Putting the pieces together...

1958 All Over Again?

Others are beginning to see a possible role model for the 2011 economy and market in the 1958 recession and bear market. Mark Hulbert is pondering the same question of what it might mean when stocks pay higher dividend rates than the ten year Treasury note yields. The Dow is currently yielding 2.8%, the SP500 2.2% and the ten year note 2.o%.

You'll be thinking I'm a Peter Bernstein fanatic in view of my recent discussion of his ideas on portfolios for modern allocators, but I reviewed one of the final publications before his death on the 1958 stock and bond yield inversion in November and December 2008.

Hulbert and Asness see the bond/stock yield reversal being due to increasing stock volatility then and now, but I see it another way. 1958 was a severe recession and the first in living memory in which inflation existed and got worse. (See the recent post on ASA.) Most people in 1958 thought that it would be bad for stocks if interest rates rose. But rates did rise and growth stocks roared up out of that 1958 low up to the 1966-73 highs with bond rates well above the Dow dividend rate. I think that's what we're going see very shortly in 2011: a reversal up in bond yields and a breakout bull market in growth stocks and gold stocks.

 

New Articles on "Near Cash" Funds and Beyond

Both of these are recent comments, reported today on MarketWatch.com . The first, by Zvi Bar, features ETFs up to about two year average duration.

My two favorites on Bar's list are 1) SHY with ~60% in US Governments and 35% in non-government mortgage issues. It has average duration of 1.84 years and pays ~0.8% based on annualizing the distributions through August divided by today's close. 2) BSV is Vanguard's short term bond fund with duration of 2.61 years, paying 2.02% holding 37% in Governments and 48% in corporates of top rating (not many banks). Both of these funds have AA average bond ratings. The choice would be based on your own duration risk profile and desire for modest income under 1% or just over 2%.

The second article, by Dave Fry of The Street, features intermediate corporate funds. Most of these are loaded with bank bonds, a lot of them from European banks, and have no appeal for me.

I don't own any of these right now and have put together my own portfolio of Vanguard, PIMCO, and Loomis Sayles bonds and have recently written it up here. But if you want a conservative all-in tradable fund, either of SHY or BSV, or even a mix of them, could work. They both have decent trading volumes.

http://seekingalpha.com/article/294186-low-fee-short-term-fixed-income-etfs-performance-and-yield-review?source=marketwatch

http://www.thestreet.com/story/11260766/1/top-10-corporate-bond-etfs.html?puc=tscmarketwatch&cm_ven=tscmarketwatch

Bernanke's Talent and Current Events

Chairman Bernanke's reputation was understanding depressions and later accepting the challenge to prevent one. However, he (and the government and congress) has repeated the mistakes Japan made following its own inflationary bubble blowout. Japan is over two decades from its peak, just as it took the US two decades to recover after its high in 1929 and mistakes in the 1930's. The magical promise that massive government borrowing to spend would produce real economic gains is now a third failure of its type.

With the manipulation by central banks and governments and resultant volatility of markets, and an absence of normal interest on savings, people living off their capital are punished in many ways and are threatened with higher taxes as well. It should not be a surprise that markets are cratering. But it requires constant study and analysis to stay ahead of simply holding average mixtures of indexes. That's why Peter Bernstein's interview by Kate Welling was so very important to me.

Having raised a lot of cash and "near cash" this year I decided to buy slowly and in small portions on big down days in the market, outlined a month ago in "Re-Thinking the Set and Forget Portfolio". The "near cash" portfolio and alternatives was reviewed again more recently. (See the left hand column under Recent Comments to click through to all these comments here, or, if viewing this after a month or so go to the Archives for August and September 2011.)

Today I added to Permanent Portfolio Fund (PRPFX) whose whole asset mix was crushed today  and to FPA Crescent Fund (FPACX). After grasping the probabilities of the FED's "twist" operation, I decided to add back several of the mortgage REITs yesterday and today. The interest payouts on "near cash" average about 3.5% but by "flavoring" them with mREITs yielding ~15%, I can raise the overall payout to 5% or more very easily. The math is easy to do. Given 0% interest for Fed Funds and not too much more for borrowing at LIBOR, the mREIT repo financing is pretty well secure for another two years. With the FED "twist" selling shorter term Treasury Notes (2-4 years), this may give the Agency mortgages and GNMAs a better yield advantage and spill over into most mREIT holdings. Nevertheless I hope to avoid getting greedy and will keep the mREITs on a short lease.

I have bought AGNC, NLY (the two largest) plus MFA, ANH, and HTS. They will take up some room intended, but not yet spent, for more Loomis Sayles (LSBDX). The "twist" could also benefit longer dated corporates and junk bonds, but I'm unwilling to go out that far on the duration curve, knowing that junks trade more with stocks than with investment grade bonds.

For clarity, I am not selling gold and will actually add to ASA in small amounts on large declines. Gold and quality foreign gold stocks have bright futures under all foreseeable scenarios from deep recession to total monetary collapse to resumption of inflation. We may see some of all three going forward.

 

 

ASA Discount Sale

ASA Gold and Precious Metals is the longest-lived US exchange-listed precious metals stock fund. ASA started up as American-South African on September 1, 1958 and has traded in the US ever since. It has been registered as a Bermuda-based fund for many years.

 

Why 1958? Was there any interest in gold back then? Oh yes, indeed. As the 1950's progressed it already became quite clear that the US was debasing its currency away from post-war international agreements (Bretton Woods etc.), and that the US government was living far beyond its means. Sound familiar?

In 1958 the deepest recession since the war(s) occurred, but for the first time in living history, there was inflation at the same time as recession. Thus there was a great interest in gold. But of courseUS citizens could not own gold bullion legally except for pre-1933 collector coins. And most US gold mining companies had been shut down in World War II on the direct order of President Roosevelt.

South Africa was the largest gold producing nation in the 1950's, and South Africa shares had very high dividend payouts, well over 10% in many cases. Several gold stock bull markets took place from the 1940's to 1960's. South African gold stocks were, however, hard to buy by individuals, and the pink slip or OTC shares had very high buy and sell commission rates. Thus NYSE-listed ASA Ltd was a successful breakthrough in 1958.

ASA originally held major blocks of very low cost basis South African shares from the 1950's, so the potential for substantial capital gains taxes weighed on ASA's stock price for decades. As South African gold and platinum outputs peaked later on and new mining companies arose from the 1970's on, some ASA diversification out of African shares began. But also the rise of gold stock mutual and ETF funds made ASA's South African emphasis look dated.

In addition, and partly due the persistent discount of ASA's price to its net asset value (NAV), a brutal vulture raid on ASA took place in 2007-2008. It forced the liquidation of a very large part of its portfolio, thereby caused major capital gains realization, and the management was replaced. The new management and its board remain to this day obsessed by the persistent discount of ASA's NYSE price to NAV and regularly tender for shareholder holdings in a futile attempt to narrow the discount. I say futile because there is a volume of literature on the subject of closed-end fund discounts, and there is absolutely no evidence that discounts can be actively eliminated except by going the open-end mutual fund conversion route. Closed-end funds rarely want to do that since the management rarely owns very much of the stock, and will thus usually be out of a job if they convert.

Despite hundreds of pubished studies on closed-end fund discounts to NAV, no one knows for sure why they occur either in the US or elsewhere! In ASA's case the repetitive tenders reduce funds under management. But the management is trying to start up its own independent gold stock accounts management, so they may find it embarrassing to themselves that their flagship trades at a persistent discount to NAV and are trying to eliminate the discount, being unaware of the  discount  literature.

Given all this distraction and the negative news of recent years and decades, why am I interested in ASA at all? Two reasons stand out: the excellent portfolio and the 15% discount to NAV. Discounts  vary, but a relatively large discount is also a sentiment gauge indicating current lack of interest due to relative market inaction. In a real gold stock bull market the discount would narrow and quite possibly even disappear. I expect a bull market in gold stocks before bullion gold's bull market ends. Despite the wretched decade behind it, ASA has performed very well.

For the record, I own ASA shares. Also for the record, ASA is a passive foreign investment trust (PFIT) for US taxable accounts. I have written about PFITs like  Central Fund of Canada (CEF) and will write more about this for ASA later. For ASA, as opposed to CEF, it makes very little difference, and you needn't do anything about it in any case until April 15, 2012 and not even then if you do not wish to register your ASA on your tax return as a PFIT.

For The Duration....

PTTRX reverses course after a bad US TBond short trade: http://tinyurl.com/3hf6l2b

"Near Cash" Alternatives

With money market fund returns so low and probably going even lower with US funds now backing away from turmoil in the higher yielding European money markets, alternatives are in order.

The chart shows the total returns of five such alternatives since June 30, 2008.

 
I have owned all of these at one time in the past five  years and currently own VFIJX as one of my "Big Six" and own smaller positions in VFIRX and PFIUX.

The table is the Vanguard website fund comparison format showing all particulars of each of the five funds as to costs (VERY important at low yield), duration, record of performance, etc.

 

All of the Vanguard are very conservatively managed with excellent individual issue selection and fabulously low annual costs. PIMCO's Unconstrained Bond Fund (PFIUX) is the most interesting of thre five and most like a hedge fund. PFIUX's charter allows it to vary the fund duration all the way from five years to minus three years! The latter would be a substantially net short position. Currently duration is about five months,  compared to a maximum average duration of 90 days for money market funds.

PFIUX is said to have been developed at the request of a PIMCO private separate account owner, and proved to be so successful that it is now offered to the public since June 2008.  PFIUX itself is available to the public with $25,000 minimums at some mutual brokerages like Vanguard and Schwab,, and for smaller minimums there are other classes of the fund at moderately higher cost.

Recent Reads: Peter Bernstein on Tactical Allocation

Peter Bernstein passed away several years ago, early in the financial crisis. An interview of him by Kate Welling in 2003, just before the March stock market low, outlined many of the problems investors have now had for the past decade. I recently rediscovered the interview and find it relevant to the issue I've been grappling with, namely how to model a portfolio to generate decent returns in volatile and uncertain times and during mandated retirement drawdowns.

As Bernstein gently pointed out, investing for the long run is fine if you are either adding money regularly or not withdrawing any. He was talking about pension funds or charitable trusts and endowments, but the the problem faced by retired people, and everyone living off their income, is the very same. Most long term investment returns come from the complete re-investment of all dividends and interest. But if you must remove dividends and income and even some capital for spending, as sometimes also happens to pensions and charitable or educational endowments, your portfolio gains are less and your volatility is higher, since you may be selling assets as markets decline as well as when they rise.

Bernstein's plea to portfolio allocators was not to be too rigid in following formulas such as the rule of 60% stocks and 40% bonds. In fact he was very dubious that stocks would give decent returns at all for a decade or longer. Even though bond yields then were low (they are lower now) he thought bonds could and would probably do better, and they did.

In the interview he also makes the now famous case for alternative investments and also for adjusting portfolios either by fairly frequent re-balancing or "even" market timing. In the interview he didn't spend much time on market timing or on re-balancing except to say that they nail down shorter term gains and are therefore a mechanistic models for increasing portfolio payoffs in uncertain and volatile times.

Bernstein also recommended giving portfolio managers greater lattitude on asset sector selection and on individual issue selection. He was not a fan of rigid reliance on stock or other indexes, especially in uncertain and risky times. Tracking index averages is far less productive than following the best managers you can find and can afford. My view is that the careful study of mutual fund returns over time can give us very talented managers at annual costs that are quite reasonable.

This all impinges upon my recent decision to stop doing my own micro-management and also to start a more mechanistic method for allocation and profit taking. Bernstein's 2003 thoughts are thus grist for my small personal mill. I am working my way into a multi-asset portfolio in the spirit of Harry Browne but run by proven productive managers I have chosen rather than by index committee formulas. Gold is the only exception since it is only gold if it's real gold and not a paper index of gold.

As with most Bernstein ideas, this interview's ideas are very thoughtful but also quite subtle. They can easily blow by people are are rigidly committed to other approaches. But at this time his suggestions make very great sense to me. The interview is fairly short and definitely a good read of the thoughts of an older and very wise veteran of money management. Sometimes the best ideas are presented softly.