Valuations and Cheap Money.

Maybe, just maybe, we need to significantly adjust our thinking going forward.  For several months now we have watched prices on large cap dividend stocks move upward and dividend yield move downward.  No better case than a position we are now dropping due to just that reason and the fact we no longer can make option premium worth the risk involved. 

Realty Income, symbol O, has been in our portfolio since we were alerted to it by Morningstar research maybe a decade ago.   We like it for many reasons, most of all the monthly dividend that the company increases on a regular schedule. We like due to the very transparent investor friendly info the company places on it's website. We really like it for what we believe is superior management and the willingness to make changes when the economy moves against them. Just a great company with a good dividend. Realty Income is a good buy at $35 in our opinion which puts the payout right at 5%. Good for a solid blue chip type company even with the non tax favored real estate trust dividend. However the stock has moved nicely above $40 now and the yield is now just above 4%. Our preference is 5% and above and as we have noted in a recent posting our universe of stocks have dwindled due to the move up in stock prices for good yielding stocks. 

Maybe we need to adjust our thinking to the new normal, or more simply accept the new era of what looks like cheap money for a longer period of time.  Many of us who lived through the late 1970's know that inflation can rear it's ugly head and wipe out your savings and make buying houses and such so expensive no one can afford them. We remember buying a municipal bond at above 15% and a CD in double digits yield as well. At the time we figured a few more of those and we could retire at no later than 40 years old. Did not happen of course. Truth was that era of high priced money was abnormal and was engineered by Fed Chair PaulVolcker and President Ronald Reagan to snuff out runaway inflation. It worked and rates have been basically on a down trend since then. Before the late 1970's normal lending rates were 4% or so and CD's and saving accounts paid less than 3% with what most people do not remember was a law that would not let banks pay more than about 3%. 

Rates today for 30 year home loans are at 3.875% for good credit, rates for CD's are around 1%, US Treasuries are around 1.5% for 10 year bonds, AA muni bonds are trading at around 4%, all of which point to rates that are significantly lower than just a few years ago.  Therefore blue chip stock dividends in the 3% to 4% area is about right for long term investing.  The dividend plus expected capital gains should earn investors around 7% and that is also about right for long term investing for investments with risk profiles of blue chip stocks. 

The point here is that these low long term rates could be with us for more than just a few months or few years.  They could be standard fare for a couple of decades or more because we have gone from an economy with 3% plus growth to one with less than 1% long term growth.  For those of us who have lived with higher rates this is going to be hard to accept and hard to change our perspective, but if we are to trade and invest in this new economic environment this is likely the future in the US for our lifetime. 

 Some of this cheap money can be laid at the feet of the US Federal Reserve which has been printing money like mad to compensate for huge US Government budget deficits.  Expected inflation can only happen when economic growth is above 4% where too much money begins chasing too few goods and that does not look like it will happen for the foreseeable future.  There is the simple fact that US citizens are tapped out consumer wise due to lots of debt and lack of employment.  Feeling poorer and being poorer they have cut back.  With the Federal Reserve saying that interest rates are staying put through late 2014 there is no expectation of economic growth on the horizon. 

So it is time to accept valuations where dividends are closer to 4% average as a trader and investor and adjust accordingly.  

We have dropped O from our portfolio currently and added PM on a temporary basis to occupy that capital space. 

                

 

Are there any good stock buys left?

The short answer might be a resounding NO.  For several months this past year readers have noticed our universe of stocks has dwindled from almost 25 to now down close to 10. The reasoning was simple for our hedging purposes in that if a security could not pay it's own freight so to speak why take a chance on it. Paying the freight meant that a combination of option premium and dividend income could cover most any scenario when forced to own it when the stock was put to us. Margin interest for us is a combination of 3.75% and 4.75% which are the current percentages for our underwriters.  Therefore in simple terms 5% dividend made sense since we like to consider the premium as our "profit" for hedging. 

Here it gets tricky since many selections which we like such as SO and DUK have indeed fallen significantly below 5% dividend levels.  Most of these dividend declines has nothing to do with cutting the dividends since many stocks have been raising their payouts. Almost all of the declines have come from investors crowding into these securities looking for yield. US Treasury payouts are a joke and fools gold for those who buy them and yes there are plenty of fools around. Ditto for many other bonds, except for municipals.  Municipals however have been calling bonds of late taking advantage of lower than low interest rates. 5% bonds are becoming 3% bonds quickly in the municipal arena. The risk profile for municipals is starting to trouble us as well. 

What this leaves are a few stocks where the option premium and dividend can be worth the trouble and our hedging going forward from this month will take a decidedly different approach.  That approach will be much more conservative and much less profitable. With the political situation and the fiscal cliff awaiting us in January in this country the huge risk now outweighs any profits available. Frankly they are not worth taking. As explained in a previous post we have finally accepted that Barack Obama can and will destroy the economy in the US by not knowing what hell he is doing and there is no need to risk so much for that high of a risk. Our greatest trading fear going forward is with the lowered number of trading stocks our concentration in those remaining is getting much larger. If Obama sets his mind to go after a company the losses could be staggering.  Maybe we should just stop trading at all now? 

We place just over $1 million dollars in value of option trades monthly. We will continue to risk the same amount, but going forward the risks will be so small on our trades to actually be a little risk at all. That difference should reduce our monthly premium take by at least 25% and maybe more. We like to play the game, but this market has gotten ridiculously risky to play in going forward for at least 5 more months.  If there is not a change in Washington DC in November we likely will hang it up on the hedging and options trading and shut down our fund. We can sit at the beach and say to heck with the country and world if indeed this country can not see ruin ahead with the current leadership. As we have said before we expect we are to be joined by many who will join us at the beach. 

Below are the current and maybe final stocks we will use for trading in our hedging activities until the November election. 

AGNC... almost guaranteed this stock is going nowhere but maybe up a little bit since it is US Government guaranteed debt and The Fed has said there will be no upward movement in interest rates for over two years. Safe and more safe. Closer to $31 is best however. 

BCE...Canadian telecommunications company that is frankly overpriced, but safe in Canada where government is business friendly. We like it $40 for the rising dividend too. 

CTL...Largest legacy telephone company should do well going forward. Economy of scale and frankly government support of rural land lines gives us some comfort.  High dividend that is safe going forward. Only risk is a bad earnings report, which is possible, but not likely. If it does report weak earnings it would be a good buying opportunity. Like here in mid to upper $30's. 

DUK...We are very close to dropping this one as the price is getting frothy.  Why take the extra risk if the payout is similar to SO. Just trade SO. We will see. 

ERF...God help us we are addicted to ERF.  Canadian oil company that has taken a pounding reducing the share price over 40%, which yes we participated in recently. However there has to be a bottom here somewhere and the risk has to be much less for more capital losses. The option premiums are rich and the dividend still above 8% even after the latest cut. 

JNK...Has held up well despite being junk bonds in a economic downdraft.  That makes for some comfort plus the high monthly dividend. 

LO... We just might being dumping this one as well like DUK above. We like tobacco and LO has more upside than any other tobacco. However it also has more downside risk here too. 

NNN.. This real estate stock has held up through thick and thin since 2008. No dividend cut and no drop in price. We too will stay with this stock even though the option premiums are not as strong as before. 

O...Frankly this stock is way overpriced here nearing $40, we like it at $35. So we will continue to write $35 options taking in the cash and being happy if we have own it via puts. 

T.. This stock continues to move up in price and it too is starting to reach the highest level we are willing to buy it. We might have to go to longer dated options to get our price. 

FTR...We have a large position of puts here and continue to fine with them if we are put the stock. The price is right here below $4 and the dividend good for the long term  We will however not add to this off balance sheet position.

    

 

ERF...The hammer finally falls on the dividend

We have opined that we have made more money on ERF than any other stock in our portfolio ever. Now we can say we have also lost more money on ERF than any other stock in our portfolio, assuming we follow through on making our current paper loss and real capital loss.   Maybe the fact that over a couple of decades we have about broke even on this stock would make others happy, but not us. The idea of course is to produce premium income without undue risk. 

Yesterday after the closing bell ERF did what most thought they would be doing next year in 2013 and cut their dividend.  The cut was 50%, which is what we had thought would be the cut, since that would provide the needed cash flow to make the company able to operate totally in the black again with the continue asset sales currently in the pipeline. ERF should be able to continue the 9 cents per share monthly payout for the foreseeable future and could be buoyed some if natural gas prices recover any at all. 

The best point here is that the 9 cents per share payout equals a nice just over 8% annual dividend. If as would be expected the short sellers finally start getting out of the security the next week or so the stock could find a footing finally here around or just below $13 per share. The risk reward at this price looks to be good and worth taking a position if you are considering doing so. 

We continue to like the option premiums here too.  One could buy the stock today at $12.65 per share and write a $13 call for 40 cents per share.  That is a 3.16% monthly premium plus the 35 cents per share kicker.  If you have to own the stock you get $9 per hundred shares monthly dividend. 

Yes, we have been fooled by ERF before, but this finally looks to be a bottom.   We continue to own a large several thousands share position and will at some point be taking a large loss in this stock, but only fools do not continue to take advantage of opportunities when offered. ERF at this price looks like an opportunity. 

Bonner H. Jones and Wilma D. Jones Scholarships...Pass it On.

This past Sunday I had the privilege to present the first Bonner H. Jones and Wilma D. Jones Leadership Scholarship at my home church in Richlands NC.  Here is the text of my remarks regarding this occasion. 

Good morning my name is Bob Dixon. I am the son of Bonner H. Jones and Wilma D. Jones, who were long time members of this church.  They together represent over 110 years of membership and service here and served in every position in this congregation except pastor. Many people in this congregation knew my father, but not my mother who passed on 28 years ago.  However she was as my father once noted the person who changed him from being a believing Christian to a practicing Christian. My wife Judy has had the same effect on my life as well.

 I was raised in this church and was a member myself participating in everything from Sunbeams to a vibrant youth choir lead by the late Ms. Anne Smith before moving on to better opportunities and dreams of youth. 

A couple of you tease me each time I return to worship with you that I have gone "city" on you.  Well I am here to tell you they are wrong. I am still a Richlands boy and proud to tell others so. I still pull for the Wildcats. Proving my Richlands pedigree I personally have circled the Toot and Tell It.   I have eaten a "Punch Burger" and drank a "Mixed drink" there. Non alcoholic for those who do not know what a mixed drink was at the Toot and Tell It.  By the way I was never taken home by Deputy Harvey Whaley. ....and yes Jerome, as he is asking right now, it was counter clockwise.  For those unaware that was the proper direction to circle the Toot and Tell It. 

                 

"Pass it on" is a phrase I heard regularly from my father from November 1, 1970 until his death 37 years later.  I expect others at his church have heard it more than a couple of times as well from him.  Honestly I remember in the last conversation we had on the phone two days prior to his passing that he had a heartfelt "moment" that day and he was going to "pass it on" at church that Wednesday night..  I understand from people who attended Wednesday night services at his church that night, First Baptist Church of Richlands NC, that he did indeed have a "moment" and let the church know in a speech that night it was way past time to move on building a Family Life Center they had been putting off for some time.  

 

Believe it not all this "pass it on" got started in a "moment" of my own when the youth choir at this church presented a musical, not just a regular ole Christian musical, but a folk rock musical to the congregation of the church Sunday night November 1. 1970 at the old church building in downtown Richlands.  Now trust me a FOLK-ROCK musical was serious business back in those days. Especially being presented at what had been a Missionary Baptist Church. The name of the musical "Tell It Like It Is" pretty well sums it up in that we the youth of the church were going to tell our elders of the church just how things really were.  Rock music, slang talk, and serious in your face stuff were part of the deal. So that Sunday night Nov. 1, 1970 we the Baptist church youth choir in front of a standing room only congregation let them have it.

 

Well to the shock of us youth many in the congregation actually liked our approach and thought just maybe we were on to something. Believe me to us young folk this was not what we were expecting, after all this stuff we were doing was serious rebellion so to speak. But except for a few who will remain nameless and have passed on now, most were appreciate and downright enjoyed our presentation. The last song in the musical was entitled "Pass It On" and my father, God bless his soul, never let me forget that phrase.

 

The song is about good Christians "passing it on" to others. The opening verse goes, "it only takes a spark to get a fire going and soon all those around can warm up in it's glowing, that is how it is with God's love once you experienced it you want to pass it on".  My father considered that wording right smart so to speak and said that is exactly what we as Christians should have been doing all along. Sorta the Great Commission summed up nicely in an easy to remember word bite it you were using today's approach. 

 

So for 37 years whenever he had a thought about what needed to be done in the church or how we should display good leadership or citizenship he would say we should  just remember we are to "pass it on". Either to the next person or next generation as anything we have is not ours, but to be used for God's glory and the future building of Christian character.  For the first couple of decades I frankly cringed when I knew he was going to say it., because it was like dishing back at me what I thought was being dished towards him to begin with. However the last couple of decades of his life I began to appreciate the use and realized not only what he was saying, but that maybe I needed to heed my own words as well.  Once you are past 35 years old it seems your father gets smarter doesn't it?

 

During those 37 years a new church education building was completed  , a new sanctuary was built , and young people Christian trained and sent out into the world with hopefully enough worship in their soul that they would grow and "pass it on". I suppose he and his generation did indeed get some things done with passing it on.   Of course it now all that comes down to me as he is gone and it is my job to "pass it on". 

 

As two blessed Christians and remembering the Great Commission for us it is my wife Judy's and my pleasure today to fund the first  Bonner H. Jones and Wilma D. Jones Scholarships at the First Baptist Church of Richlands NC.  There scholarships now endowed forever will provide funding for Christian young people from the home church to go "tell it like it is" on their own now.  My father and mother will be remembered for the Christian based life they lived and so richly gave to me.  I suppose we can now say we have begun to "Pass it On". "Mr. Bonner Hugh" as the church knew him we believe would be pleased and proud. 

As a final note my father so very much wanted to be a part of the current "Under Construction" building project planning that the church is doing vision awareness on in today's service.  The Family Life Center that this project encompasses was a dream of his and as I told him before he passed on that "as long as I am alive you will be too".  My wife and I will be participating in some form financially as he wanted and in remembrance of him to help towards the church's goals. 

Investing and a Future without Obama.

The stock market has gone down a good bit the last month and some analysts are now opining that one the  reasons is that investors see the coming tax and fiscal train wreck that awaits us at year end 2012 due to expiration of so much of the current tax and spending laws. There is also the worry that Obama will be reelected and the result will be a continuation of doing nothing to fix this fiscal mess. Even if he is reelected and wins some seats in Congress if he does not change this highly negative approach to the election he has likely poisoned the well so much no one will want to cooperate to make the situation better and that is assuming Obama man's up to the financial mess.  There remains the real possibility that Romney could win and with him we might see some light at the end of the fiscal tunnel all be it a very long tunnel.  Let's consider a future without Obama. 

 

 Here are six items and some fact about China that most investors and the media do not see which will be big underpinnings to the economy once business and investors begin to consider investing in new ventures. They are game changers.

 

 One is the fact that interest rates have been low for some time now, generational lows,  What this means is that corporations, businesses, and individuals have been able to refinance or finance debt and loans at these low rates for several decades going forward. Heavy users of capital, such as utilities, have done extremely well with this cheap financing. This huge expense saving going forward is going to reap dividends for US business not only in making profits, but also in hiring decisions and most importantly in being able to compete with other countries.  You will also find that utilities will be able to keep energy rates lower and that in itself will keep US business more competitive.  This is one of the reasons utilities have moved upward in price in the last few years. 

 

Two is the gas shale revolution. As we have opined in a posting like it or not the Obama administration, environmental extremists, and states such as New York this revolution is real. Again utilities will be the main recipient of this huge cost savings event.  Utilities are closing coal fired plants and replacing them with natural gas plants across the US and this is NOT because of EPA rules it is due to the cheap and long lasting natural gas supply right here in the US. A little known benefit of this changeover is that coal will still be mined and shipped to China for use there so the coal industry will still prosper. You also have many other industries that use coal or oil now that will switch over to gas and save money.  Now add in if we change administrations and the new one moves forward on using our new huge shale gas reserves for trucking and you get additional savings. Gas at around 3.5 cents per kwh is the cheapest fuel, cheaper than hydro, cheaper than coal, half the price of wind and nuclear, and only 10% of the price of solar. Obama being gone also allows the new Keystone XL pipeline to go forward and sometime in the next decade American will finally be totally independent on gas and oil energy via US shale gas and Canadian oil.  This could allow America to pull back on their forces in the middle east and have savings there as well.

 

Three is the simple fact that US corporations have taken the financial crisis to shed expenses and restructure balance sheets that are very solid. That is one of the reasons these companies are turning out nice profits currently. Unlike bloated government the efficiency of business has allowed it to get lean and mean. When an upturn comes these same lean operations will be prepared to add employees and spend capital on building for future sales and profits. This is one area where American corporations are at their best and that is making tough decisions and following through. It is also why we continue to opine in my postings that these newly downsized corporations are able to pay nice dividends that are good safe alternatives to low payout US Treasury bonds.

 

Four is that one of the things holding back a recovery is scared money. Investors and consumers who do have resources to invest and spend at this point in any recovery are being held back due to the fear of being targeted by the Obama administration as well as the unending verbal pounding anyone with assets is receiving directly from Obama. Once this money is turned loose jobs will begin to appear as consumers begin to make purchases. One of those purchases is likely to be in the housing area where investors could begin to buy up the over inventory of housing. 

Five is the huge stock buy backs going on behind the scenes currently.  In my 30 plus years of investing in the market I do not remember stock buy backs at this pace ever. not only is it the large number of companies doing it, but the size of the buy backs almost always in the billions of dollars.  Two factors here are important. One is that corporations currently see no better use of their cash reserves than buying back their own stock. This likely is the consequence of point number four above. That also means companies believe their stocks are good buys so maybe it is time for you to consider investing as well. The next factor is that once the economy turns around and Obama is gone the surge in business and investment will reap profits and those profits will be spread across a much smaller shareholder base. Stocks will move up due to lower PE's. Much of that money being used for stock buy backs will turn into investments in people and capital for expansion. 

 

The last reason is something most people overlook in the current world and that is unlike just about every other developed country the population in the United States is growing. Yes, it is aging some, but for the most part nothing like what is occurring in places like Europe, Japan, Russia, and even China. These countries by mid century will be places full of very old citizens. America will be young and vibrant by contrast.

Now let's address a long standing "truth" you hear constantly from the press. The ongoing consensus currently is that China is going to surpass the US as the leading economy and leading global power by 2050.  Let me put this question to bed by saying simply, "a'int going to happen."  Lots of reasons,  but the most important is culture.  I believe the reason the idea of Chinese supremacy is believed to be fact is many in this country want that to be fact. This fact is like other "consensus facts" such as global warming and peak oil, people with agendas WANT them to be so. 

 

China's culture is authoritative driven with most decisions coming from the top. This is similar to the current US Federal Government and it is highly inefficient. That produces investments in construction and industries that simply do not work efficiently. Many do not have a piece of the action so those people have no interest in improving the business in which they are employed.  Tom Friedman and Paul Krugman praise Chinese getting it done with one person dictating decisions but never has a economy of that type ever beaten a true capitalistic economy.  Americans are the ones who invent the new technologies, perfect the latest trends, and our businesses produce the best workers in the world. Our schools might send out some of the least ready employees in the world but the fact is by age 30 American business has retrained them to be the most productive on the planet.

 

China also has a Achilles heel in it's one child policy. That policy is around the year 2035 or so going to bring some serious problems to China.  Aging population to care for with many less young people to handle the task. Lots more retirees and many less people to handle exporting business. A population that actually will be shrinking. This again might thrill some environmentalists who believe the world is overpopulated, but the truth is the bigger problem is declining population. America on the other hand has a large immigrant population that is young and even with lower birth rates Americans have never gone below population replacement level. 

The economy if turned loose we could roar ahead. There is pent up demand for just about everything except houses. Cars, which are the second largest major impetus behind economic expansion in this country behind housing could literally roar ahead if allowed to do so. Average car ages in the US are the highest ever. 

 

Housing is another story but even there we are finally seeing some bottom in this industry. Again another president would finally allow the prices here to bottom out allowing investors to come in and buy up the excess inventory.

 

Frankly the only thing holding back a robust recovery is government and once government becomes accommodative you will get a recovery like the 1980's. 

 

 

 

 

May Report

Our May report reflects what we just saw with the May employment numbers and both are just plain awful.  Frankly we did not expect the Obama economic policies to hurt the economy so much this year, but we were wrong.  It seems even the US economy can be brought to it's knees by a run of awfully bad policies.  Our plans this year were to lay low with a low risk stock selection and make decent profits, not great profits.  We did know that a couple of our selections that were further out on the risk horizon but considered  the mix was fine adding in the safer selections, but that has not been the case.  As we move forward towards the second half of 2012 as we take our loss medicine we will adjust strategy to a highly risk avoidance stock selection. We have considered taking some assets off the table, but have decided against that for the time being.  As long as Obama is president it is now clear only fools take ANY serious risk and up to now WE have been fools.  

Our cash flow for May was good as we continue to produce good option premium income.  Both of our large loss positions produced high income from premiums for the month.  They are GG and ERF.  BCE and CTL were good trading vehicles as well for May.  Using May as a separate figure the annualized result was just over 17% gains. Margin costs were up, but not significantly and trading costs were as expected.  However factoring in the pending paper losses we are barely up for the 5 month 2012 period.  For the 5 month period we are at 1% annualized income net assuming paper losses.  I suppose with the 10 year US Treasury paying about 1.5% this morning we are nothing better except for the effort.  Unlike the US bond there is the real opportunity that our fund could finish the year in a double digit percentage gains since cash flow for us could continue to be solid. This is not a happy scenario, but being a trader we will remain positive that we can cut the losses and move forward for a profitable last 6 months of 2012. 

Again we note our fund is based on the fact that we are making money using leverage so if we did not use the leverage there would be no gains and no losses.  We still believe that prudent trading involves taking leverage and making profits where there would be none without the efforts.  Careful selection of stocks is the key.  We see no scenario where at year end we will be in the negative even with this economy so the effort remains worth it if for nothing but the experience and education.  However in the end we must admit we were wrong thinking even the US economy could withstand Obama's policies.