Wednesday, June 10, 2009

More Than Green Shoots in Speculative Activity

Those who want to know whether the stock market "knows" anything when it has a sustained price change, with special reference of course to the amazing bull market we entered some time ago, may be interested to know how much small speculators have ridden this bull. From Barron's (.com), here's an extended excerpt from today:

To review, closed-end funds issue a set number of shares that trade in the secondary market at a price that can be above or below their underlying net-asset value. (Open-end mutual funds issue and redeem shares daily at their NAV.)

Mariana Bush, the long-time closed-end analyst at what's now called Wells Fargo Advisors, worries that some investors may be taking unnecessary risks by paying premiums over 20%.

"We are concerned that a few investors, who are not too familiar with closed-end funds, may be lured by a specific exposure or by a yield that is too good to be true without being aware of where that fund is trading relative to its NAV. They may not even know that an NAV exists," Bush writes in a research note.

In some cases these premiums may be the result of "performance chasers," she adds. For instance, the Templeton Russia and East European Fund (ticker: TRF) has been bid up to a 98% premium (according to data from on the back of the Russia equity market, one of the strongest emerging markets in the world because of the near-doubling of crude oil prices from their lows early this year.

While Templeton Russia and East European Fund's NAV is up 65% since the beginning of the year, its market price is up an astounding 207.7%, according to Lipper data. The difference is reflected in the expansion in the fund's premium to NAV.

That's even more absurd given that investors can gain exposure to the red-hot Russian market via the Market Vectors TR Russia exchange-traded fund (RSX.) ETFs will issue and redeem shares so that their prices remain close to their NAV; RSX closed Tuesday at a relatively trivial 1.65% premium.

Performance-chasing would seem to account also for the fat premiums on the Pimco High Income Fund (PHK), 62%, and the Cushing MLP Total Return Fund (SRV), 30.6%. The Pimco fund -- whose reins were taken over recently by the Bond King himself, Bill Gross -- scored a 22% gain in NAV since the beginning of the year, but its shares have been bid up by 94.7%, according to Lipper. Similarly, the Cushing fund's NAV is up 46.5%, but its shares have soared 72.5%, to a wide premium.

Some other funds on Bush's list would come under the heading of yields that are too good to be true. The Cornerstone Progressive Return Fund (CFP), the Cornerstone Total Return Fund (CRF) and the Cornerstone Strategic Value Fund (CLM) seem to fall into that category.

For instance, CFP sports a 22.1% distribution rate, which apparently accounts for the market paying a 73% premium for the fund. This has been the result of investors' bidding up the share price 85% this year while the NAV has increased just 6.2%.

Yet a substantial portion of that 22.1% payout reflects a return of capital, as the Cornerstone funds' press releases detail for any investor inclined to read them. "The Board of Trustees believes the Fund's shareholders are well served by regular distributions which increase liquidity and provide flexibility to individual shareholders in managing their investments," according to the fund's release.

In other words, investors who buy at the current price are paying $1.73 for every dollar invested for the privilege of getting their own money back. Indeed, the release points out that the distributions include returns of capital, which "should not be confused with yield or investment return on the Fund's portfolio."

This is happening only three months after perhaps the same people who are ignorantly purchasing these vehicles at almost guaranteed significant losses were selling stocks without the guarantee that they were forgoing price rises in the future. From that perspective, the buying is more manic than was the selling.

Of course, what the truly small fry are doing with closed end funds does not necessarily correlate with what the "big fry" are doing with the Dow stocks, but it does show that there is probably a lot of anxious money that can't stand earning more or less nothing in money funds.

On a bigger picture, the clamor that higher inflation is quickly coming has become pervasive. So has the belief that, assuming the economy will bottom in a few months, the stock market has seen its lows (and perhaps its all-time low); even the bearish David Rosenberg has now signed on to that belief. Most of what I see in the financial press "warns" investors that there is a very real chance of a "melt-up" in stock prices equivalent to the melt-down of last September-November.

Except for financial stocks, your truly was quite bullish on stocks two years ago. Part of the reason was the ultra-bullish Presidential cycle (third year up). It is almost exactly two years since the first news appeared out of Bear Stearns that two of the funds they managed were in trouble. When more evidence surfaced in July and August that there were bigger problems out there in finance-land and the economy, the third-year story appeared too weak, and yours truly got out of the stock market. The nominal high in the averages in the fall of 2007 was pitiful and unpersuasive.

One never knows, but it strikes this observer that not only has too much risk appetite returned too soon, but never has a durable major stock market bottom occurred with such a high ratio of market cap to total corporate profits or to tangible book value. It continues to look like a situation where there are not a lot of sound investment choices at all; so, investors are forced to choose what they consider "less bad".

That is the polar opposite of the early 1980s, where Volcker saw to it that almost all financial assets became undervalued. When Reagan added Keynesian stimulus and essentially deregulated energy prices, it was off to the disinflationary races and almost all financial assets moved upwards for many years. However, interest rates stayed very high for years. They may stay low for an unexpected number of years even if the longer-term trend is decisively upwards.

Stay tuned.

Copyright (C) Long Lake LLC 2009

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