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11-15-2018 
 
2 years ago, Chuck Butler from EverBank said over and over that stocks couldn’t grow to the moon. We are seeing the growth stall a bit lately! Because of this, we’re looking for alternatives to make easier-fought profits.
 
Increasingly, I have had pressure to find good interest bearing debt. With rates rising, a bond at par (issue price) is literally worth less than nothing.. Most retail and many professional investors don’t know this and will make a mistake holding bonds near term.
There are no good bonds or bond funds out there. I recently spoke to a global bond analyst at Rogge’s NYC office and he told me three things: 
  1. Duration risk is wreaking havoc. If you are investing for income, you must be familiar with this risk.
  2. FLOT is one of his prominent picks right now.
  3. Stay away from corporate debt!
By now, we all know bonds are entering a bear market. This year and next year have been pre-ordained as the worst years for bonds since the 1970’s. It’s been 40 years and now is the time of reckoning – don’t get stuck with bad bonds! 
Now, there are some closed end funds that trade at a discount to Net Asset Values. JFR from Nuveen is a good example. Right now, JFR sells at 12% below the value of coupons and redemption value. Importantly, as of this date last year, JFR traded EVEN with such value. While these discounts may seem attractive, there is still further to fall and no one needs to pay $1 for what will soon be worth 90 cents.
 
This is the dilemma when you have nothing else to eat so you have to raid the hotel mini-bar. Are you that hungry that you can’t find a cheaper alternative? There are better options! Put down the $5 Baby Ruth!
 
What to watch in bonds: 
  • Inflation and rates may be at odds. The Fed tries to set interest rates with inflation in mind. At this time, the real return of the after tax yield of treasury debt is closing in on 0%. As this spread narrows toward 0 (and falls below per NIRP), bonds will drop more and more in value. In real estate, a 0% cap rate is abhorrent – so should it be in the bond market!
  • Narrowing 2-10 spread. Naturally, when the short term rate increases, the longer term 10 year rate should as well, due mostly to anticipated long term inflation. We should hope for a higher 10 year and fear its depression. As I write this, the 10 year is around 3.1%, down from 3.24% in 5 days. Looking at small changes less than a full 1% swing will never yield reliable results these days. I do anticipate, however that if the rate eclipses 3.3% the markets will react very harshly.
    • When the 10 year yield is less than the 2 year yield, this is also known as an inversion of the yield curve and signals poor economic prospects.
  • Refinancing by corporations – Exchanging debt when the term is up can be a waving red flag when rates rise. Higher interest payments deteriorate the net earnings available to stockholders. This is the primary argument on how rising interest rates correlate to the stock market.
What options are there? First, as a disclosure: speak with your advisor about all of these things.
  • Preferred stocks. Particularly in the financial and insurance sector, preferreds have respectable yields. Financials’ operations should benefit with rising rates due to improved net interest income. Dividends are generally safe moving forward. Again consider duration risk of the dividend.
  • Dividend paying companies that are noncyclical (AKA staples) should give shelter, though with much less total return predictability. We like Telecom, REIT’s, utilities and some middle market “shadow banking” companies. 
  • Merger Arbitrage – Almost daily, an acquisition is being announced. Why does this matter? Most commonly, you can determine the probability of the merger going through (passing antitrust and DoJ tests) and finally the annualized return you will be paid between the announcement and final close. At this time, there are multiple arb opportunities yielding over 10% annualized return. Not bad!
These options take more research and patience than most bond strategies have in the last 40 years, but we are all being challenged to work for yield. 
 
The Holidays 
 
Holidays are almost upon us, and the U of Michigan reported earlier this month another great consumer confidence report – this season will be another record spend! Most of the shopping will be online, even though retail sales are consistently getting stronger. 
*All I want for Christmas are profitable businesses at good prices! Let me know if you have any ideas where we can find them!
In any case, here are some tips that I hope you find helpful!
  • Use more apps/tech
    • SkyScanner for Travel
    • Venmo for money transfers
    • Etsy for high value personalized gifts
    • Phones have plateaud. The days of the newest iPhone for Christmas have mostly passed. Virtual Reality headsets, on the other hand are going to be a popular gift for the next several years as improvements are made.
  • Create a budget. Start with Income, reduce by recurring costs and one time costs. Very simple yet very powerful. 

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