Monday Morning Kickoff

Wow!! What a week it was in not only interest rate markets, but obviously in the equity markets.

The 10 year treasury opened the week in the 2.70% area and moved steadily higher all week until closing at 2.85%. Overall not a huge move, but the nervous Nellies dumped stocks and bonds helter skelter. The GDP report and the employment report both had wage inflation components that were running “hotter” than expected.

In addition to the higher wages in the various reports the FED finally got the balance sheet “runoff” underway in noticeable volumes as they let $20 billion of maturities move to cash (or maybe it is just vapor since they created dollars to buy the securities originally). Regardless it is not being reinvested. We have heard some analysts comment that there will be plenty of demand to make up for the “runoff”—we have to call BS on that thinking. The runoff started at $10 billion/month and is to move $10 billion/month higher each quarter so now we are starting the 2nd quarter and the runoff is scheduled to be $20 billion/month until April when it will move to $30 billion/month.  By the end of the year the runoff is supposed to be $50 billion/month.  If there is a belief that the Fed can runoff $50 billion a month, while the treasury runs deficits of $65 billion/month AND the European Union cuts their QE to nothing from $30 billion/month someone should wake up.  NOT GOING TO HAPPEN.  The Fed can raise rates OR they can run off the balance sheet, but later in the year they will not be able to do both unless they are dead set on a recession (this is our prediction).

Last week we only had one new issue being sold and it is yet to trade, although we see that eTrade has it set up in their database so we should see trading begin Monday or Tuesday.

Fidus Investment (NASDAQ:FDUS) sold a baby bond issue of 5.875% notes with a maturity date of 2/1/2023.  The issue is a relatively small one with 1,700,000 $25 shares being sold.  Fidus is a small BDC (business development company) with solid financials and while we like the company we would only be a buyer with a current yield of at least 6.25%-6.50%. The issue is not yet trading, but when it opens up I would think it likely it will NOT trade above $25 anytime soon since rates have popped since the announcement.  The attraction here would be the relatively short maturity date.  We shall see how this develops.

New issues sold the previous week, which are now trading on the NYSE, were Jernigan Capital (NYSE:JCAP) 7% cumulative redeemable preferred and while down it was not bad–

The Costamare Inc. (NYSE:CMRE) new 8.875% preferred issue held up very well which demonstrates the resiliency of the high yield issues.

The average $25/share preferred stock issue fell by a relatively massive 49 cents/share to close at $24.96.  It has been a long time since we have seen an average loss of this size.

Of the 442 preferreds we follow 219 are trading under $25 which is sharply higher than the previous 162 we reported last week.

Our new Enhanced High Yield Model Portfolio , which we have just begun to build and currently contains only 2 issues, lost a  bit of value which is no surprise as this portfolio will contain many perpetual preferreds.  While both high yield and fixed to floating rate preferreds will fall less than low and mid coupon issues they will still fall when interest rates rise.  Our goal for the week is to get 2 more issues purchased for the model.

The week is a fairly quiet economic announcement week with the biggest events likely to be the 6 different speeches the various FED governors will be giving.  There have been times when these speeches move markets more than important data.

Our market expectations for next week (which may be wildly wrong) is that both interest rates and equity prices will stabilize starting mid day Monday.  The balance of the week will be some give and take (up and down gyrations), with income securities gaining a bit as investors calm down a bit and become rational (it is our opinion that less seasoned income investors tend to buy high and sell low during these drops–then they refuse to get back in until prices rise when they buy).

Our watch list for the week focuses on issues that may fit well to the Enhanced High Yield Portfolio.  This would included high yield fixed rate or fixed to floating rate preferreds or baby bonds.  Additionally some of the retail related REITs are close to having current yields that are attractive.  This would include KIMCO (NYSE:KIM) which sports a 7.53% current yield or Whitestone REIT (NYSE:WSR) which is a smaller REIT which now has a 9% current yield.


The Wild Ride Continues

The DJIA is off 630 points (2 pm CST) as I write and maybe will tumble further into the close. Lots of nervous Nellies–obviously they have short memories or are youngsters. We are just a few percent off all time highs–big deal to some we are off 2.4%.

We just checked our personal portfolios and we are off 1/4%–primarily because of our concentration in term preferreds and short maturity baby bonds. One of our recent purchases, Spark preferred (SPKEP) is off 1% today–we have little concern over a 25 cent loss in a security which will pay us a hefty dividend.

It is our hope–and just that, that we will get a bit of a respite in interest rates on Monday. Typically when interest rates move they stop and regroup before moving higher/lower and a break would be welcome

As a side note the FED cut loose of $20 billion in assets in the last week–the biggest runoff yet in the quantitative tightening. Obviously removing pretty big bucks from the demand side of the marketplace can have a noticeable affect.

Fed Balance Sheet Trends can be seen here. You have to change the time frame to a shorter time frame to see the big drop in assets.

Time to Watch – Not Buy or Sell

With the employment number out and interest rates moving higher (because of the 2.9% year over year wage increase) by 4 basis points we may have another day of setbacks in the income issues market.

While it is very possible that most preferreds and baby bonds may fall today we think that bigger bargains may be yet to come in the next 5 months.  If you are a purely income investor not so worried about you capital maybe you want to nibble a bit.

If you are buying now we would stick to high yield (mortgage REITs?), fixed-to-floating, short maturity baby bonds and term preferreds.

For holders of the high quality, low coupon perpetual issues DON’T panic.  If you own these kind of issues we assume you are in it for the safe income stream and this will continue, but studying your brokerage statement multiple times a day is a good way to do HASTY things like selling.  DON’T become a buy high, sell low income investor–although honestly at least 1/2 of individuals are this type of investor.

Interest Rates Popping Sending Income Issues Dropping

The end of the trading day saw the 10 year treasury pop up to 2.77% which sent quality income issues lower,which had a strange jump in price yesterday back down. When the quality issues popped up yesterday after a big tumble the previous day we thought it seemed strange–guess investors got so excited with the couple extra nickels they could garner with higher current yields they couldn’t resist moving prices higher.

Worse than the closing treasury prices are the overnight prices in Asia as the 10 year hit 2.80%. When we wrote the Monday Morning Kickoff this week we mentioned that traders were looking for a move to 2.80% if prices breached 2.68/2.69%, but we were thinking this would take a little longer than 4 days. With the employment report first thing tomorrow we will see how markets react.

At this moment we would pause any buying until we see how things shake out in the next day or two. Short duration baby bonds and term preferreds continue to trade reasonably strong and can be bought. Perpetuals, even high yield, should be paused–why buy today when you may get them 50 cents cheaper next week?

We are kind of drooling over some REITs-in particular KIMCO (NYSE:KIM) which is a investment grade shopping center REIT. I reviewed their financials from the 3rd quarter and they were fine and they should be releasing 4th quarter results soon (corrected–to announce 2/15) and I will be anxious to see them. We expect they will be as expected and maybe that will reverse the share slide. Shares closed today at $15.36 with a current yield of 7.29%. We will watch–who wants to catch this falling knife?

Model Portfolio Being Built

We have always included model portfolios on our websites to be used generally as a teaching tool and we have begun to build these models.

It is likely we will put together quite a number of models over the coming months as we would to model high yields, super safe, and enhanced (fixed income with additional issues such as REITs added in for a potential extra boost) models.

We have started the high yield model thus far and have made 2 purchases in the portfolio (disclosure — we personally have recently purchased Spark Energy preferreds).

The High Yield Model can be found here.

We will be writing in more detail on our investment choices in the very near future.

Rates Stabilize and Quality Preferreds Pop

The average preferred stock and baby bond rose about 12 cents/share today as rates relaxed a tiny bit as the FOMC ended their meeting with the expected resultant no rate increase.

As we reviewed the preferred stocks we were somewhat surprised to see that many of the issues with large gains were the investment grade issues. Obviously investors are clamoring for the extra 1/2% current yield they can garner because of the price beat down in these quality issues OR they believe that interest rates aren’t going higher.   In addition to these gainers the Colony Northstar preferreds which had been irrationally sold off in the last month took nice bounces of 1-2%.

Some quality gainers were–

Aspen Insurance 5.625% preferred (NYSE:AHL:D) popped 40 cents, Capital One 5.2% preferred (NYSE:COF-G) was up 29 cents, Gabelli Multimedia 5.125% (NYSE:GGT-E) was up 38 cents, Suntrust Bank 4% Variable Rate Preferred (NYSE:STI-A) was up 64 cents and Validus Holdings (NYSE:VR-A) 72 cents and VR-B 54 cents–all investment grade.

Now we await the employment report on Friday to see what this might bring to interest rates.  The ADP report today showed extremely strong job creation, but this report is not lent substantial credibility.