Financial Sarcasm Roundup for 08/11/14

I have yet to find a financial expert on the Internet who is more sarcastic than me.  David Stockman's Contra Corner comes pretty close but he doesn't do haiku.

Russia thinks it can win a sanctions war against the West.  America sends a paltry amount of exports to Russia but Russia imports a huge portion of its food.  The Russkies will be hard pressed to find substitute exporters in Asia and Africa, unless of course they want to eat boatloads of rice.  The good news is that fewer Russians will get drunk on vodka if they have to eat their potato crops instead of ferment them.

Europe doesn't like US high yield bonds anymore.  The phrase "impending selloff" is really cute.  That is exactly what triggered pricing chaos in the financial markets back in August 2007 as an early warning that fixed income securities were mispriced and illiquid.  A whole bunch of shaky US companies are going to watch their cash reserves dwindle as investors turn down their junk bonds.  stock prices.  Watch out below.

China's moderate inflation stats got the West's attention.  The West ignores the low quality of China's source data, focusing on headline numbers.  Wall Street still does not comprehend the extent of fictionalization in Chinese economic statistics.  Even surveys of economic activity from private media outlets are suspect.  "Forget it, Jake, it's Chinatown."

The US Treasury is reconsidering its view of MLPs.  The Kinder Morgan restructuring may be a prescient move to get out ahead of any future regulatory rollbacks.  America's tolerance for proliferating tax shelters is reaching an apotheosis.  It was fun while it lasted but Uncle Sam needs to broaden the tax base in ways that don't frighten major donors.  Word will eventually trickle out to upper middle class tax donkeys through their tax accountants.

The best item above is the high yield debt warning from Europe.  I will be overjoyed to watch a whole bunch of yield-chasing hedge funds implode when they can't sell their synthetic securities.  Bring it on.

Fixed Income Facts and Fancy When Staring Down Inflation

An acquaintance got me thinking about the fixed-income universe.  I haven't thought about it much lately for good reason.  Fixed-income investments are wiped out in high-inflation economies and the Federal Reserve's implied policy of monetizing US sovereign debt dramatically increases the chances of high inflation.  The fixed-income universe is much broader than sovereign debt.  I ought to see if any income-generating instrument can survive high inflation.

The Dividend Yield Hunter lists multiple categories of fixed-income instruments that go way beyond bonds.  I was not aware that exchange-traded debt existed in forms other than preferred stock (not really debt, but acts like it) and funds.  The Tennessee Valley Authority, for example, lists its bonds on exchanges for the public to trade (TVC and TVE are examples).  The usual cast of characters like MLPs, royalty trusts, and REITs round out exchange-listed offerings.  I've never considered business development companies (BDCs) as fixed-income investments because they are unique ways to invest in undercapitalized small companies, sort of like VC firms but publicly traded.  Dividend Yield Hunter lists BDCs as fixed-income, presumably because they must pay out their earnings like other pass-through entities.  BDCs are also searchable over at QuantumOnline, and that site also lists exotic things like income deposit securities.

Fixed-income investing is a fine stabilizing element for a diversified portfolio in normal times when interest rates are at their long-term historical average and the national debt-to-GDP ratio is manageable.  Americans are not living in normal times any longer.  Most fixed-income investments will see their principal destroyed when high inflation reduces the dollar's value to nothing.

These are the types of fixed-income investments I have decided to avoid due to their vulnerability to inflation.
US sovereign debt of any kind.  The Fed is going to swallow these things whole when foreign central banks sell them in a panic.  The QE needed to absorb the world's outstanding stash of Treasuries will have to be monstrously huge.
Coupon debt of any kind.  This includes any corporate debt or municipal bonds that pay a fixed coupon based on the bond's face amount.  That face amount will be worth less than nothing after hyperinflation ends.  Say goodnight, internotes.
BDCs.  I don't care how generous the cash flow from repaid loans looks right now.  BDCs are highly sensitive to short-term interest rates and real rates will skyrocket at the onset of high inflation.  Their funding is unsecured, which means investors have little recourse to recover assets after bankruptcy.  No thanks.  Finally, their assets are loan portfolios.  High inflation is a debtor's dream come true because it allows them to pay existing debts with future dollars that are worth less than current dollars.  Inflation will destroy BDC loan portfolios.  These are the crucial differences between BDCs and other private equity vehicles.
High yield debt.  No way, ho-say.  This was the first debt category to crack when the market turbulence of 2007 became the crisis of 2008.  Junk bonds are always the first to be wiped out in any market downturn because their issuers have weak earnings or troubled business models.

These are the types of fixed-income investments I am open to considering, given the caveats mentioned.  Their common denominator is their basis in a hard asset sector.
MLPs.  I like pipeline MLPs as a play on hard asset servicing.  Oil and gas are energy hard assets whose demand will be price inelastic during high inflation.  My concern is whether FERC regulations will prove to be so onerous during hyperinflation that they destroy the pricing power of MLPs and their pipeline operating companies.  I cannot rule out regulatory risk with pipeline MLPs.  I may have to wait until renewable MLPs are active.
Royalty trusts.  These are collections of orphaned oil and gas wells whose owners do not need to spend capex to upgrade them.  They pass their earnings through to trust holders as the wells' reserves run down.
REITs.  These are the trickiest to consider.  Some residential REITs will fair poorly during hyperinflation if their holdings are concentrated in urban areas that are hostages to rent control ordinances.  Those will not retain their pricing power during hyperinflation.  Commercial REITs will fare better but many REITs own a mix of properties.  The best sector bet for me may be iShares Dow Jones US Real Estate (IYR), an ETF of REITs, but based on its dividends it's currently trading more than twice what it should be worth.

I feel like restating my enmity for actively managed funds of any kind, including fixed-income.  Bond mutual funds are no longer needed now that index funds and ETFs exist.  Active management of fixed income portfolios is for institutional investors and corporations who must immunize their portfolios against interest rate moves or match durations to liabilities.  They have specific goals in liability-driven investing.  The larger investing world doesn't need to constantly fine-tune a fixed-income portfolio.

I must also reiterate my disdain for the superficial analysis some fixed-income investors use to evaluate the attractiveness of securities.  I've heard some investors claim that MLPs and REITs trading for less than book value are bargains, but if those same entities have low ROEs then there's a reason they trade at such discounts.  The market is discounting their ability to generate cash flow because a low ROE indicates they use capital inefficiently.  They may be paying too much for debt because of past negative credit events or committing capital to operating payouts (like lawsuit settlements or regulatory fines) instead of facilities maintenance or improvements.

Finally, it's worth noting that rising volatility hurts the valuations of fixed-income investments.  The VIX is currently trading below its historical average of about 20.  Any rise in the VIX hurts fixed-income securities, with or without hyperinflation.

I'm staying the heck away from fixed-income investments.  I'll keep my eye on only those few types that generate cash flow from hard assets like commodities or real estate.  

Alpha-D Update for May 2012

Here it is again.  My options from last month all expired unexercised.  It's always nice to hang onto cash earned from conservative hedges.  I have renewed my covered calls on FXI and GDX to expire next month.  I also renewed a short cash-covered put position under GDX, which I am increasingly likely to do as the price of GDX keeps dropping.  I realize I'm risking having more shares of GDX put to me but I don't mind doing so if they're getting cheaper.  A bigger pile of a hard asset ETF is one thing I wouldn't mind holding as the U.S. approaches hyperinflation.

I mentioned recently that I'm strongly interested in adding natural resource MLPs to my portfolio as a hard asset hedge against future hyperinflation.  I still plan to do so at some point but I'm much more skeptical now that using ETFs of MLPs is a viable way for me to do so.  Those ETFs have some odd ways of recalculating their daily NAVs that have the same effect as using leverage.  I hate leveraged ETFs and want to stay as far away from them as possible.  I may just go for a few reasonably priced MLPs and their associated operating companies (i.e., pipelines).

I'm also still looking for long positions in currencies of countries with low debt/GDP ratios and high transparency.  If I can't find correspondent banks in countries such as Australia, New Zealand, and Canada then I will need to look at currency ETFs.

I also wonder whether an agribusiness stock will perform adequately as a hard asset hedge.  People still need to eat even if the domestic currency they use to buy groceries is depreciating.  Maybe owning a farm or  even a backyard greenhouse is a substitute for such a stock; the big difference is that I would literally eat the yield.

My remaining California muni bonds mature in about a month.  I will not replace them with any fixed income instruments at all, although I would consider the sovereign debt of the three countries I mentioned above if those bonds were available to U.S. investors in their pure individual forms.  I am still not sure whether an ETF of TIPS will keep up with a hyperinflating U.S. dollar until I finish analyzing the fine print.  I do give myself a lot of homework but it's worth my time if it protects my net worth from chaos in the U.S. economy.

Nota bene:  I am not a financial adviser, planner, or counselor.  Please bear in mind that the above discussion is not any kind of financial advice for investors.  Like I've said in my legal disclaimers, nothing I say in any of my materials constitutes investing advice.  I do not tell other people what to do with their own money.  Enjoy my discussions as a form of entertainment.  

The Haiku of Finance for 04/28/12

Seeking MLPs
Hard asset pools with a yield
Can grow with prices

Thoughts On Master Limited Partnership ETFs

The prospect of hyperinflation demands due consideration of hard asset alternatives in a portfolio.  I've been exploring master limited partnerships (MLPs) to see if they fit my investing style.

I spend my daylight hours hearing roadshow pitches from oil and gas prospectors who explore producing wells one property at a time.  These wells are difficult enough for a small company with limited finances.  Pooling single wells into MLPs aggregates their production and enables partners to allocate capital where it can add the most to production.  Pipeline MLPs are intriguing for a related reason.  Their cash flow is the result of amalgamated production in large regions, regardless of how poorly a single well may be performing at any time.

Applying some Boglehead theory to MLPs leads to the conclusion that MLPs arbitrage away risks specific to single wells and pipelines.  It follows that an ETF of MLPs would arbitrage away risks of local geography and single MLP structures, leaving an investor with broad exposure to a flow of hard assets.

I will posit that the cash flow generated by an MLP ETF is a rough substitute for the cash flow generated by fixed income investments.  One crucial difference can make all the difference in a hyperinflationary environment.  Inflation gradually destroys the principal value of a fixed income security and reduces the real value of its coupon payments.  Even TIPS may not be immune to this destruction if their principal resets are not frequent enough to keep pace with inflation, or if the resets are based on artificially suppressed CPI calculations.  A hard asset ETF such as an MLP ETF may not suffer such a deficiency.  Its cash flows are derived from the nominal value of payments made for resource flows, so its value should theoretically hold during hyperinflation if it is rapidly marked to market.

The only MLP ETF I am currently considering for this role in my portfolio is the Alerian MLP ETF (AMLP).  I have not purchased it yet for several reasons.  First, it trades at a multiple of 22 times earnings, pretty pricey given the economy's long term average P/E of 14.  Second, its expense ratio is frighteningly high at 0.85%.  Finally, it has only been around for two years, and has not paid enough coupons for me to find its value using something like my REIT ETF valuation methodology.  I believe that methodology is applicable to an MLP ETF because REITs must pass through their cash flows as dividends to shareholders, just like MLPs.

I like that AMLP is optionable, so that if I did own it I could write short puts under it while inflation drives it up.  Other MLP substitutes like ETNs don't have that flexibility.  Come to think of it, I may decide to buy into it despite my reservations above if inflation really does get going.  Bargain or not, hard assets that generate cash flows bring the best of many worlds when hyperinflation starts destroying the value of everything else.

Full disclosure:  No position in AMLP at this time; this disposition could change with the onset of high inflation in the U.S.