Friday, July 31, 2009

Were You Ever a Super Hero?

When you were a kid did you have a super hero? Well I did and my superhero was Superman. I could pin on a bath towel and it magically turned into a red superman cape. It did not matter to me that the towel was white I was still superman. By the way, what super hero did you want to be when you were little? Can you remember?

I liked Superman because he stood for truth, justice and the American way. I’m not sure that I knew then what those three things stood for, but I know I have a better understanding about them today. I recently came across one of those items that caused me to be concerned about the concept of truth.

Some of you may recall the problems experienced by the Reserve Fund last fall. This first money market fund had to close for redemptions because it's directors said that a $785 million position in Lehman commercial paper was worthless due to the bankruptcy filing of Lehman the day before.

People who had money in the fund were told that there would be no redemptions and you could not get your money out. The problems experienced by Reserve Fund and other money market funds caused the government to insure through FDIC, money market mutual funds. That protection was extended to September 2009 when it will, unless extended, expire and the FDIC insurance on about $4 trillion in money fund assets will revert back to the way things used to be.

As a routine I check the Reserve Fund web site, to see what is happening in the Primary Fund. Below is a copy of the Floating Rate Note section of that fund. I have highlighted in bold the Lehman Brothers positions for you to see. This is important; the directors of the fund could not value these positions and could not find a discernible market for this commercial paper.

As you can see below they are showing the value of these positions at full value, what they paid for the position. So, when you look at this report you are led to believe that these positions in Lehman have not lost any value and when they sell them, because the fund is in liquidation, you’ll get all your money back.

Floating Rate Note ASB FINANCE LTD. 08/25/2009 1.0712 500,000,000 9.36%
BARCLAYS BANK PLC 09/16/2009 1.0744 200,000,000 3.75%
DEUTSCHE BANK AG NY 10/21/2009 0.8388 208,000,000 3.89%
GENERAL ELEC CAP CORP 09/24/2009 0.3550 200,000,000 3.75%
HSBC USA INC 10/15/2009 0.9250 275,000,000 5.15%

LEHMAN BROS HLDGS INC 03/20/2009 0.0000 250,000,000 4.68%

LEHMAN BRTHRS HLDG INC 10/29/2008 3.7100 185,000,000 3.46%

LEHMAN BRTHRS HLDG INC 10/27/2008 3.2900 200,000,000 3.75%

LEHMAN BRTHRS HLDG INC 10/10/2008 3.0000 150,000,000 2.81%

LLOYDS TSB GROUP PLC 08/07/2009 1.2862 183,000,000 3.43%
NATIONAL AUSTRALIA BK LTD 10/06/2009 0.8594 60,000,000 1.12%
NORDEA BK EXTENDIBLE SHORT 09/24/2009 1.4494 114,000,000 2.13%
ROYAL BK SCOTLAND PLC 10/09/2009 1.0294 390,000,000 7.30%
Total Floating Rate Note 2,915,000,000 54.59%

If in fact the Lehman positions prove to be worthless, then the funds shareholders would take a loss of $785 million. Let's assume that everything else is redeemed at par and the fund takes the loss of the $785 million in the Lehman position then the net asset value goes from $.97 to $.73. The net result is the possibility in a money market fund to loose 27% on your money.

What has me in my superhero costume is that the fund can get away with showing to the public that the Lehman positions are carried at par when in fact they maybe totally worthless. As one new contact I made on my most recent trip to Sanibel said to me, “Don’t tell me they are carrying them at par.”

I have a new super power. It is called Transparency. As a super hero I want to bring to investors the need for more transparency in all types of investments. This new power will not allow me to leap tall buildings in a single bound, but it can, if people use it, thwart wrong doers like Bernie Madoff and protect investors. As investors if you do not understand an investment then don’t buy it. If it seems risky it probably is. Don’t buy it. If it sounds too good to be true then it probably is. Do not buy it. My X-ray tells me to look at the returns in the 10-year Treasury market as the benchmark for risk. If the yield on the 10-year is 3.75% and somebody is talking about 10% then think real hard, use your X-ray vision to make a good decision.

Dan Perkins

Thursday, July 9, 2009

It's summertime but the livin isn’t easy.

In my last posting I suggested that the price of oil could decline to $50 and the yield on the 10-year T-Bond could reach 3%. I still think that could happen and it may well happen faster than I thought it could. As of this posting, July 9 the price of oil was $60.57 down over $13. The yield on the 10-year T-Bond is 3.40% down from just under 4%.

I suggested in an older blog that I thought the S&P 500 could test 800 to 810 before we would see a run at 1,000 later in the year. The current level of the S&P 500 is 882and the next major level of support is 870 to 875. If we close below 871 we could quickly see 856 on the S&P 500. We may well go down quickly before the vast majority of investors realize we are down so much. Once a majority of investors sees that we have come down so far we will see a wave of panic selling. Those people who have seen a recovery in their portfolios will get scared and will be concerned that we could go all the way back to the previous bottom of 666 on the S&P 500. This last panic selling will set a new bottom and be the catalyst for the market to move up and challenge the 1,000 level on the S&P.

We still haven’t come to grips with the fact that the recovery, when it comes, will not be as robust as many people are currently thinking. I know you have heard me say this about the recovery for sometime in this Blog. I realize that to most of my readers this is old news and just like my prediction on housing of 2006, because you read it here first, when the main line starts suggesting what I have already said it seems like old news.

If I’m right about the correction, what should I be doing in my account? If you are a client of mine, not much because you already have a high level of cash that we can deploy if prices fall low enough. If you don’t have at least 15% cash then start selling your laggard stocks that did not recover when the market went up and think about what you want to buy and at what price. Just like when you go to the market you should have a shopping list, you need a shopping list for investments. What should be on your shopping list? Look at the stocks that lead the recovery that pay a handsome dividend. Go back and look up the Blog on the Nine Brothers, now Eight Brothers.

You might want to look at ten-year high quality muni bonds for the tax-free income. One of the challenges with municipal bonds is the credit quality. You might live in California but you should be careful in buying California bonds. In the past by buying your state bonds you could save federal and state income taxes. Today you might be better off having some of your money out of your state for safety and diversification.

Make your list, set a price and if what you want to buy gets close to your price buy half of what you were going to buy. Watch and see what happens and if the price falls after your initial buy then you spend the next 25% of the 100% you had to invest. If the price stabilizes, spend the rest of your money.

Soon you will be receiving your June statements. I have had several clients call me and ask if I would talk to a friend or family member about helping them with their investments. I said to them I could only handle so many clients and provide the level of service I want to provide to those clients. If you know someone that needs help let me know and I’ll call and see what I can do to help him or her.

Dan Perkins