Goldilocks Is In the Room

With the semi dovish speech by Jay Powell yesterday we have ushered in ‘Goldilocks’.  For me this means that I am now expecting as few as 1 Fed Funds rate hike in 2019.

All is great for now and the next many months as stocks have a more reasonable price and the 10 year treasury yield has moderated to the 3.06% area.

The Fed funds rate hike for December will happen–only the severe black swan event could change the inevitable hike.  Thats fine–our money market is now at 2.16% and this will raise it a bit more–a nice cash alternative.

In May, 2018 I wrote the following–

“The bottom line is I still believe that 3.25% on the 10 year is the right number for the end of the year.  If we saw this rate on a straight line basis the rates would move higher by 4 basis points a month throughout the balance of the year.  We would be very happy with that result.”

Since May the average $25/share preferred stock fell from $24.86 to the current level (as of last Friday) of $23.72.  This tells me that the average perpetual preferred holder has taken a 4% hit since May—so for all of us that are “green” we have done a good job–even if it is 1% green.

While we hit the 3.25% a bit earlier than my expectations the ‘stars aligned’ for the most part.  Even a blind squirrel finds a nut on occasion.

So back to 2019.  I believe we will see maybe a Fed Funds rate hike in June–and of course that is a maybe–and that is it for 2019.  I see GDP growth starting to taper off the 1st quarter and I hope maintains a 1.5-2%% growth through the end of the year.  Employment will weaken–not bad, but starting as early as January job growth will start stalling out–maybe 100,000-150,000 new jobs monthly instead of 200,000.  Inflation is a big unknown–but outside of the tariff situation with China it would seem reasonable to expect 2-2.5% next year.  The wage inflation I expected probably won’t happen much–a slowing economy will temper future wage increases.

Much of my data is purely anecdotal–what do I see in my neighborhood.  Housing is an issue–high prices and high interest rates.  Refinancing of mortgages is at the lowest level in 14 years and this ‘dry powder’ has fueled the strong consumer (like it did 10 years ago).  At the margins a 1% increase in housing interest rates is painful to modest folks.  Apartment building has been going gangbusters and rents are at sky high prices–overbuilt?  Credit standards in auto loans and house mortgages are too low–and this will come home to roost someday (not 2019 likely).  We need to watch Consumer Confidence very closely–I believe this will telegraph the future–thus far it has held up better than I thought it would, but with high profile job cuts at General Motors etc consumers begin to ponder their own circumstances and maybe pull in their horns a bit.

For me this personal forecast allows me to ponder additional perpetual preferred purchases.  The plan is to buy maybe a mortgage REIT perpetual (don’t know which but there are plenty to choose from), I am also looking at American Homes 4 Rent preferreds–they have numerous issue outstanding and have current yields just shy of 7% and the strong balance sheet can withstand rent stagnation.  Maybe an equity REIT preferred–not sure which one.  These are moves I think I will make starting the end of December.

So the bottom line is we think that “interest rate risk” is minimal for 2019, but of course with perpetuals there remains “duration risk”.

Lastly I have been concerned about the Federal deficits–we should all worry about those.  To date the huge deficits have been sopped up by bond buyers–BUT, tomorrow or next week or next year (or 5 years from now) buyers will reject the financials of the U.S.  It is near impossible to factor such an event into our financial plans–the day is coming–we just don’t know when it is going to occur.

My normal warning is that this is simply a lot of rambling on our part–how we see things and how we react.  Each individual is responsible for their own investments for their situation.


34 thoughts on “Goldilocks Is In the Room”

  1. On a different note, does anyone know what happens to baby bonds of a company going private. Today AmTrust Financial Services (AFSI) went private and I guess their common will not be trading tomorrow. However they have 2 BBs and a bunch of preferreds selling at huge discounts.

    1. MFZ, they will do one of two things. Leave them on the exchange, or delist them. Going private means they no longer have to do all the expensive filings and such with SEC. But if they leave the preferreds on exchange they will have to do all the filings still.
      There really is no self serving interest in leaving them on exchange unless it is required in prospectus. Delisting could actually serve several purposes. Save on filing costs, hide their financial structure better, and possibly drive the price down on these poor preforming issues even more with intentions of company buying them up on the cheap. With this outfit, I would assume delisting is coming at some point. That just means likely they head to pink sheets, grey market, and/or the baby bonds could actually be kicked into the actual bond market. Several delisted baby bonds I know of were delisted and trade as bonds with a cusip and lose their stock trading symbol.

        1. MFZ, your welcome. Just my personal observations, but it isnt the end of the world on a delisting, and many quality companies have done this also…WEC is a powerhouse utility highly rated and they delisted IEH which was an Intergys baby bond when WEC acquired Intergys. In fact those old high quality utility preferreds such as CNTHP and AILLL actually were delisted and sent to OTC many moons ago…It does make buying and selling a bitmore difficult as the bid/ask spreads usually widen. And when delisted baby bonds head to the bond market, they will royally try to rip you off there.

        2. MFZ, I just looked. Those issues including the Maiden preferreds are having a horrible day today. I got lucky playing a bounce off of them last January holding a few days and flipping. I decided I got lucky and not to do that again..And then I pulled same stunt with PCG and SCE preferreds and got lucky again. I really hope to stay out of the trash anymore. Its hard though at times I admit.

          1. MFZ and Gridbird, I can give you one example of a company that went private, but this was back in 2006. Bedford Property Investors had a number of commercial/industrial properties on the west coast and was taken private in 2006. I owned about 300 shares of their 7.625% preferred stock. After taken private by LBA properties, they delisted the preferred stock and it tanked.

            Was with T. Rowe Price at the time, and they called me. LBA Realty made a tender offer on the shares at $17.50 and I declined the offer. Held them longer and finally got out around $22.50 if I remember correctly, but it has been a number of years. They were finally called at $25 par in March 2016.

            Bottom line: some of the companies taken private have shrewd owners. They will delist, and then make a tender offer on the cheap for some of the preferred shares. This deal worked out well for people that held, but it is sometimes very difficult to get financial statements after a buyout is complete. You can research a little on Quantumonline under the name “LBA Fund” but all issues do not work out this well.

            1. Generally if you own insurers that go private you can find the info as they have to give it to the state regulators from where they are based, so you can back door it. I have access to Phoenix Insurance that went private and their PFX bond went delisted to bond market. They actually had a little honor and had owners of PFX to vote on it and gave them a 10 cent bonus check per share when majority approved to delist. AFSI just smells dirty and needs a bath.

              1. Grid is right on this one – if you did deep enough you can find financial filings by insurance companies, as they are normally regulated by each state – similar to some of the smaller utility companies. I’m just not familiar enough with AmTrust to provide any type of opinion.

                1. I have to confess, Kaptain, I dont look at the Phoenix financials anymore. Im holding until maturity or bankruptcy and I kept the investment small. And to be honest, reading and understanding an insurance companies financials without any real hand holding from Moodys or S&P is really above me. This is where those dividend dumpster divers on SA get in trouble with their wallet flattening picks. They only understand half of what they think they do. And it bites them in the rear.

  2. Tim,
    I picked up some DKT today on the drop.
    Yes, German cops raided headquarters today over alleged money laundry.
    They already have ID’d two main banksters.
    But …. really! Deutsche Bank is Deutsche-Land! May get fined, though will absorb the wrist-slap.
    DKT has been around for a long time. May be considered Perpetual? 8.05% / par. Historically trades between $25.50 – 27. Great for an IRA….
    JMHO … of course

    1. Steve G
      Do you knowthe tax consequencesf or this issue if held in an IRA, do German taxes apply. I have the same questions for the ING and AEG issues if anyone can help.
      Thank you in advance

  3. Tim, I really think the higher interest rates are going to put a damper on the housing market in the next couple of months. Home prices in my area are back to around their record highs last seen in 2006. While I know incomes are higher (for most people) now than 12 years ago, I would not want to be a first time homeowner financing 95% of the purchase price of a house due to current prices and interest rates. This may slow the economy down over the next couple of years and I too am hoping for only 1 interest rate increase from the Fed in 2019.

    1. And higher rates may cause a secondary problem. People who locked into 3.5-3.75%, 30 year mortgage rates are going to be less inclined to let it go for one around 5% if they moved. I know I am never giving mine up and slow paying it too.

      1. Grid, you have that right on the money. I refinanced my place a few years ago with a 10 year fixed loan at 2.99%, and the first floor of the house is my rental unit. It could easily be paid off, but have no interest in doing that as there are yields in the 6-7% area for preferreds now and it just does not make economic sense. Plus, there are many people with rates below 4% and I cannot see them moving and taking on a new loan at around 5% as most people decide to purchase a larger place which means taking on more debt.

        1. kl, Congrats on the 2.99%, we’re at 3.125%. Hard to imagine giving that up unless writing a check for the next place. The rate move from mid 3%s to 5% equates to a 20% reduction in purchasing power for buyers. (it’s not the full 40% because of dilution effects of non-interest items such as RE taxes, home insurance and the principal part of the payment) This is absolutely translating to the housing market. Anyone who bought with less than 20% down in the last few years stands to be at least 100% or more financed in short order as the average buyer adjusts their purchase price range to their new reality.

          1. alpha8, the bank was running a special deal for new customers about 5-6 years ago with no fees so I took the deal. Heck, they even paid for the appraisal on the place at no charge. 3.125% is a great deal for you as well and you must have excellent credit. I’m not planning to move and just have a few years left on the loan. People in my area are paying about $160k for a townhouse, but if they want to move up to a nicer single family home then they are looking at $200k. So I don’t think many people are going to move up and will just stay in place – which really dampens the housing market.

            Of course, this is all relative. Bought my first house back in about 1993. It was a side by side duplex and rented out the other side. But, I paid about 8% interest on the place back then.

            1. LOL…I can remember a time when I would have thought I’d died and gone to heaven if my mortgage was 8%. My first house in the early 80’s had a rate of 14.75%. My rate now is 4.125% and had about 7 years left on a refinanced 15 year mortgage but I’ve decided to pay it off by the first week of February. I gave the bank $160,000 last week to that end. You should have seen the look on the bank tellers face when I told her to transfer that amount from checking to the mortgage loan. Priceless!

              What’s left is now is equivalent to a medium sized car loan and I’m saying goodbye to that the first week of February when the money on a CD matures. Both vehicle loans had several years left but I paid them off last summer and kissing the mortgage goodbye means I don’t owe anybody anything. Whoo- Hoo!!!! Not being a slave to debt is already feeling good…very good indeed!

    2. Lou, I look around my area and see zero lot line starter homes going for $700K+ and am thankful I am not a first time home buyer; they are doing 100% financing (a recipe for disaster)! I am awaiting next year to see if my son gets into a Med School (I will move to were ever he gets into medical school) and then I can finally sell my home and cash out. I bought this home for cash about 15 years ago and thought I overpaid to be in my area. I can’t believe what people are paying now per square foot and know that the new home buyers will NEVER make money on reselling. The maintenance, taxes and insurance make these homes almost unaffordable unless one is very wealthy. I truly feel bad for young families that want to put down roots and be in a quality school system. IF the Fed keep raising rates it puts more pressure on the housing industry all over our country and I believe that rates should be much lower to continue the economic growth we have all enjoyed. Inflation? What inflation… We are all living through very interesting times and my prayers and thoughts are for a prosperous future, but I am concerned that the next generation will have a much harder economic environment than we all have been fortunate to live through. Wishing you profitable investing, Nomad

      1. Nomad, with prices of $700k in your area it will be difficult for “normal” people to purchase homes and ever get any type of capital appreciation – which should be normal for a regular home purchase. If they are now doing 100% again ( and we know what happened the last time it happened), there will likely be a number of foreclosures over the next decade. As you mentioned, just the taxes and insurance costs must be expensive on these properties. Decent homes in my area are going for $250k+, but there is still a lot of downside potential here even at those prices.

  4. pfds lower for the most part again today.. 3mLIBOR at 2.75, some 3m CD’s offered at 2.4-2.45, h/y savings over 2%, our FIDO mmkt as noted by Tim.. watching yr end volatility here closely.. FED verbiage dial back may embolden trade toughness.. rents and low end wage pressure still adding a lot to real inflation imo.. hiring signs up everywhere round here..

    1. Bea–you and others have noticed that even with the Powell dovishness (relatively) and falling 10 year preferreds are still ticking a few cents lower. Of course they won’t turn on a dime, but would be surprised to get 25 cents back before year close.

      As I noted I think we will see some softness in jobs starting in January–wage pressures may continue on the low end–in particular in states like Minnesota where legislation continues to push them up some.

  5. Hi Tim – I used to follow the Yield hunter site and glad I am finally able to follow here. I appreciate your information and insights. I can’t explain things too technically but I’ve been thinking for a while that everyone pretty much has what they NEED, so if interest rates or prices rise, people will just stop buying stuff which will put the kibash on rates going too much higher. Not sure if that’s what is happening but it makes the baby bonds and preferred that much more attractive – I added to PRIF-A today at $24.30 when I noticed it was trading down a bit. Thanks again!

    1. timdman–in a nut shell I think that may be happening—people may just be starting to ‘pull in their horns’ a bit. This is just my very unscientific observation and it will be a couple months before we know if this is really occurring–watch auto sales and consumer confidence.

      Glad to have you here.

      1. Tim, with regards to auto sales there are certainly issues in the market place. The price of new vehicles has risen so much that leases dominate the sales market and there is a glut of off-lease vehicles that have been flooding the dealerships and private sales. That being said, I loaded my portfolio again today with more ALLY preferred A. This issue is almost 3 years past call (callable since 2/15/16) with a maturity date of 2/15/40 (I hope I and the security make it that long). ALLY.A is floating at 3 months LIBOR (currently 2.70663%) with a kicker of 5.785% so we are at a whopping 8.49163%. Let us all pray that are long this floating preferred trust that it is never called.
        Wishing you profitable investing, Nomad

        1. Nomad, shame on me, but I violated an investing principal that I rarely break except with my AILLL. I bought 400 more myself today. Its time to stare them down and dare that call!

            1. Tim, I tried to hold back. But this issue has been such an easy money trading vehicle, the old gunslinger had to walk to the OK Corral for one last big gunfight with this issue. I am down 35 cents on this issue since I repurchased a couple weeks ago. This year has been such an easy year, this 35 cent loss on my 1000 shares feels like an ass whipping. I have lived a sheltered life this year. Finally swung at one in the dirt. But that wasnt strike 3 yet with this issue, so I am still in the batters box!

                1. Nomad, I didnt even have to hit the link. I remember Ron Hunt and all his hit batsman. Sadly I remember more 1970s MLB players than I do todays players. I was looking at my preferred roster and I have really overhauled on the edges, and got back in on some after I sold higher and repurchased lower. Trying to stay ahead of the posse. ALLY-A was back at 25.52 trading after hours on 8000 shares, so maybe the sell pressure is over. As long as a redemption isnt being served it will regain its moho. Hmmm, maybe it was Tim who ponied up and bought those 8,000 shares after market. 🙂

              1. I going to look at it in the a.m. I did pick up some star-I today which was being bantered about on SI–got it at 21.80 and it closed at 22.20–goes ex div tomorrow. Probably will exit if it survives the ex-div markdown and/or even bounces a bit.

        2. Thanks for the input Nomad–I did notice the ALLY-A down today–will check that one in the morning.

    2. Good find on PRIF-A. This seems to be a pretty decent interest rate with the 200% asset coverage requirements.

      Quantumonline contradicts itself on whether the dividends are qualified for this issue. The text says one thing, but the box below indicates the opposite. I have a trust fund it might fit if they are qualified.

      1. Hi ScottR–they should be qualified per the prospectus they filed with this issue–although it is very complex and they qualify that if they don’t have taxable income it would be a ‘return of capital’ (which is normal for preferred dividends). Additionally some of the dividend may be classified as ‘capital gains’. This is all part of the RIC (registered investment company) rules. If they do NOT meet the RIC rules which require a distribution of at least 90% of taxable income dividends would be ordinary income.

        I can see why QOL has conflicts on this one.

        1. Thanks Tim. Reading over the company info I remember why I passed on this one before. I don’t really understand the risks involved in what they invest in well enough to feel comfortable with this issue.

          And in all honesty, I forgot I had seen this particular preferred before.

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