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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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Tom Armistead's Instablog
  • Sticking with the Plan 5 comments
    Aug 6, 2011 9:23 AM | about stocks: SPY, XLF, IP, ITW, HCBK, MET, PRU, HIG
    Reviewing trades for last week, I cashed in the bulk of my hedges. Scaled out of SPY Dec 2012 140.0 puts at intervals of 2.5, making the last sale when SPY stood at 117.5. Also scaled out of Dec 2011 XLF puts at intervals of .25, last sale when XLF stood at 13.25. 

    Remaining hedges would be completely sold out when SPY hits 112.5 and XLF hits 12.5. 

    The funds were deployed rolling LEAPS positions down. Example, with IP at 25.22, sold to close 10 IP Jan 2012 25.0 calls and buy to open 10 IP Jan 2012 22.5 calls, net debit of 1.45, for the 2.50 spread.  Similar trades done on HCBK, HPQ, and ITW.

    MET, PRU and HIG are also candidates to roll the LEAPS positions down.  I held off because they are financials, volatile, and would likely participate in a further market decline, in which case better prices will be available.

    Reviewed portfolio early in the week, using delta and beta, it will go up or down 3.27 for every 1 on the S&P.  Probably more because I liquidated a lot of the hedge during the week. Also reviewed average p/b, p/s, etc., per Morningstar, average price to book is 1.10, vs. a 5 year average of 1.58.  Similar results with p/s.  Reversion to the mean would be a 43% increase. 

    Average stars rating is 3.89 per Morningstar, a little higher than normal, due to prices declines increaing stars under their system.

    Plan to watch market behavior Monday and make a decision whether to liquidate the rest of the hedges or not.  Also plan to roll LEAPS for MET, PRU and HIG down, may need to sell off the hedge to provide the funds.

    I think the S&P downgrade of US will not make a big impression on the markets, it makes a certain amount of sense if you consider the attitude of the Republicans and the likelihood of inflation long term.  An investor in US Bonds runs the risk of waiting for his money, or receiving debased dollars in repayment, sufficient to warrant the downgrade.

    I expect that the Euro situation around Italy and Spain will stabilize.  Those who hope to profit from creating difficulties need for the interest rates on their 10 years to get up to 7% and hang there, a credible plan to provide emergency liquidity should resolve the issue.
    Stocks: SPY, XLF, IP, ITW, HCBK, MET, PRU, HIG
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  • bbarberayr
    , contributor
    Comments (151) | Send Message
     
    Thanks for the update Tom.

     

    Hard to see we go a whole lot lower with valuations where they are.

     

    Interesting article in the WSJ about the effects the downgrade may have on the life insurance companies. Basically, what does this mean for the AAA insurance companies and how this may affect capital holding requirements (and therefore ROI's).

     

    online.wsj.com/article...
    6 Aug 2011, 05:06 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (5219) | Send Message
     
    Author’s reply » It looks like it's up to the NAIC to determine whether treasuries are backed by the full faith and credit of the US Government. Maybe not, a little bit less than full.

     

    I felt one the the strong points with some of the P&C companies was the amount of treasuries they were holding, that was why some of them like CB and TRV just sailed through the crisis.

     

    I still like them.
    6 Aug 2011, 05:15 PM Reply Like
  • expatsp
    , contributor
    Comments (199) | Send Message
     
    Another vote thanking you for the update. I agree with your logic.
    6 Aug 2011, 06:10 PM Reply Like
  • bbarberayr
    , contributor
    Comments (151) | Send Message
     
    Tom,

     

    Looked at the Travellers 10-K and have a question maybe you answer.

     

    Why do some insurance companies classify their securities in their balance sheet as "Amortized Cost" as opposed to "Available for sale, at fair value" and is one way better/safer than the other?

     

    Also, some companies classify their securities as "Held to Maturity" and "Available for sale". I believe this is to match up the security with the liability and avoid having large earnings swings which aren't likely to ever be realized, but do you think it is better to break assets out like this or to carry these at fair value on the balance sheet?

     

    Thanks.
    7 Aug 2011, 12:30 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (5219) | Send Message
     
    Author’s reply » bbar,

     

    My personal opinion, which I picked up long ago as an insurance trainee, is that amortized cost is the proper way of accounting for bonds, provided they are not in default. The reason was, during the Depression regulators found that if they did things on market value all the companies were technically insolvent.

     

    And that way of handling it was validated, in that the companies involved for the most part made it through the Depression, paid their claims, and the bonds that didn't default reverted to amortized cost over time.

     

    For treasuries and the like, fair value or market value is higher than amortized cost right now, because interest rates have declined.

     

    Most insurance companies present two book values - one according to GAAP and the other excluding AOCI (All other comprehensive income). Most of the difference is between market value and amortized cost on investments. If you track the two book value figures for insurance companies during the financial crisis you will see that in some cases GAAP book values went down to well under BV ex AOCI but ultimately came back to pretty much the same level. MET would be an example. For TRV, the two values stayed pretty close, because the assets were high quality.

     

    The issue becomes problematical when regulators and rating agencies get involved. The effect is pro-cyclical, in that a company that is holding questionalbe assets may be forced to sell at the bottom or recapitalize by a dilutive share offering, due to concerns about whether the assets involved will actually return to amortized cost.

     

    CB and TRV, both of which hold very high quality assets, did well during the downturn. ALL, which had a lot of poor quality RMBS, did very badly. HIG also did very poorly, based on asset quality not being good.

     

    So in retrospect the best way for an insurance company to handle its investments is to make them mature to match their claims obligations, and invest in high quality assets rather than reaching for yield. Anything else causes trouble.

     

    I did an article last year on the two versions of book value, with charts that show how the things played out during the financial crisis: seekingalpha.com/artic...

     

    Hope this helps,

     

    Tom
    7 Aug 2011, 01:13 PM Reply Like
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