Tuesday, December 16, 2008: Issue #583
Guest Editorial by Nick Lanyi at The Street Authority
Editor’s Note: In today’s edition, we welcome back Nick Lanyi, high-yield investment expert at The Street Authority. Nick’s written several columns for us in recent months, showing you how it’s possible to grab fat yields, even in a sinking, cash-strapped global economy. With investors searching high and low for income-producing opportunities, this is one of the most important topics in the market today. So read on to get Nick’s latest thoughts - and find out how you can pocket a safe 9.9% yield.
Martin Denholm, Managing Editor, Smart Profits Report
Even With Rampant Volatility And Crushed Yields, You Can Find Healthy Opportunities
Since the sub-prime mortgage crisis clobbered the market last summer - the trigger point for dragging the U.S. into what could be the worst economic recession since the Great Depression - investors have struggled to find many decent, safe opportunities.
But here’s one…
The stock market is currently filled with the highest volatility in almost 75 years. In October, for example, the total day-to-day point movement on the Dow was 7,818 - more than four times what we saw in 2007 and more than 10 times than in 2006. The S&P 500 is down roughly 42% for the year and the prospects for a speedy economic recovery are non-existent.
But paradoxically, income investors have had something to celebrate lately. The virtual meltdown in the credit markets has resulted in a surprising silver lining: Yields on safe, investment-grade preferred stocks have risen.
Yes, preferred stocks have always offered better yield opportunities than other asset classes - but thanks to the credit crunch, the gap has become even wider. For example…
- The average yield for stocks in the S&P 500 is 3.5% - a return that is purely a function of unfavorable mathematics, given the 42% slump for the U.S. benchmark.
- A six-month CD is only going to net you an average of 2.9%.
- The average bond yield, as measured by the Lehman Aggregate Bond Index, is still only 5.2%.
- BUT… the 12-month yield on preferred shares, as measured by the payout on the PreferredsOnline Index, is 10%. And dozens of high-quality preferred stocks are paying higher-than-average yields right now.
Let’s see how we can take advantage…
A Plethora Of Preferreds
Slapped down by the credit mess, cash-strapped banks are shoring up their balance sheets by issuing billions of dollars in new preferred shares.
And one of the biggest buyers of these ultra-safe securities has been none other than Warren Buffett, who has snapped up $5 billion worth of preferred stock, which carries a 10% yield, from both Goldman Sachs (NYSE: GS) and General Electric (NYSE: GE). Many other companies are offering similar issues.
The increased supply of new preferred stock flooding the market is sending share prices lower. And since share prices and yields move in opposite directions, the supply surge is also lifting yields to historically high levels.
That’s great news for income investors at a time when great financial news is at low tide - especially as the Fed keeps pushing yields down on everything from Treasuries to money-market accounts.
Preferred Income Is Safe Income
One of the biggest benefits of preferred shares is that not only do they pay higher yields than regular stocks, their payouts are also more secure than common dividends.
Preferred shareholders have a claim to a company’s assets ahead of common shareholders - hence why they’re called “preferred.” In other words, if a company runs into trouble, it must pay preferred dividends before common-stock dividends.
And while a preferred stock can still default on its payments, ratings company Standard and Poor’s classifies this as an “extremely rare” occurrence. Principal Global Investors estimated that the historical default rate for investment-grade preferred stocks was less than 0.2%.
Want another couple of benefits?
Preferred Income Is Predictable, Low Volatility Income, Too
Unlike common dividends, preferred payouts are predictable in that they don’t rise and fall with a company’s earnings. In fact, as you can see below, the most recent data from Standard & Poor’s shows that November was the worst month since May 1958 for dividend cuts.
And after the last few months of whiplash-producing market swings, investors certainly enjoy the low volatility of these holdings. Preferred stocks are also a great way to diversify your portfolio to ensure regular, timely dividend payments. This is particularly important for retirees.
The Time To Jump On This Opportunity Is Now
So what’s driving today’s unprecedented gap between preferred yields and the yields offered by other investment-grade securities?
Simply put, a temporary supply increase. As more investors gobble up the latest preferred offerings, this gap will start to narrow. Bottom line: It’s time to lock in these bloated yields now.
In the current issue of High-Yield Investing, my colleague Carla Pasternak updated her subscribers on a preferred issue she has held in her model portfolio since late 2005. This company’s business model is sheer genius…
It uses ultra low-cost, short-term loans to buy government-secured mortgage-backed securities. In other words, it borrows at a very low rate, collects a relatively high rate and pockets the spread. Simple, but elegant - and the preferred shares pay a rich 9.9% yield.
Not only that, this preferred stock has dished out reliable distributions since its IPO in December 1992. Investors who bought when the preferred issue went public have enjoyed over 180 consecutive payments - come rain or shine.
Even throughout the major challenges of the past year, this preferred stock has held up very well. Over that time, it’s chalked up a total return of 10.8% - outperforming the S&P 500 by 52 percentage points. But that’s nothing new… this preferred stock has actually outperformed the S&P by nearly 50 percentage points over the past five years.
Carla has put together a comprehensive analysis of this exceptional opportunity, spelling out how the safety of its government-backed holdings and legally obligated monthly dividend payments are especially attractive given the current conditions in the markets. To read Carla’s report, please visit this link.
Best regards,
Nick Lanyi
Co-Editor, Global Dividend Opportunities at The Street Authority
