High Yield Bonds- Amazing Trend Persistence

I use the Bank Of America Merrill Lynch US High Yield Master II index to track US high yield bond prices. The BondId for this index is H0A0 on the Merrill Lynch Index web site. I like this index because it includes interest earned each day in the index value and correlates very well with open end high yield bond fund value. (Note:Closed-end bond funds tend to trade with a lot of emotional noise and do not track this index well.)

The index has appreciated 55.5% in the last 12 months. But what is most remarkable is the trend persistence. The last down day for the index was November 30. Since then, it has been up for 24 straight days. During this win streak, the index has appreciated from 664.164 to 690.892 or about 4%. I have previously posted on TFCIX which correlates closely with the H0A0 index and is also on a 24 day winning streak.

2010 Investment Outlook

We are coming off of a strong market year in 2009 after a very weak year in 2008. I looked back through market history for similar years in the past and found the following:

1934: The market rallied strongly in 1933 after the terrible down years from 1930 through 1932. In 1934, the market basically went sideways with fairly low volatility.

1976: The market had a very good year in 1975 after the bear market in late 1973 and 1974. In 1976, the market jumped around 10% in January, but then stayed in a fairly narrow trading range with lower volatility the remainder of the year before another rally in December.

2004: The market had a strong year in 2003 after the dot-com bust years of 2000 through 2002. In 2004, the market opened up strongly in January, but then went into a zig-zag pattern with a downward bias throughout most of the year, before regaining the losses in November/December. Overall, the market again basically went sideways in 2004 with lower volatility.

If history repeats, 2010 will see the overall stock market stay in a fairly narrow trading range with low volatility. But there should still be opportunities to make money in specific sectors, in energy or commodities and in other world equity markets. I think we may see more action in fixed income markets by the end of 2010.

But instead of trying to predict what will occur, the best approach may be to keep mental trailing stop losses on investments and stay invested in asset classes that are trading above their 125 day moving averages. Of course, special situation investing in closed-end funds can work in any market environment, but only when good opportunities occur.

 

 

Follow-up on GSC Investment Corp.

On December 31, 2009, GSC Investment (ticker: GNV) announced the results of the recent dividend payout of $1.825 in cash and stock. Shareholders had until December 17, 2009 to elect whether to receive a portion of the dividend in cash with the remainder in shares of common stock. Shareholders who elected to receive the cash received a combination of cash and common stock.

1)       The total payout was $2.1 million in cash and 8,648,725 shares of common stock or 104% of GSC Investment Corp.’s outstanding shares prior to the dividend.

2)       The amount of cash elected to be received was greater than the cash limit of 13.7% of the aggregate dividend amount allowed. The number of shares of common stock comprising the stock portion was calculated based on a price of $1.5099 per share, which equaled the volume weighted average trading price per share of the common stock on December 24 and 28, 29 of 2009.

3)       Shareholders who elected to receive the dividend solely in shares of common stock received 1.209 shares of common stock for each share of common stock they owned on the record date. Holders of approximately 39% of the Company’s common stock elected to receive only stock or did not make an election so this was the default option.

4)       Shareholders who elected to receive the dividend in all cash, received cash in the amount of $0.411 per share or 22.5% of the $1.825 dividend and 0.936 shares of common stock or 77.5% of the total dividend for each share of common stock they owned on the record date.

GSC Investment has not reported the new NAV value yet on cefconnect which still shows 6.91. Most likely the new value after the offering will drop to around 3.40. The stock closed at 1.75 on Friday, so the new discount to NAV should be around 50%. While this may look attractive, the expense ratio for GNV is reported on cefconnect is very high at 5.08% before interest expense. I almost never buy closed-end funds with expense ratios over 2% a year.

Full Disclosure: No position in GNV

Berkshire Hathaway- Ten Year Review

Now that the decade has ended, I wanted to see how Berkshire Hathaway (ticker:BRKA) has performed relative to earlier periods. I looked at market prices for the last three decades along with book value growth. While BRKA did outperform the S&P 500 in the last decade, the 5.85% annualized return is somewhat of a disappointment. The main problem is size. Apparently even Warren Buffett finds it impossible to earn consistently high double digit returns with more than $100 billion under management.

Market Price Appreciation

The Oughts: 12/31/1999= 56,100   12/31/2009= 99,155                       Annualized Return= 5.86%

The Nineties: 12/29/1989= 8,675   12/31/1999= 56,100               Annualized Return= 20.52%

The Eighties: 12/79/1979= 320   12/29/1989= 8,675                     Annualized Return= 39.10%

Book Value Annualized Return

The Oughts  (est.)= 8.0%

The Nineties = 24.3%

The Eighties = 29.0%

The Seventies = 22.4%

The price to book of BRKA is currently around 1.2 which is historically quite low. Normally a purchase of BRKA at a price to book of 1.50 or less works out pretty well in the long run. But it is highly unlikely that BRKA will again earn 20+% annualized returns in the next decade because of its huge size.

Full Disclosure: Long BRKA

Massive Dilution in GSC Investment Corp.

GSC Investment Corp (ticker:GNV) is a specialty finance company that trades as a closed end fund. Its discount to NAV is currently listed as -77.42%, but this is highly deceptive. Last month, the fund announced a $1.825 per share dividend, with an ex-dividend date of November 23 and a payable date on December 31, 2009. Each shareholder may elect to receive up to $0.25 in cash. The remaining $1.575 per share of the dividend will be paid in shares of GNV stock. The exercise price for the newly issued stock is based on the weighted average price of GNV for the three days of Dec. 24, 28, 29.

Anyone who will receive this large dividend may have an incentive to try to lower the market price of GNV on these three days. The lower the price goes, the more new shares will be issued and the lower the new NAV.

As of Dec. 23, GNV has a listed NAV of $6.91, but once the dividend shares are distributed, the number of shares outstanding will balloon. If GNV has a weighted average market price of 1.50 for the three days, the NAV should drop to around $3.00 a share, depending on how many investors accept the cash. For lower prices, the NAV will drop even more.

Full Disclosure: No position in GNV

The Yield Curve moves to record spread

The spread between the 2-year and 10-year Treasury Note increased by 10 basis points today and has moved to a record high of 281 basis points. Historically, when this spread widens, the economy is expected to improve quickly in the future. Steep yield curves are normally seen at the beginning of an economic expansion after a recession. The weak economy and the Fed have depressed short-term interest rates; but intermediate rates begin to rise once the demand for capital is re-established by growing economic activity.

Unlike many sentiment indicators, the yield curve indicator has real money behind it and tends to be pretty accurate. If this indicator is correct, we will not have a double dip recession. Intermediate Bond funds have produced excellent performance but may be nearing a top. I have been cutting back on my fixed rate bond fund holdings and adding to my holdings of floating rate bond funds which benefit from rising intermediate bond rates.

Vacation Reading

A good book to read on vacation to get a valuable long term perspective on the financial markets is “The Ascent of Money: A Financial History of the World” by Niall Ferguson, a history professor at Harvard. The book discusses a long series of financial manias, panics and crashes along with a fascinating list of characters including Medici, Savonarola, John Law, Nathan Rothschild, Hernando de Soto, Milton Friedman and George Soros.

The last chapter in the book discusses the “empire” of Chimerica which refers to the combined economic power of the US and China. Chimerica has accounted for about 40% of worldwide growth over the last ten years, but has resulted in large imbalances in currency reserves. Last month, Ferguson published an op-ed piece in the NY Times called “The Great Wallop”  where he recommends a revaluation of the Chinese renminbi currency.

Amazing Trend Persistence in TFCIX

I have posted on TFCIX previously. It invests in distressed investments across the credit spectrum.

The fund is showing amazing trend persistence. You often see bond funds have a win streak where they are up or unchanged for N days in a row where N>10.  TFCIX is currently exhibiting such a streak and has been up for 13 consecutive days (as of the close Dec. 17). What is unusual is that all 13 days have been up days, with no unchanged days. I follow many other bond funds, and don’t know of any that have been that consistent over the last few weeks.

TFCIX has a 2% exit redemption fee for holding periods under 1 year, so it cannot be traded. But the  long win streak may mean the fund is experiencing significant fund inflows.

CFP- Clarification and corrections

My article a few days ago on CFP was inaccurate on a number of points and I would like to set things straight. Some of my readers may assume a conspiracy that does not exist. Ron Olin reads my blog and sent the following clarifications:
1. Ron Olin sold his management firm, Deep Discount Advisors, a number of years ago. The name was then changed by the new owner to Doliver. Ron retains a role as a paid consultant, but doesn’t run the company and is not a principal.
2. Doliver is a registered investment advisory firm, and not a fund. It has no connection with Cornerstone Advisors. It manages accounts for a large number of individuals based on the specific investment needs of its clients. As such, it is required to file 13G forms when the total holdings of its clients exceed certain thresholds on any specific security, like CFP. The associated share numbers change whenever a client leaves, or if a client sells or buys shares on its own initiative. Only a small percentage of the reduced CFP share holdings reported from the 13G filings were the result of sales initiated by Doliver.
3. BPM Partners has no association with Bradshaw. I had a “senior moment”, and confused the name Bracewell with Bradshaw.
4. Because Bradshaw is married to a sister of Ron Olin’s wife, Olin formally recused himself from advising Doliver or any of its clients with regard to participating in the CFP IPO. He did make a large personal investment in CFP, because he thought it was attractively priced, given the history of the other Cornerstones.
5. Ron Olin still owns most of the original shares of CFP that he purchased for his personal account. If and when he reduces these holdings significantly, he will record it in an amendment to his personal federal filing as required by law.
6. Ron Olin believes that intelligent CEF investing can out-perform the S&P500 by 5% to 7% a year, and that CFP may deserve a substantial premium, based on long-term projected returns and because it throws off substantial cash flow shielded from tax due to capital loss carry-forwards generated by the market collapse in 2008.

I still believe CFP is overvalued at these levels and would not buy it now, but Ron Olin is an experienced CEF investor, and may be right that CFP could be reasonably valued here. Based on the history of the Cornerstone sister funds it could even trade at higher premiums at times.

S&P 500 Covered Call Fund (BEP) is liquidating

The S&P 500 Covered Call Fund Inc. (ticker:BEP) has announced a liquidation date of February 2, 2010 which is almost two months earlier than the termination date of March 31, 2010 specified in the Fund’s charter. The final NAV value will be set on January 29, 2010 and all net assets will be distributed on February 2, 2010.

BEP closed today at a 8.4% premium over NAV which will be disappearing in less than two months. Its sister fund BEO is also way overpriced, but won’t be liquidating until later in 2010, probably around September.

Full Disclosure: Short BEP (hedged against other long positions).