Risk/Reward Vol. 216
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
"You're just too good to be true/Can't take my eyes off of you
You'd be like heaven to touch/I wanna hold you so much."---lyrics from "Too Good To Be True" sung by The Four Seasons
"You keep lifting me higher/Than I've ever been lifted before
So keep it up/Quench my desire
And I'll be at your side for evermore."---lyrics from "Higher and Higher" sung by Jackie Wilson
"Wherever it is/I'll fly
Whatever it takes/I'll try."---lyrics from "Whatever It Takes" sung by Leona Lewis
The Dow Jones Industrial Average, the NASDAQ Composite and the S&P 500 are all in tailspins. But, this week was "just too good to be true" for those who own income securities. Preferred stock, mortgage real estate investment trusts and leveraged closed end funds "were like heaven to touch/I loved holding them so much." Why you ask? As I have written in the past (Vols. 172 and 207 www.riskrewardblog.blogspot.com ), income securities are priced in relation to (or "spread" from) the 10 Year U.S. Treasury Bond. As the interest rate on the 10Year decreases (and concomitantly its price increases), the yields from other income securities become more attractive to investors, and the prices thereof increase. With the release on Wednesday of the minutes from the March Federal Reserve meeting, concerns about the Fed raising interest rates any time soon abated. In response, the yield on the 10 Year sank into low 2.6% territory. In turn, the prices of income securities held firm or increased on Thursday and Friday even as the broader markets sputtered and crashed.
For example, despite double digit gains year to date, several preferred stock closed end funds attracted higher bids all week. The reason is clear: they are paying an 8+% dividend. That is remarkable in this yield starved world. Indeed, the ones I own "keep lifting me higher/Than I've ever been lifted before." Moreover, so long as the 10Year interest rate stays at or below 2.8%, I believe these funds will "keep it up/ and Quench my desire." If they do, "I'll be at their side for evermore." A good place to research them is www.cefconnect.com . Access the Fund Screener, and screen for Taxable Income-Preferreds. You will see 17 funds displayed. They are all very similar. I like to buy ones that trade at a discount to net asset value. If you do buy, however, remember noted investor Frankie Valli's warning: "Can't take my eyes off of you". Because, if the 10Year rate increases, preferred funds will drop like rocks. These are not for the faint of heart.
Central banks keep interest rates low to discourage saving, to encourage investment and to spur economic growth. In the wake of the Great Recession, central bankers have adopted other "Wherever it is/I'll fly/Whatever it is/I'll try" policies to further encourage growth including forward guidance and outright asset purchases ( e.g. quantitative easing). Unfortunately, these initiatives have not been as successful as hoped, and central bankers are running out of ammunition. Interest rates can not go much lower without adverse consequences, many of which are beginning to surface For example, junk bonds now average a meager 5.2% return; subprime collateralized loan obligations (CLO'S) are selling as they did in 2007; and Greece successfully issued 5 year bonds just this week at 4.95%. These rates do not adequately compensate investors for the risks they are undertaking. To make matters worse, many fear that demographics (read, 40 years of low birth rates in developed nations) have reduced demand so much that world wide deflation may be near. The Japanese economy (the world's third largest) has been deflationary for the past several years; little wonder considering more adult than baby diapers are sold there. No kidding! (pun intended.) As I have written previously (Vol. 204 www.riskrewardblog.blogspot.com ), deflation is a greater threat today than inflation.
In sum, current central bank monetary policies have run out of steam as engines of economic growth. And, with interest rates as low as they are, central bankers have little if anything left to offer. One can debate the form, but a change in fiscal policy is sorely needed. I prefer Reaganomics (tax reform) over Keynes (government spending). Unfortunately, there is little prospect for either during an election year. Not surprisingly, these days I find myself singing:
"Ronnie, Ronnie, Ronnie why did you go?
Ronnie, oh Ronnie, Ronnie I am regretting
But can't stop forgetting
Because you/ You were my first love."
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