Day: July 12, 2012

On Floating Rates

On Floating Rates

I have to admit I don’t have much sympathy for those who lent or borrowed at floating rates like LIBOR.? Personally, I have always preferred fixed-rate deals where everything is locked in from the beginning.? It means the terms are fixed, and either you can meet them or you can’t.

There are two problems with floating rate deals.? The first is that you can’t control your funding costs.? This stems from two things: short rates are volatile, and the index is typically not controlled, though it often acts like it is.? Here is an example: there were mortgages that floated off of the one-year Treasury Note rate.? Then the Treasury cancelled the one-year Treasury Note auction, and investment banks scrambled to come up with a substitute.? As I recall, they used the interpolated rate on six month bills, and two year notes.

When I was a corporate bond manager, aside from rare occasions, I never bought floating rate debt.? Why?? I needed more certainty for the client.? Fixed rate bonds and loans are more certain.? When you float, you are subject to the vicissitudes of the index, whether a borrower or a lender.

Whatever else is true, you do not control a floating rate index.? If a related party has some influence on it, that is a negative surprise, but there may be nothing illegal about their influence, particularly if it is moderate as is likely with LIBOR.

As I say to so many others in related situations: don’t give others options against you; don’t play in their casino by their rules.? Average people should not let financial institutions have variability of terms; terms should be fixed to the greatest extent possible.

And, why do borrowers go for floating rates, if they can be harmed by them?? Because they are cheaper on average.? Yield lust works on the downside as well, and many borrow shorter than is prudent for them, in order to save a little.? Works most of the time, but not all of the time, and when it doesn’t work, it can be ugly.

Thus I encourage fixed rate finance, as always, and encourage lenders and borrowers to fix their financing in advance.

New Highs, New Lows, Yield Greed

New Highs, New Lows, Yield Greed

When I read this post by Ivan Hoff, I decided to look at the new high and new lows lists, which I never do now, but used to do regularly back in the days when I read a paper Wall Street Journal every day.? Now our philosophies for doing so differ.? He is looking for buy high, sell higher, and I am looking for misunderstood companies that are first safe, then cheap.

So after the close, I copied the new highs and new lows for the NYSE, NASDAQ, and Amex as a group.? There were 203 highs and 89 lows.

But then I noticed something funny: a large number (53) of the new highs came from preferred stock, hybrid debt, and bonds — yieldy stuff.? With the lows, there was some weird stuff, but 7 companies had rights and warrants, hitting new lows, and one new muni bond fund, NKGD, which was just noise.

Then I looked at the industries that they were in, mostly to separate out the ETPs and CEFs from everything else.? Here are the tables:

New Highs

Values
Row Labels Sum of mktcap Count of ticker
0715 – Insurance (Property & Casualty)

205,242

2

0524 – Tobacco

97,162

2

0803 – Biotechnology & Drugs

62,010

8

0521 – Personal & Household Products

40,837

2

0963 – Retail (Specialty Non-Apparel)

38,396

1

1203 – Electric Utilities

20,944

7

0515 – Food Processing

17,571

1

0721 – Misc. Financial Services

15,158

57

0115 – Forestry & Wood Products

11,980

1

0727 – Regional Banks

6,434

22

0806 – Healthcare Facilities

5,358

3

1209 – Water Utilities

4,356

2

1106 – Airline

3,595

2

1206 – Natural Gas Utilities

3,363

2

0812 – Medical Equipment & Supplies

3,209

4

0957 – Retail (Grocery)

2,472

3

0951 – Retail (Department & Discount)

2,356

1

1018 – Computer Services

2,039

1

1024 – Electronic Instruments & Controls

1,790

1

0612 – Oil Well Services & Equipment

1,335

1

0730 – S&Ls/Savings Banks

1,290

9

0915 – Communications Services

1,007

2

1036 – Software & Programming

832

2

0718 – Investment Services

548

2

0209 – Construction – Supplies and Fixtures

494

2

0712 – Insurance (Miscellaneous)

347

1

0942 – Restaurants

333

1

0703 – Consumer Financial Services

322

2

1033 – Semiconductors

316

1

0421 – Furniture & Fixtures

120

1

0909 – Business Services

33

1

1003 – Communications Equipment

31

1

0133 – Paper & Paper Products

17

1

0912 – Casinos & Gaming

0

1

Grand Total

551,295

150

Exclude Misc Fin Svcs

536,137

93

New Lows

Values
Row Labels Sum of mktcap Count of ticker
0118 – Gold & Silver

41,488

9

1036 – Software & Programming

16,268

7

1003 – Communications Equipment

14,856

7

0515 – Food Processing

12,732

2

1033 – Semiconductors

10,351

2

1109 – Misc. Transportation

8,131

1

0206 – Construction & Agricultural Machinery

5,849

1

0948 – Retail (Catalog & Mail Order)

5,451

1

0951 – Retail (Department & Discount)

4,837

1

0603 – Coal

4,479

2

0424 – Jewelry & Silverware

4,243

1

0103 – Chemical Manufacturing

3,933

3

0203 – Aerospace and Defense

2,995

1

1018 – Computer Services

2,851

3

0218 – Misc. Capital Goods

2,300

2

0924 – Personal Services

2,292

1

0927 – Printing & Publishing

2,043

1

0124 – Metal Mining

2,024

2

0721 – Misc. Financial Services

1,903

2

0215 – Construction Services

1,802

1

0939 – Rental & Leasing

1,760

1

0915 – Communications Services

1,616

1

0418 – Footwear

1,439

1

1024 – Electronic Instruments & Controls

1,384

2

0909 – Business Services

1,223

1

0812 – Medical Equipment & Supplies

1,077

5

0612 – Oil Well Services & Equipment

1,075

1

0918 – Hotels & Motels

937

1

0969 – Schools

836

1

0609 – Oil & Gas Operations

820

1

0933 – Real Estate Operations

731

1

0415 – Auto & Truck Parts

703

2

0127 – Misc. Fabricated Products

693

2

1021 – Computer Storage Devices

512

2

0966 – Retail (Technology)

418

1

0703 – Consumer Financial Services

195

1

0806 – Healthcare Facilities

64

1

0727 – Regional Banks

61

1

0803 – Biotechnology & Drugs

54

2

0930 – Printing Services

6

1

0942 – Restaurants

5

1

0421 – Furniture & Fixtures

4

1

Grand Total

166,437

81

Exclude Misc Fin Svcs

164,534

79

By the time you are done separating out the passive vehicles, because one is miscategorized in the new highs, you have for regular stocks 92 highs versus 79 lows.? The market cap spread favors the highs because of Berkshire Hathaway, Altria, Amgen, Target, Kimberly Clark, Reynolds American, and H.J. Heinz.? The only large company among the lows was Barrick Gold.

I should add that all of the ETPs and CEFs making new highs were all fixed income funds.? ALL!

Then I looked at the yields of the common stocks that were making new highs and new lows.? For new highs, 35 out of 92 (38%) have yields over 2%.? For new lows, 10 out of 79 (13%) have yields over 2%.

This is a market that is driven by yield and safety/non-cyclicality.? The new highs are predominantly in stable industries, and the new lows in cyclical industries.

I’ve said it before, but I’ll say it again, yield is not real.? It is a residual of a larger economic process.? If you own a bond, preferred stock, or common stock that pays dividends, your future well-being relies on the economic success of that company.? With stocks, that connection is direct, with bonds it means avoiding default.? Other securities face similar limits.? Yields cease to exist when companies fail; chasing yield as a main strategy will fail, because fund shareholders will give up during the hard times when capital gets marked down, and sell.

Though the portfolio that I manage for clients has an above average dividend yield, I do not look for dividend yields; I look for solid companies, and the dividend yields find me.? (Buybacks too.)? I do not reach for yield.? There are many investors that are reaching for yield in this environment, and I think they will eventually get burned.

So be wary over yield.? It may not pop for a year or two; it might pop tomorrow.? I identify risks, and risks typically don’t come with dates.? Just be wary.? When everyone is scrambling for yield, it is probably best to not aim for a yieldy portfolio.

PS — note all the banks and S&Ls on the new highs list, and they are almost all small firms.

Full Disclosure: long AMGN

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