Risk/Reward Vol. 103
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN
"I want the easy/Easy money/Easy money
I could get lucky/Things could go right"--lyrics from "Easy Money" by Billy Joel
"Got a handful of stacks/Better grab an umbrella
I make it rain/ I make it rain"---lyrics from "Make It Rain" by Fat Joe
"Give 'em hell boy, while you can/Make them fight to take the title you defend
"Til they nail you with a double cross again/It's a risky business"--lyrics from "Risky Business" by Kris Kristofferson
"Wait I'm talkin' fast car, big estate/Money come in cash plus in the bank
Brother don't believe me, throw it in your face/Women, I'm in the building like real estate"--lyrics from "Real Estate" by Wiz Khalifa
"You are the sunshine of my life/That's why I'll always be around
You are the apple of my eye/Forever you'll stay in my heart"--lyrics from "Apple of My Eye" by Stevie Wonder
"And while he was handlin' this risky chore/Made himself a legend, forevermore
Davy, Davy Crockett, the man who don't know fear/Davy, Davy Crockett, the King of the Wild Frontier"--lyrics from "Legend of Davy Crockett" sung by everybody 60 and older
Talk about EASY MONEY! How about the non-political (tongue caught in cheek) Ben Bernanke and his best buds on the Federal Reserve? Apparently the modest, but real recovery we are experiencing was not enough to satisfy Uncle Ben and his cohorts in this election year. So, on Wednesday, the Federal Reserve announced that we are in for three more years of "Easy Money" in the form of low, short term interest rates and another round of government bond purchases by the Fed (QE3) if we "get lucky". Not since fabled footballer Pacman Jones visited a Las Vegas strip club has anyone "made it rain" more dollar bills than good Ol' Ben. Let's all shake our booties in celebration. NOT.
I simply observe the following. Because of the Federal Reserve's unholy desire to keep all interest rates low, one can no longer look to Treasury notes (and instruments pegged to them such as bank cd's) for a decent, safe return on one's nest egg. This not only adversely impacts individuals trying to build, or worse, exist on savings and 401K's, but it is a huge problem for pension funds which now need to invade principal to meet benefit obligations. For some perspective on this, consider that from 1980 to 1985 the interest on 10 year Treasury notes never fell below 10%. From 1985 through 1992, it never fell below 7%. From 1992 through 2000, it averaged 6%, and from 2000 through 2008, it averaged 4%. Today it hovers at 1.90%. We are all being forced into progressively riskier investments while the "double cross" of government deficit spending mounts in force and effect. Look at Europe, dear Readers, we are not far behind.
Enough lamentation! How do we prosper in the upcoming times of uber-low interest rates?
An obvious way is to invest in companies that rely on leverage (the difference between the cost and the return on borrowed funds). Companies in the business of buying government guaranteed mortgages do just that. These companies, known as mortgage investment companies or mortgage reits, buy guaranteed mortgages from Fannie Mae and Freddie Mac using a combination of equity and borrowed funds. They have very little "top line" or gross income risk and make their money by borrowing, short term, on the cheap. Voila! This week I added to my positions in AGNC and Annaly (NLY) (even though on Wednesday, NLY announced that its founder and CEO Mike Farrell was undergoing chemotherapy for cancer). Both pay double digit dividends which I believe will continue.
On a larger scale, commercial real estate, which is rebounding nicely on its own, should do better in a low interest rate environment. Even Wiz Khalifa can appreciate that profits will be enhanced by lower borrowing costs whether rents escalate or remain constant. For tax reasons, most commercial real estate (office buildings, apartments, shopping centers, warehouses, etc.) is owned by real estate investment trusts (REITs). I like REITs because they are required to "pass through" 90% of their income to shareholders and thus pay excellent dividends. There are scores of publicly traded REITs, many of which are listed and described at www.quantumonline.com Out of caution, I often invest in the preferred shares of REITS, the dividends on which must be paid before any distributions to common shareholders. For those that prefer a diversified approach, I suggest looking at some real estate investment trust closed end funds, which operate much like mutual funds or etf's, but can use leverage (there's that concept again! ) to enhance returns. I own RQI.
Business development companies (BDC's) about which I have written recently also should do well in a low interest environment. Again, those looking for diversification in this sector may want to buy a closed end fund. I like FGB.
Holy Steve Jobs, Batman! How about Apple! After reporting blockbuster numbers this week, it is now tied with Exxon as the most valuable company in the world, with a market capitalization of over $400billion. Moreover, it continues to grow revenue and profits at a prodigious pace. It is clearly the world's best company---but it is not the world's best stock. It trades at only 9 times forward earnings (only 7 times if you subtract its $100billion in cash) which is far below the historic average of the S&P 500 (12-15x). Apple may "forever stay in the hearts" of its cult-like users (I am one), but I " (Stevie) Wonder" if its shareholders (I am one also) will "always be around" if they don't get some "sunshine"---like a juicy dividend, perhaps.
For those looking to "handle a risky chore", I suggest studying Frontier Communications (FTR), the legacy land line telecom company about which I have written in the past. Like a june bug to a blue light, I have been attracted to its outsized dividend for 2 years, and have been in and out of the stock in a disappointing way. Obviously, the conventional wisdom is that FTR cannot maintain its $0.75 dividend which at Friday's closing price of $4.31 represents a return of 17.4%! I am betting (and this is BETTING, my friends, not investing) that the company performs well enough to keep the dividend. I should get a good read on this next month when it reports earnings. If I am right, I, too, will be a King of the Wild Frontier. But in the interim, I am ignoring my 8% loss limit. This cuts against my nature, which, unlike that of Davy Crockett, "knows fear".
And so dear Readers, we must not only accept risk, we must embrace it. Recall if you will, some other Billy Joel lyrics:
"Some people hope for a miracle cure/Some people just accept the world as it is
But, I'm not willing to lay down and die/Because I am an innocent man
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