PrefBlog

I received the following eMail from a Reader who is not as Assiduous as he should be:

I haven’t been to your blog for a while but I went there today to get your perspective on what was happening with preferred spreads. Sure looks like a buying opportunity at 6%+ as one of your readers commented (RY, SLF , Pow, Pwf …. do not hesitate , do not be afraid , do not analyse to much , BUY !!). Others would analyze as don’t buy to average down. What’s your (long term) perspective on all this? Are you buying (what would be your top 10 list in this market)? Regards,

P.S. Feel free to post on your blog.

The post being referred to is Party Like It’s 1999!, in which I made the point that the interest-equivalent PerpetualDiscount spread was pretty close to a ten year high; the comment quoted was by Assiduous Reader lafontaine. And as far as a “Top 10 List” is concerned … I offer that service – not precisely ‘Top 10’ but the same idea – through my monthly newsletter, PrefLetter.

I don’t like market timing and I don’t do market timing. Financial Markets are chaotic; things that weren’t important a year ago can become the driving force in the blink of an eye; the Law of Unintended Consequences punishes any policy-maker with the temerity to indulge in central planning (and any portfolio manager with the temerity to overlay his own projections on policy changes); and, perhaps most insidiously, there are a lot of players with a vested interest in confusing the issue.

Journalists need something to write about; Dealers want to change your analysis of a situation so you’ll trade. Financial advisors find it easier to convince clients that the account is being aggressively and pro-actively managed in their best interest if there are a few actual trades to point at.

And every trade costs money – commissions and spread and sometimes market impact.

My philosopy is to be fully invested at all times. Make yourself an asset allocation based on your personal needs and your long-term view of expected risks and returns. Review it once a year. Always ask yourself: ‘What if I’m wrong?’

A disdain for market timing does not mean inactivity. My fund does an awful lot of trading … but this is never because of a view that the market is going to go up or down. It’s simply me telling the cowboys: ‘You want to trade? You want to pay the spread? You want to pay the cost of market impact? OK, you can pay that to me. Twist my arm!’ I’m not always right when I agree to a trade. Fortunately, I don’t have to be right every time to do a good job for my clients. Historically, my assessments of relative value have been accurate enough to outperform the market – although, I must point out, that is no guarantee for the future!

The more similar two instruments, the easier it is to identify the cheap one. Two discounted perps from the same issuer are easy to compare. A PerpetualDiscount and a PerpetualPremium from the same issuer is a little harder. A PerpetualDiscount and cash is … difficult in the extreme.

That being said, I think the recent decline in the market is overdone. It has happened without corresponding declines in the broader credit markets; it has happened without particularly horrible news from the issuers [bank common shareholders may well suffer in the coming months. So? I’m buying their prefs on the basis of them being able to (i) continue paying the dividend, and (ii) avoiding a bankruptcy that would impair my capital. I can’t see any but the most infinitesimal changes in the probability of those two outcomes]. Inflation is always a worry, but (a) it appears to be under control, and (b) back on the Central Bankers’ agendas and (c) not considered a major problem by the broader credit markets.

I consider that the extra interest-equivalent yield provided by preferreds handsomely compensates for their additional term risk, liquidity risk and credit risk (provided you don’t overdo it! What if I’m wrong?). As spreads increase without a clear fundamental driver, I suspect that more and more people will eventually agree with me. These people will pile into the market, absorbing spread costs and market impact costs … and I will certainly exert my utmost efforts to put myself in position to say ‘Thank you very much! Ka-Ching!‘

Monday June 23 will be a most interesting day. We can expect BCE issues to skyrocket, as the chances of the deal closing have increased; to the extent that (i) the money that may be received by BCE preferred shareholders will the reinvested in the preferred market and (ii) the market anticipates this tsunami of money; we may well see a good pop in the broader preferred share market. Will I bet on it? Have I bet on it? No and No.

This entry was posted on Saturday, June 21st, 2008 at 11:40 am and is filed under Reader Initiated Comments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.