a great story - yes they are leveraged, but I love the energy story and if we happen to start growing, we will need more energy.

I am buying a little more here.

here is a new entry for me.  I am liking emerging markets for a long term play and so I am buying some.

Monday, December 2, 2013

Update on PFF
I noticed that this month the dividend payout was quite a bit larger than the trend.  This bears watching.  I am holding off selling right now, but I did buy some 10 year treasury notes this morning.  In addition, I sold off my HYG and BKLN both of which were subject to the reasoning from this morning.
Performance is updated!  Sorry for the lag on October.
Lately (it probably has something to do with the new year, resolutions and all that), I have been thinking about asset allocation.

I've had some good discussion with a friend who has a few nifty ideas on the subject which dovetail nicely with my ultimate goal of having a portfolio that didn't require too much maintenance and, importantly, I could consider in it's entirety.  What I mean by that is that I want to have one portfolio to think about rather than a collection of strategies.

During this review process, I have thought long and hard about the role of certain asset classes in my portfolio.  I will take preferred stocks as a prime example.  These are represented with the ETF's PFF, JTP and JPS in my portfolio.  JTP and JPS are trading at steep discounts and so they represent some value to me.  PFF is different.  PFF's yield is down to about 4.8%.  This is still a decent yield and I think this asset class still deserves consideration for a place in the portfolio.  However, I do not believe there is a lot of upside in Preferred stocks as a while.  We have recovered all of the steep discounts in the securities that was created in the 2007 debacle.  So what we are left with is yield.  As we have all witnessed, the media is trying to warn us that rates are going up sometime soon.  While I have difficulty with this given that we have not seen the growth, I still must agree that the pressure is to the upside and all it would take is one surprisingly good economic number (or a high inflation number)  and rates would be off to the races on the upside.

Bonds (and bond like securities like preferred stock tends to cushion a portfolio when stocks have a rough go.  However, the correlation at this point between preferred and common stock is rising (on the downside) and falling on the upside.  When stocks do well, preferreds will earn their yield but not much more.  If we have a bad earnings spell or bad economic news stocks and preferred stock will go down.  Preferred will go down less, but I believe they will still suffer.

So, I have concluded that I should replace PFF with bonds which should go up if stocks falter.  Treasuries have the highest probability to exhibit this behavior.  I am still deciding which to go with - a fund, or actual bonds or even TIPS.

Actual bonds have the advantage that if I am wrong, they will go down in value in the near term, but ultimately, I will get my money back.  Bond funds do not have this characteristics as they are managing to a duration/maturity benchmark and the portfolio is turning over.

I will look to implement this in the coming weeks.

Wednesday, November 20, 2013

This is an interesting article.  It points out a fairly subtle point, but an important one nonetheless.

Dispersion is a measure of how varied a sample population is on a given measure.  In this case, the article talks about PE ratios.  Dispersion goes down when the market stops distinguishing between companies.  Typically this happens when markets are saturated with money.  The bears point to the Fed actions and say that the market is being flooded with cheap money.  However, this conclusion flies in the face of the evidence that leverage has been going down.

So, what is the truth?  Maybe, as Jack Nicholson might say,  "we can't handle the truth!"  The market is getting more streamlined and efficient and as such, there is no place to hide.  No cheap valuation cushioning the blow if earnings don't come through.  If there is a cheap company out there, the readily available flow of information ensures that everyone knows about it.

So what we are left with is...economic growth (for most) and innovation for some.  Of course there will always be new products disrupting the current market, but the prices won't be cheap.  Imagine, a casino (I know, this is a dangerous analogy for the markets, but stay with me) with many games, each with very attractive (for the casino) payout rations.  That is to say, better than statistically fair.  The casino does well as it has customers that are willing to come and be entertained.  As new casinos see the success, they open up with more statistically fair games which attract the original casinos customers.  Of course, over time, the first casino has to make it's games more fair (margins/probability of success for the casino come down).  Eventually, the market gets to a point where all the players are at the payout ratios that allow them to stay in business with some probability.  But that probability is not 100%.

I think that is where we are approaching with the stock market.  Information is available like never before and access to trading is cheap and high quality.

We are getting closer to truly efficient markets!  This is a good thing, but not always comforting.  It would be nice to imagine that there is a crystal ball out there and someone has the key to successful investing.  I do not believe there is such a thing, but there are prudent management strategies, ie: diversification, position management (not letting positions get too big), keeping speculation small in proportion, and others rules.

While I think it is too difficult to pick the winners and losers, it is much easier to consider (and forecast) economic growth.  In the US, without too much intervention, it happens.  Sometimes we have recessions and that will cause profits to fall and stocks to decline.  More times than not, we will turn around and stocks will recover in aggregate.

Right now, we are toeing a fine line.  I could easily see us dip into recession territory, but I can see us accelerating as well and that is why my equity exposure is very low (around 15%), but I am probably being too bearish.  Long term, I see positive growth and as such, stocks should be a healthy portion of one's portfolio in order to participate.

I like this one as well:

Thursday, November 14, 2013

I have entered into a small GLD position @124.18.  I am persuaded by the very public position dumping by big hedge funds.  At some point in the future, there will be an inflation scare (and perhaps more than a scare).  I'm not much of a chart person, but it seems to me that the pullback has brought gold to it's previous trend line.  So, to me, it seems a reasonable buy.  I will start small and look to build a position.  I have not decided on a percentage weight yet.

Those who know me will recognize this as a big departure from my usual stance.  I have not been a fan of gold.  However, the market works in "mysterious ways" and who am I to judge?  I often find myself "fighting the tape" in Wall Street parlance and it tends to cost me money.

I am resolving to be better about that.

I have also sold a bit more S&P futures which brings my exposure down to about 21%.  I have been losing this month as stocks are up over 2%.  I think there will be a pullback where I can buy back the hedge, having protected gains in the meantime.

Friday, November 8, 2013

Puzzled.  I think the market is trying to get a bit too cute in pricing.  Economic growth is close to ideal level of around 3%, inflation is low, employment improving.   Yes, the improving economy means that the Fed will reduce it's activities in the future, but not yet and in any case they would pull back in the face of a better economy.  So, there may be more of a pullback, but I will buy some more into the sell off.

Thursday, November 7, 2013

Nice result for JCP

Very nice jump in economic growth up to 2.8% (annualized).

QCOM is being hammered because it is predicting slower growth than some on Wall Street predicted.  I see no cause for alarm This company is strong and worth buying more here at 66.52

COP and the other energies getting hit perhaps because the beginning of tapering (augured by the stronger economic growth) would potentially hit growth.  I find this argument a bit chicken and egg.  If we get growth that is good and the cyclicals will do well.  If we's because we are getting growth!  I like buying more.

I am maintaining a low equity exposure because I do feel that overall, things are a bit fluffy, but I am getting more positive if we get any more confirmation on growth.

Wednesday, November 6, 2013

What can I say...I am a sucker for downtrodden companies.


All of these qualify.  CHK ($26.23) and CLMT ($28.08)  actually did ok on the revenue side which is rare these days.  I'm buying CHK and not selling CLMT.  JCP ($7.80) we know is a long shot, but they do still have a (albeit damaged) brand and prime retail space.  I think all of these are worth speculative positions.

FCX  I'm buying more
COP  Buying more solid company with room to go relative to it's larger peers.

VZ  Not selling.  Very solid numbers here.  Telecom is a main theme of mine and it does not make sense to sell any.  I like ATT slightly better from a value perspective, but VZ is still a solid hold.

Monday, October 28, 2013


Small caps have also seen PE expansion.  The level for the Russell 2000 is at 27+.  While the numbers can get a lot higher with these stocks, it is a trouble sign.

T, VZ, S
I really like T versus VZ.  If I were a pairs trader, I would buy T and short VZ.  But, I love this space long term.  It is an area of true growth (wireless) and these two are the best in town.  Maybe S can make some inroads.  It may be worth a spec buy.  I don't see much downside but upside may be a long time from now.  I am adding to my position in T and MAY sell some of my VZ, but probably not.

I like this company.  They are having some trouble with patent roll offs, but I still think it is well run and will be a part of an expanding health care market.

I updated my portfolio page.

In summary, I am increasingly concerned with valuations and revenues.  I have no doubt that companies can continue to squeeze efficiency, but I do think there will be bouts of concern in the market and so there will be volatility.  We are priced, not for perfection, but not too far from that, I fear.

The PE expansion has been dramatic and I suspect we don't have much to add from that source.  So, it will have to come from earnings.

I missed the boat selling KMB too early as it led the consumer pack with PE expansion.  Since September 5, the PE went from 16.2 to 18.5.

As with KMI, the PE expansion has been significant.  I have taken them off of Buy on Dip and just left them at hold.  I could easily be swayed to sell these.

COP is at it's high and while I am a bit nervous, there really is no reason to sell.  The PE stands at 12.4 which is a bump from 11.7 in September, but not alarming.

I think everyone is waiting for the shoe to drop on this one.  The dividend is about to be paid.  I suspect it will drop from the current level.  The question is, since everyone expects it, will the stock goes up once we see the "bogeyman".  We just don't know how much the drop is going to be and so there is fear.  I don't have a big position here, but I may exit nonetheless as the volatility can be high.  There has been some positive legal developments and that may provide some upside potential.

Thursday, October 24, 2013

ATT posted good results and is suffering a bit today.  It has lagged VZ over the last 1-5 years, but it still delivers solid results and pays an excellent dividend (5.2%).  I am adding to my position today around 34.60

Tuesday, October 22, 2013


High yield bonds have had a great run.  Normally, the low yields would give me pause.  One thing to consider, though is that HYG, for example, has seen it's duration come down from the 9 year area (not sure of the exact number) down to 4 years.

That is short enough that it offers a bit of protection in case yields spike up again.  I would still rather own preferred stocks yielding over 6% but, the high yield market is offering a reasonable alternative.

The key counter to this, is that default rates have been at lifetime lows (below 2%, I believe).  So, in a sense, the high yield market is priced for perfection, and that should always make us a bit worried.

In my portfolio, high yield is present but fairly small.

When bad news is good news, it is definitely a strong market.  A weak employment number, once a cause for concern, now gets the market going up.  Investing truly is a strange activity.

I'm not buying it.  This is overdone and I am going to sell here and wait for some sort of pullback.  I am back down to about 10% equity exposure.

Thursday, October 17, 2013

This is a strong buy for me and the fact that it is getting hit is an opportunity to buy it a bit cheaper.  The company delivered good earnings (if a bit lower than expectations) and VERY strong revenue growth.  Any company that is finding a way to grow revenues is a big hit with me.

OK, well we got that out of the way, no, sort of, maybe...

The truth is the discussion is just postponed until the beginning of the year.  Perhaps that will give them time to actually negotiate and come up with a pro-growth solution that also doesn't include the country being held up at "bond" point.

Speaking of bonds, I think it is pretty safe to say that tapering discussion are going to be put on hold, officially.  What I find interesting, and perhaps telling, is that bonds have not recovered ANY of the ground lost when the tapering talk started.  I find it hard to believe everyone expected it to go on forever, so given that it was going to stop, it was just a matter of timing.  Should there really be a 1% move in the 10 year area because the tapering is starting a bit earlier than expected?

Given that it has not recovered, perhaps there is something else going on.  Is the market trying to price in increased growth prospects? Risk of inflation?  Well the inflation can be seen comparing the TIPS pricing to the regular bonds.  The "breakeven" inflation rate as it is called is around 2.3% (3.7% 30 yr bonds-1.4% for TIPS) which is not much different than the 2.2% in May before the taper talks.  Also it is still low by historical 3% standards.  Growth prospects may be better, but we still have not seen it come through in the numbers.

Perhaps the real culprit is a change in the risk profile of the US.  If market participants expect more volatility in US rates, then more return is required.  In addition, there is the problem of potential loss in credibility (reserve currency status).  Probably there is some mix between these factors.  But, the fact that bonds have not rallied means that barring some crisis in other parts of the world, there is limited upside in bond prices and the risk is to the downside.

That said, it still makes sense to me to find what are compelling opportunities in preferred stocks and corporate bonds.  With 10 yr government at 2.7 and corporates around 3.8 (LQD) for just a bit longer, I think there can be more reward going out a bit on the risk spectrum, given that I think corporate profits will continue to be strong, if not growing slowly.

There is probably not a lot of benefit gained by adding yield by moving duration out, though.  Given the overall risk for bond yields to the upside (prices lower) that I just highlighted, it probably makes more sense staying under 10 years.

More later...

Wednesday, October 16, 2013

On request, I updated the Portfolio Page to be IPhone friendly.

Thanks for the feedback.

Sunday, October 13, 2013

New Page!!

I will revert to the regular posts, but I have added a new page with my portfolio.  I added this because it may be helpful to see the whole portfolio at once rather than my comments one position at a time.

I hope you find it useful.

As for the markets, we are still waiting for any sign of resolution in Washington.  The longer this drags out, the more likely we will have a sudden drop in the S&P 500.  It is a very risky proposition to time this market.  As I wrote previously, I was going to trade the range and so after having bought some of my hedge back around 1653, I re-sold it in the 1690's.

I expect volatility and I want to profit from it.  I will use these levels as guide points to "play around".

That said, over longer time periods, stocks are still reasonable to hold and I wouldn't get too cute trying to time this market.

Good luck.

Thursday, October 10, 2013

What do you think of the new look?  
Perhaps more helpful?


My commentary would go here...

Potential Action

S&P Future
Freeport McMoRan
General Electric
Conoco Phillips
Kinder Morgan
Johnson  &Johnson
small stock ETF
Preferred stock (leveraged)
Preferred stock
NY Muni fund (leveraged)
Bank Loans
Bank Loans (leveraged)
Bank Loans (leveraged)

Big cap










Buy on Dip
Buy on Dip
Buy on Dip

Buy on Dip
Buy on Dip
Buy on Dip
Buy on Dip
Buy on Dip

Buy on Dip
Buy on Dip
Buy on Dip

Buy on Dip
Sell on Rally

Dip and Rally

Position Codes: +/- Long or short
C Core are key ideas that tend to be stable
S Are speculative and generally small (to keep risk low)
Size Codes: Big, Small and blank for average
Potential Action codes: B Buy -means buy right now
Dip Buy on dip means I am waiting for a pullback
S Sell over the short term
Rally Sell on a rally
Blank no action contemplated

Market trading on hope for a short term deal.  Emphasis on "short".  The more I think about the situation, the more I think the politicians are trying to act like celebrities - if they are not getting enough press, then start a commotion.  Make a public display and you are back!  It's hard to explain it any other way.  I understand that they feel they are trying to be fiscally prudent, I don't think it is right to hang up the works and hold the country hostage.  They are truly acting like children throwing themselves on the floor (parents out there will understand :).

The upshot though, is that I don't think this is over by any stretch.  I bought back some of my hedge and am up to about 25% equity exposure - still way under my benchmark (as usual).  I will probably be varying the exposure between 40% (on a big down move to say around 1575) and 10% at 1725.

I don't recommend this type of short term trading for most, I am just communicating what I am doing personally.  Stocks right now have an earnings yield (inverse of forward PE) of around 6.7%.  With 10yr Treasury at 2.6, that is a spread of over 4%.  Historically this is still a good level to buy stocks.  Hence, why I don't like the idea of short term timing for most people.  Long term, you should still be better off holding a significant stock position.

I also still think rates are going lower before they go higher and so I like fixed income positions.  That said, the market is providing such good opportunities in credit (high yield, high grade, muni, preferreds, loans) that one can build a portfolio of these ETF's and hedge out the bond risk and still earn over 3%!

This is still a big position for me and will continue to be.  One thing to be aware of and perhaps another reason it has come down is that it has some exposure to Puerto Rico and the fiscal situation is pretty bad there.  Not Detroit, but pretty close.  I believe this to be priced in, but there may be some downside if they default.

Thursday, October 3, 2013

The longer the stalemate in Washington goes on, the more damage it is doing to the economy.  Top line growth will suffer as a consequence.

I am pessimistic and my equity exposure reflects this.  Currently at about 11%, I am looking for opportunities to pick up "blue chip" stocks (at least to me they are) as they come down with everything else.  An example is JNJ which is down close to 10% from it's highs and I think is good value, so I bought some.  Not super-cheap mind you, but cheap nonetheless.

Over time it has not paid well to be out of stocks, so I am looking for a sign to buy back my hedge.  Once the shenanigans in DC are past, stocks will rally, I believe.  But we have to play the waiting game.  It also is difficult to try to time the market - one is rarely able to "pick the bottom" as it were.  I think the best we can hope for is to buy into the down move progressively.

JPS and JTP and PFF continue to be some of my favorites.  These preferred stock based Closed End Funds trade with fantastic yield and in the case of the first two, offer substantial discounts to their NAV (net asset value).  To me, 8% yield is a fantastic result even if rates rise.

Monday, September 23, 2013

I am watching the relationship between TLT and SPY.  Friday (and today's) movement in TLT versus the SPY are perhaps an indication that an inverse relationship between these two asset classes is returning.

If that's the case. then TLT would return to being able to diversify a portfolio.

Thursday, September 19, 2013

One conclusion we can draw from the news and market reaction to it is that stocks are showing some interest rate sensitivity at this level.  It is more than I thought, but the market is king.  What can we learn from it?

If we review previous market activity, we saw clear negative bond reaction to the specter of higher rates but we did not see much of a negative response from stocks.  One explanation is because the market expected the Fed knew something about prospective growth that was on the way.

Now that we have a move lower in yields, stocks have reacted positively.  So, maybe stocks do have more room to go up if rates go down further (which I expect), but what about the converse- will the market be as sure that if the Fed stops accommodating it will be because they see growth?  Or has the Fed lost some credibility?  

Is there some asymmetry that we as investors can take advantage of?  For my own part, I have been too ready to worry about top line growth.  The market is not there yet.  It is not a focus.  I have written in the past about the change in focus from time to time.  Right now it's all about the Fed decision.  As such I should have seen that if I was right about the non tapering, stocks would see lower rates and move positively.  If I was wrong, bonds would continue to slide down in price and stocks would not care.  The "caring"/focus may come after once the Fed path decision is out of the way.  So for me, it should have been stay long stocks and keep/add to my bonds.  Instead, I started worrying about the top line growth a bit too soon and cut my equity exposure which has cost me about 1% so far.  Not fun.

So where from here?  It's still about the Fed.  The focus will shift to data and whether the Fed will read that positively.  So maybe now the top line discussion will start again.  

For my money, we are still in a very slow growth economy and the risk is for a further slow down if rates stay up.  So, I believe it is logical for me to stay low in stock exposure and maintain my bonds (if not increase).  But herein lies a management issue.  I usually try to set up my portfolio in a hedged manner.  I want to have bets that payoff when I am right, but also some that pay off if I am wrong.

If I am wrong and there is a spark somewhere, stocks will go up and bonds will go down.  My portfolio will get hurt both ways.

Spread products can help here.  Things like loans (VTA, VVR), muni (MHN, MUB), preferreds (PFF, JPS, JTP) I believe will do well in both scenarios.  My bet in those is sizeable around 50-60% of my portfolio.

If I were to properly construct my portfolio (make it more efficient as in lowest risk for a given return expectation), then I should not have same-way bets on in both my bonds and stocks.

In order to achieve that, I will shorten my duration while maintaining the credit position.  I can do this by selling my TLT.  The downside to this strategy is that if there is a global risk off event, I won't have a position that makes money.  I won't lose too much though as my stock exposure is minimal.

Wednesday, September 18, 2013

Surprise!  Not.

This episode reveals a little appreciated fact about investing.  You can be right and lose money (as I have).  I did not believe it made any sense to let off the easing pedal (at least if you believe what the Fed said they were looking at).  And so, it came to pass.  At least for now.

The end of the fed accommodations is approaching, but for now they are holding the line.  Which brings me to y other point which is the lack of top line growth.  I do not believe stocks should go up merely because rates are staying low.  That does not make sense either.  I think that rates have been low for long enough that the "refi" at the corporate level is basically done.  Earnings will not improve much from lower financing rates.

So earnings at this point have to come from productivity or top line growth.  Productivity is tough when companies are not making significant capital expenditures (which they haven't because they have been squeezing margins to get every last dollar out).  So it needs to come from top line and I just  don't see it yet.

Thus, I am taking my equity exposure down significantly - to about 10%.  I could still benefit from a rising stock market as spreads improve on the ETF's that were pummeled, but we shall see.

Monday, September 9, 2013

ATT has seen a big retreat of over 10% from it's highs.  It trades at a great multiple and has an excellent yield of over 5%.  I like the telecoms a lot.  I hold VZ as well.  For my money, wireless is the only way forward and these companies are positioned to benefit from expansion in the wireless world.

I have bought some this morning in the low 33's.

I also am buying some more preferreds through JTP.  I like this play.  The fund trades at a sizeable discount of 12% and yields around 8%.  I don't know if the market will love these again, but at least it pays a good yield and I think that yield is safe.

Friday, September 6, 2013

Another poor number on the employment front.  In addition, June was revised down by almost 50%!!

So, for today, bonds have seen a reprieve from the selling.

While I am feeling ok about my bet on bonds, both maturity and credit, I am less confident on stocks (not sleeping well if truth be told).
My exposure is high around 55% and I am trying to justify it.  Walking through the rationale with this blog helps me clarify my thoughts so, I will attempt to do so.

Estimated earnings on S&P 500 is about $110 as far as I can tell.  This is a moving target, but I think it's close.  With the index at 1660, that puts the forward PE ratio at about 15.1 and the earnings yield E/P at 6.62%.  With 10 year treasuries at a bit less than 3%, that leaves the risk premium for stocks around 3.7%.  Historically, this is still a good signal for owning stocks (anything north of 3% has rarely resulted in negative returns for stocks.

However, we are not in super cheap territory and any surprises in the inputs and stocks don't look as attractive.  For example, if bonds yields creep up to the 3.5 area (would not surprise me in the short term) or earnings start to falter.  This latter possibility is the one that has me worried.  While I feel that companies will do well enough to pay their debts, I am not so sure the market will be happy with earnings growth prospects.  We have not seen any top line growth to speak of and ultimately, the market will focus in this and revise the multiple they are willing to pay for stocks.  We could see a return to stock premiums of 4.5% which would imply a PE of 13 and an index level of 1430!

Presumably, there is a counter-case - earnings continue upward, we get a surprise in top line growth, rates go lower.  All of these are possible in which case, we could get a move up, but it is difficult to see any more PE expansion.  Maybe 16 is possible, but I would be surprised.  I don't think you get a big move into stocks if bonds keep falling in price because overall the economy is leveraged and rates do matter to earnings.  I would rather feel strongly about growth from top line rather than squeezing pennies from costs.  But, that does not seem to be the most likely outcome.  Perhaps the biggest  upward pressure is from funds being underinvested, but with our fiscal picture unclear (and more war possibilities) I think the macro picture is murky enough to hold funds from making large allocations to equities.

So currently I am seeing limited upside for stocks and some serious potential downside.  I don't normally make short term timing bets, but I am considering doing so and using some technical indicator (like our previous high- 1703.50ish) as a stop loss level.  Or, using the 16 multiple which would take me to 1760.  The trouble from the technical side is that I see support around the 1636 level and we are closer to that, so from a risk reward perspective, it makes sense to wait to see a break of that before acting.  Disclaimer:  I AM NOT A TECHNICIAN, so anything I do on that front is probably mularkey!

The most sensible approach is to moderate my exposure back to benchmark levels around 45%, or maybe a touch lower then maybe I can get some shut-eye.

Thursday, September 5, 2013

I've updated performance for August (and July somehow it didn't save previously)

Overall stock exposure is high for me at around 55%.  That said, my portfolio is underperforming as I don't seem to have the "right" 55%.  Part of the problem is that I classify PFF, JTP and JPS as equity and they have behaved more like interest rate sensitive stocks.  I don't disagree with that assessment as preferreds have limited upside.  Back when I first purchased PFF, this was not the case as the preferreds were trading at such a huge discount that they acted like stocks during the rally.  They are now more fully priced, so from here it will behave more like fixed income.  I definitely should have been more dynamic in reclassifying the ETF's in my portfolio.

If I reclassify, my weight in stocks is around 40% and about 60% in bonds.  This would be more in line with my performance versus the benchmark.

In the past, I have not been as concerned with lower returns, as my Sharpe ratio was staying at a comfortably high level.  I have recently dropped below 1.0, which I am not happy with.  The interpretation is that my portfolio is too risky for the return I am getting.  The benchmark is still well above and I should take steps to look more like the benchmark.

Aside from some poor stock selection (AAPL, RAX and few other) the major source of my underperformance is longer duration.   I have had my bond exposure too long versus the benchmark of 10 year treasuries.  I am still convinced that long maturity bonds  are a good buy.  I am not convinced by growth in the US (or globally for that matter).  QE taper, or not, our rates should not be going up.  In addition, my muni bet has been a killer.

I do expect the muni ETF to come back over time (with the help of dividends, of course) but it may take a while.  I should add some more on down days.  If I do, it will be on a duration hedged basis.

has suffered a close to 10% drop, perhaps on some news that an analyst is going to show that company has some irregularities.

I am going to take this opportunity to buy a bit more of this stock.

are trading at relatively high multiples.  I previously trimmed  (or completely got out) of some of my big cap dividend stocks (KO, PG, GE, JNJ) and while that proved to be a good move, I did not sell any CLX and KMB, even though they were just as highly valued.  I chose not to at the time because I reasoned that their higher dividend payouts would shield them a bit more from downside.  I am not so optimistic right now so I am looking to trim those positions and maybe get out.  Taxes can sometimes be a hindrance to moving positions around, but I try my best to not let them intrude too much.
JNJ and GE are now close to buy levels again.

I will look to replace the equity exposure with SPY or IWM.

Friday, August 30, 2013

A good (if expected) revision for second quarter GDP growth to 2.5% vs 1.7.  This is a massive change and instinctively makes me think of rigged games.  But, let's take it at face value and think pro-actively.

With a growth rate of 2.5% and inflation at 1.5-2, that argues for long term rates in the 4-4.5% range. Our 30 year is there at the low end.  If we consider that the market expects inflation over the long term, to be around 2.4, then we may extend as high as 5%.

This brings to mind an important distinction to make between bonds and bond funds.  Bond funds (and ETF's) are generally managed to certain characteristics (i.e. TLT long maturity 20+ year US Govt Bonds).  Their holdings do not "roll down".  In other words, the duration/maturity remain somewhat constant.  As such, they are riskier than individual bonds which "roll down" in maturity and, assuming the issuer does not default, pay back the lender.

In Bill Gross's last Insight piece,

he goes through a rather roundabout way of describing different ways to earn bond premium.  What I think is the most important conclusion is that there are multiple ways to earn spread on bonds.  When rates are very low, the maturity premium (extending maturity) is not a great option.  I understand this conclusion but in this last move, it wasn't just maturity that got hammered, it was everything else too - credit, volatility, whatever - if it's was bond related,  it was sold aggressively.

This somewhat indiscriminate selling has left us with some opportunities - in preferreds, munis, loans, corporate bonds, high yield.  And with maturity as well.  I think the curve is a bit steep and the long end represents good "relative" value.  This is a a tricky term, you can be correct making a relative value trade and still lose if you didn't hedge out all of the other risks properly, so I would leave the relative value trades to full time portfolio managers.

I am losing a bit of my zeal for the low interest rate environment not so much from the standpoint of the long end, but eventually, we will be in a situation where the short end is going to become suspect and if that transition doesn't go smoothly (what does?) then we will have a fair amount of volatility to contend with.  Right now, I think finding places to earn spread when there are discounts to NAV in ETF's, is a good place to start because there is an extra bit of cushion if rates do go up further.

Monday, August 26, 2013

Today I am selling some of my AAPL position.  It has been a large weight -5.5% and while it is still cheap, I don't think it as special any more.  I will reduce it closer to 3% position which will be similar to my other single stocks.  I will look to replace it with SPY or IWM.

Friday, August 23, 2013

This is a chart of TLT, the long dated US government bond ETF.  Through most of 2013, the Fed has been buying 85 billion / month.  Previously, in 2012 it was buying 40-45.

A lot has been made of the effect of the bond buying, but I honestly don't see it.  Bonds did not rally substantively in that period.  One can argue then that if they stop buying, then bonds will drop, and that may be as a big buyer will leave the market.  But, tapering does not mean they will sell either.

I would argue that the long term treasury, while affected by supply demand, is more a reflection of growth prospects.  A global one at that.  What are our prospects now versus earlier.  Inflation is no higher, so I would not sell bonds on that basis.

I think the selling is overdone and project a rally in the TLT back to the 110-115 levels.

Thursday, August 22, 2013

I had a good discussion with a friend about the "normal" level of interest rates. I know you are thinking, "What scintillating discussions!", but please contain your excitement ;).  

Above is a graph of "EXPECTED" real interest rates from 1960-2012.  I'll put quotes around expected because I am doing a quick and dirty analysis and not being particularly careful.  For those that care about the details I did use, I used an average 10 year rate for the year (so this assumes the market is basically efficient) and I used the inflation rate for the previous year (so the market has some memory here).  Ideally I would use the expected inflation rate, but I do not have access to that info immediately.

I do think the basic idea will come across though.

I wanted to have an idea of how much market's expectation changed over time.  The answer is quite a lot.  In the last 50 years, we have ranged from -2.5 - to +9.4.  There have been a lot of different effects here - high and low tax regimes, inflation, (almost deflation), productivity changes, busts and booms.

On average the real return is around 2.6%.  I have been saying I would buy TIPS if the real return reached 2%, perhaps I am a bit low on my goal.  Another conclusion is that we are not in any particularly new world contrary to many pundits.

This graph shows S&P returns versus CHANGES in expected returns.  We see the proper expected trend, a decrease in expected real interest rates coincides with generally positive S&P returns.  I think there is a causal relationship here.  It can be a bit of a puzzle to see large positive real interest rate changes and positive S&P returns, but we can view this as a positive sign because I think that is where we will find ourselves this year.  Real return expectations are being ratcheted up and stocks are remaining buoyant.

As I alluded to in a previous note, it appears we are having a change in overall expectations.  Over the last few years, we have seen a downward trend in real expected returns and that may be changing.  If so, then S&P returns should see a head wind that will keep returns from exploding upwards.  Stocks should be ok so long as inflation does not get away from the Fed.  Bonds of course will face the stiffest challenge.  Bonds will suffer on a re-valuation of real interest rates.

So a re0valuation may be healthy over the long term back to "normal" levels around 2.5% and stocks can handle this while bonds will suffer.

HOWEVER, and this is a big "but" for me, the question is will the Fed "allow  a revaluation?  I am in the camp that speculates that the Fed will NOT and so will continue to keep supporting the market.  

In either scenario, spread product (corporate bonds, loans, high yield, muni) will be a good investment because they have gotten wacked (technical term) and are trading at high spreads versus treasuries.  Stocks are ok as well and I like the preferreds especially because they are safer and carry a nice yield.

I may be wrong about the Fed in which case, bonds will continue to sell off (at least government bonds).  So my conclusion is that I should eliminate my government bond exposure (TLT) and replace with either stocks or my spread product ETF's.  The only reason to hold off would be that TLT in theory would protect me if there is a crisis of some sort, which of course is difficult to predict.  Currently my weight in TLT is about 6.5%.  I may leave it there and instead look to add to my other bond positions or add to equity.