March 3, 2008
We live in interesting times! Make that, we live in tumultuous times.
Besides a huge drop in the markets the last two days in February (and a little today too), you might recall that a few days go I mentioned that I wondered what the next shoe to drop might be. Unfortunately, now, I think it's becoming clearer. The subprime debacle which has led to an almost complete credit crunch, which in turn has led to a liquidity crisis (like just hearing that college/student loans have just about dried up) has now affected the closed end fund environment.
One of the things that I would like you to do is to go to http://www.cefa.com/ web site and read the CEFA President's letter "The Current Liquidity Issue". What the letter is basically saying, is that when closed-end funds go out to raise money in an auction, there are no buyers showing up for their preferred shares. That is the money that CEFs use to gain them leverage which in turn allows them to bump up their yield. This is the first time ever that there has been a complete failure of where people (funds) go to get money.
What does that mean to us? From my perspective it means that any CEF that uses leverage could or will be hurt if they can't find funds that they use for leverage to pump up their yields. That's how we have been getting 7-8-9-10%, etc. yields over time. The CEFs that I selected for Income Planner, and many of which I have owned myself for many years, use leverage. Up to now that has never been a bad thing.
But these are not normal times. Today it appears to me that the landscape has changed. The mess brought on by the subprime situation is reaching into areas that no one (us laymen especially) could have foreseen, other than those that were perpetuating this fraud. I wonder how many others have been completely blindsighted by all of this.
So if CEFs can't get the money they need, what happens? First, they may have to de-leverage. If they do, then the yields will probably be cut equal to the amount of the leverage. So if they have 33% leverage, the yields could be cut by 1/3. And you can guess, when investors (so-called) see the dividends cut, the share prices follow as everyone panics. Second, they could change their structure from closed-end to open-end funds. This means that instead of their shares selling either at a premium or a discount to NAV, they would now start selling at NAV. That could be another hammer to share prices.
Since all of this has come out of nowhere, there's no visibility as to where all of this is going or what the outcome might be. For a while, everything will be business as usual. The funds have indicated that they will reach to their own pockets to keep things stable. But how long will that last? A quarter, two quarters? To me, the future is cloudy.
So what is the best course of action right now? If you own any of the CEFs I have recommended, consider selling them if you have a gain or a slight loss. We can always find somewhere else to move the money. In a retirement account, this could be painful since we can't deduct any loss. If you have a significant loss in anything you have bought, then it's a toss-up. Let me know if you own any and where you stand with those particular securities. Then, perhaps I can suggest something. The fund managements are working diligently to find alternative arrangements and all of this may in the end be a false alarm. Nothing will change overnight, I just want to take a cautious approach.
I can understand the punishment we took in some of our financial holdings and REITs last year since that is where the mess started. But now the mess is spreading. Bonds and bond funds are also being hit. Even municipals, which is crazy. The bond insurers have been on pins and needles waiting to see if the rating agencies were going to downgrade their rating. For now, that issue calmed down last week. But that would cause another crisis.
So what I would like you to do, is just hold off on buying any CEFs and bonds right now, particularly the new subscribers. Let me review all of this in the next week or so. Maybe we go more heavily into other dividend paying securities and ETFs. All our oil and gas royalty trusts have done very well. Our food related securities are still things I think are great. The shippers are cyclical and like clock work are up and down depending on the season. Commodities which I have always felt were very volatile have continued to do nothing but go up. Think gold, silver, copper, coal, etc. and maybe we just missed out here. Foreign ETFs and foreign currencies with the dollar continuing to go down might still be attractive. As you know, I've added some of that information in the Portfolio section.
As always, if you have any concerns, questions or other issues, please let me know. I'm in the middle of all this with my own money and try to stay on top of all the nonsense that is going on out there. But I think a lot has been hidden from us and just like Chinese water torture, a little more, then a little more, then a little more again comes out. The whole financial structure is broken down.
I want to reiterate. Nothing will happen tomorrow. I may be overly cautious. But it's best to be aware of what is going on as early as possible. The people responsible for all the easy money that was thrown around will never see jail, where they all belong. Those of us who always keep our noses clean are the ones made to suffer.
I will write you more soon.
Pete Lipke
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