Portfolio Management – Page 62

Forget Your Cost Basis

Posted on 31 July 2012 by David Merkel

All good investment decision-making is forward looking.? Whether you are buying or selling, it doesn’t matter where prices have been in the past.

Now, that said, price and volume charts may occasionally indicate where there is support or resistance.? That might be worthy of consideration in the short-run.? When I was an institutional bond manager, competing against few others, but larger others, that was more important.? Not sure it is so important when competitors are smaller.

My main concern is that investors focus forward.? Use your best data. and estimate future advantage.? Be aware of mean reversion, so don’t let mere changes in price affect your opinion.? Always aim for the best possible future return.

We win and lose constantly in the market.? Don’t let past successes delude you, they may be historical accidents. Instead, focus forward to try to see what opportunities and threats are in front of you.

There were two hard things I had to learn when I was a corporate bond manager: 1) learning to sell lower than my original sell. 2) Learning to buy higher than my original buy.? That meant I had to forget my original cost basis, and try to estimate the best forward value that I could.

That is a tough place to be, but it is rational.? Always look forward, and estimate where you will have the best outcomes going forward.? You will get superior results from doing that.

On Life Insurance and Life Reinsurance

Posted on 30 July 2012 by David Merkel

I get good questions from readers.? Here’s one from this post:

Is there a reason why life reinsurance companies are better positioned then life insurers?

Don?t they face the same problems that they won?t be able to generate as they roll their portfolios into lower yielding bonds going forward (since rates have come down so much)?

Basically just wondering why you think RGA is cheap at 84% of AOCI adjusted book but not the rest of the life insurance industry at 35%-75% of tangible book?

Is it mostly due to your opinion of management?

I started to leave a reply and the normally reliable software glitched, and I lost it. Dejected, I decided to make it a post.

First, life reinsurance is much less competitive than life insurance.? Globally and in the US, the top 5 life reinsurers have ~80% of the market share.? Life insurance is far more fragmented, and has a decent slug of mutual insurers who don’t have an explicit profit motive.? (Note: many of the large mutuals are exceedingly well run, which makes the competition even stiffer.

Second, life reinsurance is mostly mortality exposure-based, versus life insurers which are mostly investment spread based.? The law of large numbers favors the life reinsurers over the insurers.? Low interest rates will not affect reinsurers as much as insurers.? Hint to those who analyze life insurers and reinsurers: look in the statutory statements, which have a lot more data than the GAAP statements for odd reserves that indicate a significant chance of losses if interest rates continue to remain low.

Third, life insurers have weaknesses in reserving practices for variable products with secondary guarantees.? There is no good way to calculate what a proper reserve should be.? The implied options are odd, and have no natural hedges.

That’s why I only own one life insurance company; one that has simple products.? Aside from low interest rates, valuations are low at life insurers because of lack of certainty over reserves.

So, much as I like RGA management, they are not the main reason why I like the company.? RGA executes well, and has an excellent reputation in its industry.

Here’s another question that I received via e-mail:

Prices of financial services stocks are too cheap for me to resist these days. ?I see companies like Citigroup as being just given away by Mr. Market.

?Within insurance, my equity exposure is limited to AIG, which I consider to be well managed, misunderstood, and priced attractively enough to continue holding. ?Over the past month other insurers have started to grab my attention (HIG, MFC, MET, PRU). ?HIG stands out as being the least sensitive to the possibility of a decade of financial repression. ?Do you have any favorites that you would care to share? ?This topic could make for a timely blog posting.

I responded:

Value trap.? Focus on sustainable ROEs that will validate book value.? The accounting of AIG is a quagmire, even after their disposals.

There is a further difficulty with life insurers at present.? The GAAP accounting standards do not fairly reserve for secondary guarantees on insurance and annuity policies; truth, as a life actuary and a financial analyst, the options offered are so complex and long-dated, that I?m not sure there is a way to value them.? Over the last 10-20 years, we knew that this could be an issue, but we are now seeing the issue creep in as stock performance ebbs.

But if you disagree, consider PNX, it has all of the issues, and then some.? Be sure to get the Statutory books of the companies you buy here, because that drives dividend payments to the indebted holding company.

And one more e-mail:

Hi David,?? I have enjoyed reading your blog for many years (even before GGG recommended it)

I have two questions for you about insurance companies in general — I know you are very busy, I am just hoping you can point me to some websites where I can do my own homework.

(1) If I want to check the financials of a number of mutual insurance companies, is there a consolidated source??? Do I need to pull the annual statements of each one and are the different state accounting rules comparable?

(2) As I understand it (and I am quite new to this so I may have this wrong) — mutual insurance companies use “statutory accounting”, which is different from US GAAP.??? Is there a website or library book that explains the differences between these two methods????? Does statutory accounting differ from state to state?

Again, I am sure you are very busy and I will have to do my own research / homework.? You seem to be more knowledgeable than most about insurance accounting, and I am hoping you can point me to some documentation that will help me gain a better understanding.

My response:

1a)? Consolidated source: https://eapps.naic.org/insData/ , but most companies will send it to you if you ask.? Haven?t been turned down yet, aside from Berkshire Hathaway? and I?m working on that.

1b) Generally, you have to pull each one.? Some companies will do a combined set of schedules for their investments.? When I got AIG 3 years ago, there were 60+ books?

1c) There are slight differences by state, but most of the time you can neglect that.

2a) Mutual companies use statutory accounting, but so do stock companies for the state?s analysis of insurance subsidiary solvency.? And, though stock companies use GAAP for reporting to shareholders, many mutual companies will have an internal pseudo-GAAP basis for analyzing long-term profitability, and for management bonuses, yeh.? Statutory accounting is in some ways more critical than GAAP even for stock companies, because that determines how much cash can be distributed to the holding company, which is crucial if the holding company needs to make interest payments, or wants to make dividend payments.? This is one reason why actuaries often price products by calculating marginal distributable earnings.

2b) I have attached what I think is a short primer on GAAP vs Stat accounting.? This is a big topic, and the NAIC sells all manner of resources at high prices with all of the gory details.? This should give you a good start.? I general, the volunteers from the actuarial societies put out some good summary stuff, but you have to hunt for it.

Keep fighting the good fight.? Bloggers are the conscience of Wall Street and DC?

=-=–==-=-=–=-=-=-=-=-=-=-=-=-==–=-=-=-=-=-=-=-=-=-==-=-=-=-=-=-=-=-

Life insurance is tough because there is uncertainty on claim payment on timing, and uncertainty of investment earnings.? The latter is usually more serious, because the law of large numbers does not help.? Add in the valuation issues, and now you know why a life actuary primarily invests in P&C insurance companies, life reinsurers, and simple life companies.

Full disclosure: long RGA

Missing Earnings Estimates

Posted on 28 July 201229 July 2012 by David Merkel

Missing earnings estimates hurts in the short run, but it doesn’t mean much if there is no indication that the overall earnings trend has changed.? If the overall trend in earnings has turned down watch out.? Prices can fall as for Zynga and Facebook.

Then you have something like Reinsurance Group of America [RGA].? It recently missed earnings by 12 cents. $1.77 expected, $1.65 actual.? You should want your companies to miss estimates every now and then.? It raises the probability that the accounting is honest.? With a company like RGA, earnings comes down to how many/few large value life insurance policy deaths they have in a quarter.? You are subject to the “law of small numbers” even with the second largest life reinsurance block in the world, because it is the big policies that matter.

Even this does not qualify as a bad quarter for RGA.? Can’t remember a time when they lost money, but they have missed by far more.? Often I have bought shares on such a day; I did not get any on the brief lousy open after the earnings announcement.

With RGA, I hope the price goes down.? I will buy more.? Why?

It rarely misses earnings.? The company is conservative with guidance, and usually beats.? Cumulatively, over 2 years it always beats.
Life Reinsurance is an oligopoly.? It is one of the less competitive areas of the insurance industry.
It is valued at less than 8x current earnings, which are expected to grow, and less than book value, and even book value less AOCI.
You have actuaries running the place.? Actuaries have an ethics code.? I’ve met the management; talked with them on the phone.? Occasionally been on their conference calls.? They seem honest and competent.? I have worked for dishonest and/or incompetent insurance management teams occasionally.? I know what they feel like.? One thing dishonest insurers do is always make earnings by shorting reserves, and then, when the reserving imbalance is too great, deliver a lollapalooza of a bad quarter which more than erases the seeming excess earnings.

That RGA would deliver a slight miss is encouraging to me.? The accounting is honest.? RGA is the #2 or #1 firm globally in what it does.? Unlike the deceased Scottish Re, it was conservative in M&A.? It let Scottish Re overpay for deals, while it sat back and saw an undercapitalized competitor cobble together a life reinsurance block nearly as large, but one that was unprofitable, because of the high prices paid to get it, and the opaque holding company structure (worthy of AIG in miniature).

More generally, when a company misses earnings:

Does it revise current guidance?? If it doesn’t it may be temporary, and a fluke of accounting rules.? Look at the accruals to give you a clue.
How are industry dynamics?? If everyone is missing estimates, there is a reason to mark future prospects down.
Analyze where companies in similar industries have been taken private.? That serves as a ground floor for where valuations could go.

And with that, I leave you with RGA.? I have argued for years that Buffett should buy it.? Excellent company, does not need guidance.? Could take over his inferior #5 position in life reinsurance which has lost money and become #1 … and then the life reinsurance industry will have no more pure plays.? Kind of sad, but logical, because larger P&C reinsurers benefit from the diversification.

So RGA missed earnings.? Who cares?? A little lower and I load the boat.

Full disclosure: long RGA

Book Review: Visual Guide to Financial Markets

Posted on 28 July 201228 July 2012 by David Merkel

This is a good book and I recommend it to certain people.? Thus when you see the number of stars I give it at Amazon, know that for those whom the book is good, it is really good.? But there are some who will get less out of the book.

The author, David Wilson, is an excellent explainer of markets to those who are just learning.? He frequently does “The Chart of the Day” at Bloomberg, giving considerable insight to neophytes and professionals as he boils down complex topics into one graph.

As I began to read the book, I noted to myself, “Oh, in a number of places, they are using Bloomberg Terminal formats without mentioning it.? At the end of the book, they give a list of Bloomberg Terminal codes that would be useful to those who subscribe to the ~$2,000/month service. (Yeh, it costs that much, and it is worth it if you can afford/use it.)

I say this partly because I was a rare Bloomberg user that had expertise with all of the “yellow keys” of Bloomberg.? I’m intellectually curious, so when I first used a Bloomberg terminal back in late 1992, I played around with it to see what it could deliver.? It could deliver a lot, and it has expanded exponentially since then.? It is one amazing system.

But what if you could cobble together the most important 50% of what you get on a Bloomberg terminal, ad pay nothing?? That’s me.? It takes extra work, but you can do it.? I miss my Bloomberg terminal, because I can’t afford it now, but for those that can afford it, it is a wealth of information.

Thus, back to the book.? The book reads like one who imbibes both Bloomberg’s editorial ideals: “keep it simple. explain, give them the facts,” and teaching beginner users of a Bloomberg terminal on how to think about the markets.? Note that the terminal never gets mentioned until an appendix at the end.? But those that use a Bloomberg terminal to a high degree understand how the market is segmented.? We don’t ask the same questions with municipal bonds as we do with stocks.

This book is a very good book for beginners in the markets.? It explains a lot of things well, with reasonable detail.? It is not a good book for experts — you know all this, but if you want to get an introduction to some tangential areas you might not know, this could still help you.? This book brings you up to an intelligent beginner level in a wide number of areas.

What areas does it cover:

Stocks
Bonds (of many sorts — corporate, government, municipal, mortgage, etc.)
Money markets
Indexes
Commodities
Derivatives (options, swaps, futures, forwards)
Mutual Funds (open-end and ETFs)

The book highlights at the edges of its pages the main ideas, processes for using the information described, and definitions of financial terms.

Quibbles

When the book gives definitions, it is white on a vivid green background, and is hard to read.? The text should have been black against the vivid green.

The book implicitly assumes that people get quotes from a Bloomberg terminal.? Aside from professionals, few people do.? Until Bloomberg markets a retail service for individuals, offering the basics for 5% of the cost, there is little utility from explaining the nuances of a Bloomberg quote.

The title is slightly misleading, because the the book is no more “visual” than most.? There are a decent amount of graphs, but for a book that calls itself visual, I would have expected more.

Who would benefit from this book:?? This book is best for those that have access to a Bloomberg terminal, but are not expert in using it. Second best, it could help those without a Bloomberg terminal, but want to learn the basics of investing.? Dave is a good teacher.? Finally, for those with experience, this book is redundant.? If you want to, you can buy it here: Visual Guide to Financial Markets (Bloomberg Financial).

Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

Lonely Puppies, or Abandoned Mutts

Posted on 25 July 2012 by David Merkel

I have often owned companies with little to no sell-side analyst coverage.? Ask yourself this, how many companies trading on US exchanges are there:

That have no analyst coverage
That are US-based
That have a Market Cap over $250 million
That aren’t passthrough vehicles
And have pitiful liquidity at least

I made the following list by using a Media General database, and cross-checking it with Yahoo Finance.? Yeah, I live on the cheap.? Here we go:

Company	Industry	Ticker	Market Cap $M
Terra Nitrogen Company, L.P.	0103 – Chemical Manufacturing	TNH	??????????? 4,235
Icahn Enterprises, L.P.	0963 – Retail (Specialty Non-Apparel)	IEP	?????????? ?4,065
Valhi, Inc.	0103 – Chemical Manufacturing	VHI	??????????? 3,856
Seaboard Corporation	0515 – Food Processing	SEB	??????????? 2,619
EQT Midstream Partners LP	1206 – Natural Gas Utilities	EQM	??????????????? 908
Contango Oil & Gas Company	0609 – Oil & Gas Operations	MCF	??????????????? 901
Nortek Inc	0406 – Appliances & Tools	NTK	??????????????? 797
Sabine Royalty Trust	0609 – Oil & Gas Operations	SBR	??????????????? 781
Dorchester Minerals LP	0609 – Oil & Gas Operations	DMLP	??????????????? 695
Rouse Properties Inc	0933 – Real Estate Operations	RSE	??????????????? 681
Star Scientific, Inc.	0524 – Tobacco	CIGX	??????????????? 590
NL Industries, Inc.	0103 – Chemical Manufacturing	NL	??????????????? 578
1st Source Corporation	0727 – Regional Banks	SRCE	??????????????? 547
Apco Oil & Gas International I	0609 – Oil & Gas Operations	APAGF	??????????????? 546
CorVel Corporation	0806 – Healthcare Facilities	CRVL	??????????????? 518
National Western Life Insuranc	0709 – Insurance (Life)	NWLI	??????????????? 513
Village Super Market, Inc.	0957 – Retail (Grocery)	VLGEA	??????????????? 468
Atrion Corporation	0812 – Medical Equipment & Supplies	ATRI	??????????????? 416
Presidential Life Corp	0709 – Insurance (Life)	PLFE	??????????????? 411
PHI Inc.	0612 – Oil Well Services & Equipment	PHII	??????????????? 409
Seneca Foods Corp	0515 – Food Processing	SENEA	??????????????? 324
Lifevantage Corporation	0809 – Major Drugs	LFVN	??????????????? 306
Preformed Line Products Compan	0127 – Misc. Fabricated Products	PLPC	??????????????? 300
Westwood Holdings Group, Inc.	0718 – Investment Services	WHG	??????????????? 294
Ladenburg Thalmann Financial S	0718 – Investment Services	LTS	??????????????? 287
Camden National Corporation	0727 – Regional Banks	CAC	??????????? ????281
Federal National Mortgage Asso	0703 – Consumer Financial Services	FNMA	??????????????? 278
Fisher Communications, Inc.	0906 – Broadcasting & Cable TV	FSCI	??????????????? 278
Pendrell Corp	0718 – Investment Services	PCO	??????????????? 277
U.S. Lime & Minerals Inc.	0212 – Construction – Raw Materials	USLM	??????????????? 271
Winmark Corporation	0963 – Retail (Specialty Non-Apparel)	WINA	??????????????? 264
Arden Group, Inc.	0957 – Retail (Grocery)	ARDNA	??????????????? 263
Clifton Savings Bancorp, Inc.	0727 – Regional Banks	CSBK	??????????????? 262

Not so surprising, there are:

A lot of limited partnerships and royalty trusts.
Many financial firms.
Many companies where there is a controlling shareholder, and liquidity is scarce relative to size.

All that said, this is an area of the market where few tread, and there may be some values to be had.

Now, there were some companies that were far less liquid, and with less disclosure,? that fit the above criteria, and I list them here.

Extremely Limited Liquidity
Company	Industry	Ticker	Market Cap $M
Belk Inc	0951 – Retail (Department & Discount)	BLKIA	??????????? 1,839
SunGame Corporation	1036 – Software & Programming	SGMZ	??????????????? 746
First National Bank Alaska	0727 – Regional Banks	FBAK	??????????????? 555
Computer Services, Inc.	1036 – Software & Programming	CSVI	??????????????? 463
First Citizens Bancorporation,	0727 – Regional Banks	FCBN	??????????????? 410
TherapeuticsMD Inc	0921 – Motion Pictures	TXMD	??????????????? 311
Hills Bancorporation	0727 – Regional Banks	HBIA	??????????????? 304
Farmers & Merchants Bancorp	0727 – Regional Banks	FMCB	??????????????? 284

Some of these look promising as longs, if you can get shares. Others look promising as shorts, if you can get a borrow.? Remember that the illiquid end of the market is the place where promoters play, creating their own internal version of the “bucket shop,” getting people to buy in at higher valuations, while they sell out for a profit.

These are companies where personal research can pay off, because few others are analyzing them.? I own one of them, and it is:

Full Disclosure: long NWLI

Packages! Packages!

Posted on 21 July 201223 July 2012 by David Merkel

When I started doing stock investing, I began sending off information requests to 70-120 companies at a time via mail.? In those days, I would print off the letters at my computer, and mailing labels as well.? I would generate the addresses from the AAII Stock Investor program that I still use.

But I got my kids into the game:

One kid would put the stamp on the envelope.
The next would put on the address label.
I would sign the letter, and compare the addresses hand the letter and envelope to the next kid.
The letter would be folded and stuffed by the next kid.
The next kid would seal the envelope, and drop it in a box.

It was fun to do that, but it was even more fun when the flood of “packages” came.? When I got home from work, I would grab the mail from the mailbox, and would call the children to me.

“Packages! Packages!” they would say.? I would sit on the floor, my back against the couch, and the kids would sit in a U around me.? I would open each package, and tell them:

Where the company is.
What the company does.

In this case, the annual report was a help, because the pictures aided the understanding of the children.? At the end, I would point to the “stuffed shirt board of directors.”? I have never thought much about directors, because they are mostly lapdogs of the management.? I also have thought that directors are a waste of resources, and should be eliminated.? Let the shareholders elect the CEO directly.? Yes, I know this would be awkward, but maybe we should pursue the idea that boards aren’t that useful.

After I answered questions from my children, I would analyze the data that the companies sent me.? I found the comparison across companies to be useful.

But later I found that I could submit the data requests over the internet.? So, no more paper letters.? But for some time, I would still ask via e-mail for companies to mail me physical data, which I would share with my kids.

Today, I read everything online.? There are no more packages in my mailbox, and I wonder if that is not a loss.? When I got physical mail, I would spend more time reading it than now, when I read it online.? There is more leisure in reading the physical text, than reading the online version.? Online, we all tend to move more quickly, and we ignore things that we shouldn’t.? I am reconsidering getting paper data from companies.? It is much easier to curl up with and analyze, with fewer distractions.

What to do on Bonds?

Posted on 13 July 2012 by David Merkel

I’ve had good returns on bonds over the last year, largely because I invested in long deflation investment grade bonds.? I took on a lot of duration risk by investing long, and it paid off.? I’ve reduced the size of my duration bet, but it is still large relative to the consensus.? That said, momentum tends to persist.

But what to do now?? Yes, rates could still go lower on the long end.? Credit spreads could still tighten on the long end and elsewhere.? Most of my credit related positions have done well, including preferred stocks of banks.

I have a positive view on conforming mortgages, though I have no position there now.

On illiquidity I have a negative view because things are volatile enough that you need flexibility.

On FX, I am long the Swiss Franc, and it has been a loser.? I suspect that with weakness in the euro, the Swissie will not break its link with the Euro.? At present, the US Dollar seems ascendant.? What can stand in its way?

I am tempted to put money into emerging markets debt, because their economies are run in a more orthodox manner than the developed economies, but not by much.

Really, I am scratching my head over all the various risks, and thinking that short-term investment grade credit is the only thing that I like.? Beyond that, I am open to suggestions.

On Floating Rates

Posted on 12 July 2012 by David Merkel

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

Posted on 12 July 201212 July 2012 by David Merkel

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

On Internal Indexes, like LIBOR

Posted on 5 July 2012 by David Merkel

When I was a life actuary, following the deferred annuity market, the concept of market-value-adjusted annuities arose.? Annuity values could react like bonds to:

An external index rate, or,
An internal index, driven off of the new money rate for annuities

Now, the internal index sounds soft, but it is not so.? Yes, you can lower your new money rate but reserves grow on indexed products.? You can raise your rates, but reserves will shrink.? It’s not perfect here, but the internal index will work over the long haul.

So when I look at LIBOR and potential manipulation, I don’t see a lot of reason for concern.

When bond deals are priced, the relative yield is what is priced; it does not matter what the benchmark is, roughly the same overall yield would have been obtained.? Spreads are a way of expressing the excess yield over equivalent maturity government or AA bank (swap/LIBOR) yields.? They are a result of the process, not a driver of the process.

If 3-month LIBOR were replaced by the on-the-run 3-month Treasury yield, new deals would be priced, and the spreads would be higher by the TED (EuroDollar – Treasury) yield spread.

When I was a bond manager, dealer desks would often try to sell or buy bonds off of unusual benchmarks.? I would always make the necessary adjustments to calculate the option adjusted spread over interpolated swap rates, with further adjustments for the degree of premium or discount to par.? (Note: A premium bond carries extra credit risk because if it defaults, the most you can recover is par.? Opposite for discount bonds.? There is a mathematical method for calculating the amount of yield tradeoff between premium/par/discount bonds, even in the absence of a credit default swap [CDS] market.? You assume that the spread over swap is the CDS premium, and calculate the annual cost of insuring the premium to par.? Deduct that from the current spread, and you have the hypothetical true par spread.? Once you have that, you can make rational swap trades.)

What I am trying to say is that benchmarks/indexes aren’t all powerful.? Bright bond investors look past them, and analyze the economics of the situation.? Same for intelligent borrowers; they know that LIBOR rises during times of financial stress.? If you are a floating rate investor/borrower, you ought to analyze the rate that your investment/loan is tied to.

Many commentators with knowledge of the situation think that lawsuits regarding LIBOR will amount to little (one, two).? Yes, there may have been some manipulation in a micro-sense for some banks, but in terms of having a big effect on many, I don’t think that is possible.? There might be some degree to which borrowers benefited and savers/lenders lost.? That’s a tough case to press on any side.? Courts favor borrowers, and they benefited from any manipulation.

In closing, I don’t think much will come from the “LIBOR scandal” the same way that nothing will come from the “rating agencies scandal.” Both are examples of summarizing information/opinions that investors can use at their own risk.? They are not fiduciaries; those who use the information do so at their own risk.