Wiped Out?

Hardly a day passes that we do not see that a hedge fund has closed.  Many of the long time hedge funds in the past year have taken significant losses and the resulting exit of investors.  The reasons are many but mostly they revolve around a market where placing hedge bets increasingly result in losses.  Since these losses are hedged the loss factor can sometimes be many times the bet made.  Hedging in it's simplest essence is stock insurance either on the bull or bear side.  Any insurance market where losses become unacceptable or more importantly where the writer of the insurance can no longer see some reasonable assumption that the majority of the hedges will end up making money the writer stops making insurance shop. 

This is exactly what has happened in the US stock markets as more funds are as I said exiting the market.  Without the insurance protection, but more importantly without the insurance protection with reasonable premiums investors are left totally naked.  Like it or not lack of hedging in the stock and bond markets mean a much more unstable investing market going forward. Imagine automobiles and homes where insurance companies will not write insurance or where the insurance cost is higher than most people can afford.  

Our fund has in the last year taken some losses as well, but even into the last quarter we were positive cash flow. Much of this is due to the structure of our fund in that we hedge only certain kinds of stocks and then only a dozen of those that make the cut. We have been selective and our structure has always made cash flow a priority with a built in planning where even when we might be sitting on losses we could cover interest and trading fees until the market improved.  The key was to make enough cash flow via premium gains to make money.  However there has to be some solid base of reliable stock pricing to make this plan work.  In the past year the constant unreliability of stock pricing has made placing hedges almost impossible.  Much of this is due to a political environment where one has no idea where Obama or some other politician makes doing business for this or that business much harder by some policy move.  In the past year be it oil, tobacco, telecom, real estate, business development, and finally utilities have been hit by some form of policy change that resulted in stock price hits that could not be hedged via the normal news cycle. 

The last one utilities is by far the most extreme in that for years those businesses operated as boring regulated dividend producing widow and orphan stocks.  No longer is that the case.  Southern Company the first company we ever blogged about was as boring as they come.  This past week they finally succumbed to the global warming/climate change policy and took a earnings hit.  We honestly believed that was impossible up to now since the regulatory environment they operated in was most positive. 

The past week following the re-election of Obama the full force of the unreliability of earnings and dividends has come forward in a large sell off in the stock market and the pending losses in our fund are now more than our accumulated cash flow over the past year.  We are hoping their will be some relief in the brutal sell off of the past week the next five days prior to the options expiration cycle ending next Friday that will at least bring us back to even for the year. Even if it does not we are now considering ending our hedge activity after many years of doing so since the Obama environment makes it too difficult to do planning with so many unknowns involving policy decisions. 

We have always played with house money and used other people's money to make insurance coverage decisions.  Therefore if we do indeed decide to exit the trading market we leave with no more assets or no less assets than we brought in, just the loss of cash flow.   Frankly in a political environment where common sense and logic are replaced with emotion and cronyism we just prefer not to play.  Over the next couple of months our blogging will be much less as we continue to survey the current trading environment.  We will take this time to unravel our positions and begin an orderly exit of the options market.  We suggest others consider removing assets from danger as well. 

               

Searching for that Helen Keller moment.

This post was put openly online today and I am reposting it here for purposes of my readers to see since many who read my posts DO get the point. 

Yes I have seen many of your posts from my liberal Facebook friends who supported Obama regarding some mean spirited posts on FB you said you noticed by some of your and maybe even my conservative FB friends.   First off I have checked back and did not see any of my posts I considered mean spirited, but maybe you took them that way.  If they came across that way I apologize now.  All my posts either in jests or just pointed on a subject were purposed in finding that "Helen Keller' moment with those of you who I believed did not grasp the seriousness of the election. 

By saying that Helen Keller moment I meant that moment in the life of Ms. Keller where after a long and tortuous effort by her teacher Anne Sullivan where she 'gets it' and begins to frantically want to learn all she can after the light goes off about her situation.  if you have seen the movie you know her teacher was at her wits end trying to communicate but as a teacher knew IF she connected the quest would be worthwhile. 

Not to be overly cocky here, but for most of you reading this post I understand the American free market system better than you do.  I talk regularly as I have for over three decades with small business owners and I connect with their concerns and hard work they put in to survive and sometimes hopefully thrive. Most small business people take great risk with saved capital to make a go of it. Most of you frankly do not since you only see most of this from the outside. I can tell it by hearing you talk or just seeing your posts. You might even think small business people are rich SOB's who either make too much or do not hire you because they want to keep the profits to themselves. Nothing could be further from the truth as the vast majority of small business support local charities, schools, and employ local people.  They also enjoy making life better for their communities as well and like to grow and hire more employees. It is just in their blood.  Something most people do not grasp to be honest. 

Over the past four years most of these small business people have suffered significantly due to the recession as have their employees.  They want things to be better economically and know that the regulatory environment and downright mistrust Obama has placed on them has done nothing more than make things worse economically. They also know Obamacare is the doom to many of these small businesses as they can not afford the costs and stay in business.  To that point Obama had to go to make things better.  Anything else the media tells you or you believe frankly is not true and my efforts on Facebook has been to try and make that point get home.  

Add in the simple fact that Obamacare long term ends your liberty of choice regarding your own health care decisions.  Like it of not that is simple fact.  Your vote for Obama meant that you were willing to throw away your liberty and continue the slow death of small business.   I frankly am sorry I could not connect as I have opined on my blog smalltowninvestor.com which most of you do not read that this election does not effect my personal well being much as I am old enough to literally run out the clock and live life before things really go bad.  In going bad means we can not go on as Obama and some believe forever spending like drunk sailors and not go broke.  Trust me on this one taxing the so called rich there is not enough money to tax to solve the problem.  So to that end I failed in helping most of you see the "Helen Keller" moment.  I am not mad at you I am sad for you for the pain and problems will be yours.  At this point there is no hope and to that I am very sorry.  

 

EXC...Looks like we are wrong again.

In at least two postings in the last couple of months we have mentioned that EXC looked to be a good buy.  The price was depressed and the dividend solid.  Well we look to have called a position wrong once more this year.  

Today EXC took a pounding.   The stock after reporting somewhat weak earnings actually was headed up in price due to some positive comments from the CEO regarding future earnings prospects.  Then the CEO should have shut up, but nope he went on to casually suggest they might consider lowering their dividend payout down the road.  That led to a over $2 sell off in the shares now selling at just over $33.   

Frankly we seem to have laid another egg here with a call and since we own put options on this one it will cost us several thousand to exit the position.  We expect that the stock will recover some since the sell off was quite sharp.  But that will likely be temporary since once said dividends generally are cut.   Also note the stock will go ex-dividend Nov. 15 so if you are holding this stock make that consideration in your decision. 

Our surprise is this stock is a regulated utility and even with the costs of the Hurricane Sandy clean up the regulators would likely allow them to recover the costs via some rates adjustments.  But today the CEO said that former rate adjustment requests were not looking good either.   Since EXC and Barack Obama have some tight connections should we take today's action as a sign Obama is going to lose?

               

 

Boom Economy to Come?

Hardly a day passes that we do not talk with a small business person who tells me some version of this next sentence.  "Once the election is over and I see that Obama will no longer be President I will begin to invest capital in future business projects and hire people."    There are even real estate speculators who are holding off spending in this already lower than low interest rate environment expressing similar comments.  It all boils down to one point Romney will need to do little to get the economy going forward in a more positive growth phase other than winning next week.  We frankly expect by December it will be obvious to most that business is improving. Once he is President, if he wins, and makes some policy moves we fully expect a full economic boom to commence in less than two years. 

Fear of government is not what our founders had in mind when they wrote the constitution.  Actually they wanted the government to fear the people.  With Obama in charge the people, and more importantly investors, will not invest hard earned and saved capital due to concern that either it will be taken away, regulated away, or just plain stolen in some way.  Americans have a choice next week, either change the investing environment to one more friendly to small investors who do create most of the new jobs in this country or continue to live a life of lower expectations and lower quality of life.  Only fools can not see the obvious and with the current government education system in the US we have graduated a number of fools. 

Personally we have withheld significant investments and invested capital since at least last year due to this fear of Obama.  We are sad because there is so much more we can do to provide capital in ways to help investors, small business, and frankly consultation work.  We would be thrilled to begin investing, but fools we are not.  The last two years have not been kind to our trading platform since Obama makes so many rules and changes so often it is simply impossible to provide the 'stock insurance" we like to sell.  We have tried  to do business albeit in a smaller capital structure making sure not to lose money while still trying to make money. Caution has been the way we have done business since the odds are against us when having Obama as President. 

The choice for us next week will be simple.  Expand our horizons and look to make some money and for the first time in awhile make taxable income with a Romney win.  The other option is to pull in our resources in further, continue to stay off the tax rolls,  discontinue most if not all of our important volunteer work and civic boards, and lastly head to the beach for the next couple of decades.  The later one is if Obama wins.  Understand there are many like us just waiting to decide weather to re-engage in this economy and country or leave it to you who have re-elected Obama.  That last point is important because if many of us with capital and volunteer time leave the public environment you younger people will be forced to fill in where we left.  Your lifestyles will change more than you know.  Your choice.

                 

Death and Taxes..Only one concerns us.

This posting is one we wanted to do back over a year ago when we did our series on mentors, but decided not to because of personal reasons. Today those personal reasons are gone so we thought it was time to give credit to someone who was our other financial mentor.  

Death and taxes are said to be the only things certain in life, but in our case only the former concerns us and not the later. The reason is simple our early financial life was directed with annual visits to a CPA in our hometown.  When we first began work life our father told us to go to the local CPA to do our taxes and maybe he would take us as a client.   The CPA likely could have told us no since he had lots of high profile business, but for some reason he took us as a client and we have prospered for almost four decades due to his guidance those early years we used him as our tax accountant. 

H. Donald Scott we suppose saw us as someone who might have a future and maybe could be a good long term business prospect. You see Mr. Scott was frankly one of the smartest and most ingenious people we ever met concerning financial and tax matters. Fortunately we also were a quick learner and good listener and as he dispensed tax, financial, and investing advice we took it in like a sponge.  One thing he told us was that making lots of money was nice, but if you were going to turn around and give lots of it back to the Federal and State Governments why bother to make it in the first place.  It would be like giving up to 50% of your labor away.  The way to change this was to use, take advantage, and manipulate legally the tax code. Treat it almost as a friend and not an enemy. So we did and whenever our CPA suggested a tax free, tax deferred, and tax avoidance strategy we not only listened we applied the technique and used it going forward. 

Mr. Scott on almost every annual visit gave us a piece of investing advice that would help us make money. An example of which was investing in a small Mississippi firm that was making a big push into telecommunications after the deregulation in the 1980's.  We promptly went out and bought 1000 shares of the pink listed stock LDDS that would one day turn into World Comm.  Now yes World Comm and Bernie Ellhers would one day make news from being a company run afoul of the law, but we had long before that period made some very nice profits in the early run-up in the stock price and exited the position.  All that tidy profit in our tax deferred IRA of course. 

Through the years we have used the early training we got from this CPA to move with the prevailing tax laws and rules to maximize our cash flow and minimize our tax bill. Honestly we expect for someone who has been blessed with our income we have likely paid less tax legally than anyone alive. We were audited some years ago when one year we sent in a tax return owing almost no taxes on a sizable income.  The tax auditor told us he thought we were quite clever with our use of the tax code but did tell us that there was a mistake in our return. The mistake was we had forgotten to take a tax credit owed us and we were actually due a refund check for taxes not paid.  All legal and legit of course. 

Now this next statement generally drives liberals and democrats we know ballistic.  Since we retired in 2008 we have yet to pay a single dime of income tax. Better yet if we so desire we can live out this life and never pay a single dime ever.   The reasons are quite simple the years of planning and using the tax code to our benefit as taught us by Mr. Scott has led us to the point of being off the income tax rolls both state and federal permanently if we so desire. 

Yes, anyone can do this, but most people are not willing to do the planning or take the time to make their finances form to being non taxed.  Not paying tax means you get to use the full measure of your income and actually need less than those paying taxes to do live the same standard of life.  Here is the kicker if we were actually looking after ourselves we would prefer that Obama get re-elected because his policy is to continue the current tax code. Only Republicans want to change the code to make everyone pay more by taking out all the huge cornucopia of tax avoidance techniques that are all legal in today's code.  With Romney we would be forced to pay tax, with Obama none. Try that little piece of info on for size liberals. 

Not to get into specifics here because much of this tax free existence is gained from hard learned experience and maximizing the tax code to our advantage but here are a few pointers.  Using tax deferred vehicles to take as much of your earned income off the tax rolls is almost sacrosanct. Roth and regular IRA's, 401-k's, and HSA's should be used to their very max allowed.  There are many small business angles on these retirement vehicles as well.  When spending money always consider how the expenditure can be used as a deduction or credit against any tax one might owe. Consider if there is a business use attached to the expense and spend accordingly.  Investing in individual tax free municipal bonds from your home state are slam dunks that most people either avoid due to the research involved or just not willing to take the time to learn. Once you have tapped out retirement vehicles noted above do not avoid tax deferred annuities as well since they can allow you to add punch to retirement income and take almost tax free withdrawals.   Charitable giving is a easy way to take money that might be taxed and used by the government but instead used by you for social purposes you prefer.   When all else fails buy something that throws off lots of tax benefits like real estate as again I would rather spend my money in some form of private use than government use. Finally and most importantly keep very good and very precise records.  I keep a file in my desk where I write down anything that might save taxes and update it quarterly just to make sure I do not miss anything.   Yes,  all this can be time consuming, but if you treat if like a work to be done where you literally make tax money back then you get paid to do it. 

Our current CPA has continued many of those early techniques and added a few of their own, but without the good start we would not be in position today. 

Anyway all this goes back to our mentor of our early financial life and for the training and smarts we say thank you. 

Third Quarter Report

For those wondering where our monthly reports went to they are gone.  We have decided why spend time doing those when quarterly will do and besides we prefer time ON the beach as opposed to time AT the beach doing reports. 

So with that noted we finished the third quarter with a 7.39% annualized yield.  Our year to date performance has been not very good in our opinion and it is mainly due to the losses we have booked from bad investment decisions this year.  By far the largest mistake was our early year loss in ERF with amounts to about half of all of losses for 2012.  GG was our second largest, but only about 20% of the ERF loss.  We have also included in the third quarter report a pending loss in LO, which unless there is a huge move we will take a year end.  We currently see no other security where we have a loss to take. 

Our trading fees this year are well within our desired parameter and margin costs have been contained nicely.  

Option premiums are producing expected cash flow and dividends are double margin costs which meet expectations as well.  The key to doing any hedge activity is to keep losses to a minimum and premium cash flow maxed.  This year only one part of that has been on track. 

With three months to go we still have the possibility of a double digit percentage gain for the year.  We frankly will be glad when the election is settled and there is some degree of certainly as to tax policy for the next year.

             

CTL. at the right price.

Who knows why stocks sell off sometimes, but they surely do.  CTL has sold off since late Sept. from around $43 per share to now around $39 per share.  The stock went ex-dividend Sept. 7 so that is not the reason and we have scanned the message boards, news releases, as well as the pundit crowd and can find no reason there for the sell off either.  

So with that said CTL is now yielding right at 7.5% and this is a solid dependable yield, not one just pushed up due to the downward move in stock price.  For those who have not deployed assets in CTL now might be the time.  We have no idea if this stock is going to go down some more, but here at just uner $39 per share you get a good company at a good price and a yield that makes anyone owning US Treasuries view with envy. 

So even if CTL reports a weaker than expected earnings this quarter we still like CTL and believe now is a good time to buy.   

We own CTL options.