BondsOnline Advisor – December 2007
By Stephen Taub
The BondsOnline Advisor strives to present you with income investment insights from analysts throughout the United States. Bonds, preferred stocks, real estate investment trusts, or master limited partnerships can be a part of a successful income portfolio – and BondsOnline and PreferredsOnline provide the “Income Investor Tools” to keep you informed.
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Global Banks Outlook
Credit Suisee Securities recently raised its rating on global banks to benchmark from 30% underweight for a number of reasons.
It said the price-to-book relative to the market of global banks is 13% below its average and only 6% off recession lows. In addition, it asserted that cyclicals and banks have decoupled by what it deems to be an abnormal degree. It is also confident that the economies in the US and the rest of the world will not experience a hard landing.
Also, the investment bank expects underlying profitability to improve as there is less competition in the mortgage market and against securitized lending. “We believe short rates will fall significantly globally,” it added.
So, why didn’t the bank raise its weighting further? CS explained that banks are very cyclical. “We have not yet seen the appropriate policy response to be bullish of the cycle,” it added. In addition, CS noted that banks have become abnormally sensitive to property in the US, UK and Spain, where 55%, 73% and 83% of total lending is now to property and construction, respectively.
Also, it pointed out that banks in the UK and the US are abnormally highly leveraged. “Real loan growth is still high and must fall,” it added.
With financials down sharply, the investment bank is also reducing the size of its underweight in financials. For example, it cut its underweight in the regional banks to 25% from 45% and in the REITs to 15% from 20%.
In fact, CS pointed out that the sharp selloff in REITs stocks has led to some value re-emerging, based on dividend yields of 4.2% relative to 10-year bond yields. “However, a downturn in the commercial real estate market looks imminent as lending has virtually dried up making deals unprofitable and the REITs are still not cheap relative to the rest of the equity market on yield or book,” it added.
US Markets Strategy
Citi recently cut its S&P 500 operating EPS estimate, from $94.70 to $91.75 for 2007, and from $100.75 to $96.50 for 2008. It asserted that consensus EPS estimates for 2008 “seem implausibly high.” However, it added that it does not expect S&P 500 earnings to grow in the fourth quarter of this year.
The biggest reason for the estimate cut: Record losses in the financial sector, which have significantly lowered U.S. profits in the second half, said Citi. “Financial instability is the most serious new threat to the U.S. economic expansion,” the banking giant recently told clients.
Even so, it stressed that actual economic performance, thus far, “has been decent.” It noted that real GDP has risen 2.6% over the past year, and 3.6% excluding residential investment.
It now expects full-year average real GDP growth rates of 2.2% and 2.3% in 2007 and 2008 respectively. “However, to achieve this outcome, financial stability will need to be secured,” it stressed. “We now believe this will require more significant easing steps from the Federal Reserve to offset private credit markets, which have continued to tighten intermittently even after the central bank’s initial easing steps.”
Latin America Strategy
Deutsche Bank Securities forecasts 20% upside in US dollars for Latin American equities in 2008. “Latin American stocks should come back for a mild encore in 2008 and extend the bull market to six years,” the bank recently told clients.
Brazil is its top equity market in Latin America for 2008, where it is looking for 24% gains. This is followed by 18% in Mexico and 11% in Chile.
However, it warned investors not to expect a smooth ride. It warned that stocks should experience one or more corrections—drops exceeding 10%--in 2008 due to the advanced stage of the current bull market, which will be entering its sixth year if the bank is correct.
Its top stock picks in Latin America are NII Holdings, Grupo Mexico, Banco do Brasil, Tractebel, Suzano, CVRD, Entel, Vivo, CSN and Positivo.
And what are the largest risks for investors? Deutsche singles out 10 market risks in its radar screen for next year. They are: 1) trade protectionism, 2) U.S. credit crunch, 3) U.S. real estate, 4) U.S. dollar, 5) U.S. inflation, 6) crude oil, 7) a Chinese equity bubble, 8) food inflation, 9) Latin American equity valuations and 10) European real estate.
Energy MLPs
Lehman recently reiterated “outperform” ratings or initiated coverage with an “outperform” on a handful of master limited partnerships, and a “market perform” rating on another high yielding MLP.
For details of the six energy midstream master limited partnerships reviewed this month, including target prices, please see the current issue of Yield and Income Newsletter. PreferredsOnline subscribers receive this monthly newsletter as part of their subscription.
REITs
Citibank says REITs in general are still beaten down due to the real estate slump and credit crunch. As a result, they trade at large discounts to net asset value and offer attractive dividend yields.
Citi recently told clients there are few catalysts to turn around the discounts. As a result, it expects zero to negative 10% total returns for REITs over the next 12 months.
“Absolute valuations of real estate are closer to peak levels than historical norms,” it asserted in a recent report, stressing the unknowns over how much real estate prices will correct “leaves the group adrift.”
It noted that at a recent NAREIT conference, activist shareholders “were stalking companies and working the halls” to figure out how companies plan to close their NAV discount. “Some may well succeed in effecting change,” it added. “However, given the general lack of catalysts for investors to come into the group, it appears more and more companies will be candidates for activists.”
Citi, however, is not eschewing all REITs stocks. It asserted that two, with underlying businesses that are likely to continue to see strong underlying fundamentals, are the REITs for investors to focus on in the next six to 12 months. In addition, it noted that \two of the largest mall REITs have already completed most of their 2008 leasing, “leaving them relatively insulated from a material deceleration in underlying fundamentals.”
On the other hand, Citi noted that although it highly regards the management teams and the assets of major office owners, “headwinds will weigh on the shares from several fronts.” However, it added that uncertainty regarding the extent of the layoffs in financial services, change in market rental rates due to financial services and how much cap rates will rise should make it hard for these shares to deliver positive total returns near term.
Credit Suisse Securities recently reiterated “outperform” ratings on five mortgage REITs, noting that although valuations have recovered from the lows established in August, they are still well below historical averages. The average dividend yield is 13%, up 500 basis points from year-end and 410 basis points higher than the average over the past 2-plus years, according to a recent report. In addition, the average price to book multiple is 90% compared to 159% at the end of 2006 and 147% average since the beginning of 2005.
Keep in mind that many of these stocks are currently priced to suggest an expected cut in the dividend payout sometime in 2008. However, even at the adjusted anticipated yield, CS thinks these stocks are currently attractive.
For complete list of nine REITs reviewed this month, including target prices, please see the current issue of Yield and Income Newsletter. PreferredsOnline subscribers receive this monthly newsletter as part of their subscription.
Closed-End Funds
Stifel Nicolaus recently upgraded to “buy” three other closed-end funds-- The Nuveen Equity Premium Opportunity Fund; the NFJ Dividend, Interest & Premium Strategy Fund, and The Eaton Vance Enhanced Equity Income Fund II. In all three cases, the brokerage pointed out that the fund's NAV total returns have beaten the S&P 500 in the year-to-date while its share price has declined. “We believe the sharp decoupling of NAV and share price performance provides an exceptionally attractive entry point for investors,” the brokerage noted in recent reports about each of the three funds. If you are thinking of getting into these funds before year-end be careful, Stifel warned. There also may be some remaining volatility as tax loss selling begins in earnest, it noted.
Preferred Stocks
UBS Wealth Management Research recently told clients it has become more selective in assigning “outperform” ratings to preferreds in the Financial Sector. It recently lowered the ratings on issues from Citigroup, Merrill Lynch, and Morgan Stanley from “outperform” to “market perform.”
“We think preferred prices may stay volatile in the near term due to the uncertainty of further write-downs at financial institutions,” UBS wrote. “Longer term, we believe preferreds offer value at their current historically wide spread levels.”
In general, UBS Wealth Management Research moved from a moderate overweight to neutral allocation for preferreds in the beginning of November, citing what it believes to be the increased likelihood of spreads remaining vulnerable to news of further write-downs filtering from the financial sector. “The preferred market could remain in a fragile state until market participants gain a better understanding of the full extent and magnitude these losses,” it added.
It also noted that the potential for continued new issuance could also create challenges. Even so, UBS noted that preferred spreads levels are now pricing in much of the uncertainty and are higher than fundamentals can justify. “We think the preferred market offers value for long-term investors and look for preferred spreads to improve over time,” it added.
For complete coverage, including target prices, please see the current issue of Yield and Income Newsletter. PreferredsOnline subscribers receive this monthly newsletter as part of their subscription.
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