The trouble is, nothing is 100 percent safe under all circumstances. And even pinpointing the highest percentage investments can be a chore when the economy is apparently shrinking and credit markets are still recovering from their deepest freeze in decades.
At the peak of the credit crisis last fall, even money market funds were suspect, as the $60 billion Primary Reserve Fund actually “broke the buck.” That prompted a massive government intervention to ensure money funds and restore investor confidence, which was ultimately successful in heading off a panic.
This week, the Securities and Exchange Commission (SEC) proposed tightening the rules governing money fund investments to reduce the odds of another meltdown. If passed, funds catering to retail investors would have to keep at least 5 percent of their assets in cash, Treasury paper or some other asset “that could be sold in a day.”
At least 15 percent would have to be saleable within a week, presumably under the worst conditions. And funds would also have to show they’re able to process redemptions at prices other than $1 a share, in order to prove they can still do so should the value of their assets ever break a buck. Limits on funds catering to institutions would be similar.
All that sounds reasonable, as does an SEC resolution to put more scrutiny on credit raters’ assessment of money fund asset risk. On the other hand, I expect most Americans probably thought much tougher safeguards than these were already in place. And these measures fall well short of the Feds’ implicit guarantee last fall that it would bail out investors in failing money funds the way it would protect depositors in failing banks.
Certainly, money funds can be trusted in normal times to provide a secure parking place for cash. When inflation is on the rise–as I believe it will be in coming years–their yields will increase along with it by virtue of the short term nature of the paper they hold. And in the meantime, many of them have all the convenience of a checking account.
Moreover, the overwhelming majority of money market funds did stand up to the worst credit market conditions in decades. Some had to rely on the strength of their parent companies, which were determined not to have their reputations tarred by the ignominy of breaking a buck.
But most simply never strayed beyond the bounds of prudence with their investments and always carried adequate liquidity to meet redemptions. That was in part due to good business, as they always wanted to be ready for their investors to pull funds from loss-leading money funds to other vehicles where fees are much higher. Money funds like the Vanguard family’s charge such low expenses that they can maintain competitive yields without taking nearly the risks rival funds do to get the same return.
The point, however, is money funds should never be blindly trusted, any more than any other single investment. You’ve got to know what your fund is doing, just as you need to know the business help of any company whose common stock, preferred stock or bonds you own.
Look to the Whole
The long and short of it is there really is no absolute safest investment that can be trusted under any circumstances. Any quest to find one is simply a waste of time. Rather, real safety depends on how well an entire portfolio is constructed against the dangers that lurk.
Apologies to the politically correct, but this market has a serious case of split personality. One day, the headlines read bearish, as the economy seems to sink deeper into a slough of despond. Investors head for the hills. The next, the news is decidedly more positive and hopeful, and the buyers come back.
It’s the same pattern we’ve seen for several weeks now. Stocks of great companies remain far cheaper than they were last year. Yields, including those backed by rock-steady businesses, are the highest they’ve been in years.
Meanwhile, there are definite signs that global growth is turning up. This week, the Organization for Economic Cooperation and Development (OECD) revised upward its estimate for the global economy for the first time since 2007. To be sure, the forecast is still dismal: 4.1 percent shrinkage in 2009 followed by anemic 0.7 percent growth in 2010. And the OECD stated a recovery in Europe was nowhere in sight.
But this news is undeniably still a positive step from prior projections. And it includes forecasts for some rather sharp turnarounds in the US, Brazil, Russia and Mexico, along with a return to robust growth in India and China.
It’s this Asia-led growth that’s likely to emerge as the primary driver for the recovery of a whole range of industries, particularly the commodity related as those countries continue to urbanize rapidly. That’s once again a good reason to pick up a copy of my colleague Yiannis Mostrous’ book, The Silk Road to Riches: How You Can Profit by Investing in Asia’s Newfound Prosperity, which lays out the long-term case for the region and how its quantum changes are affecting the rest of the world.
On the other hand, the market is still deeply worried about how much more pain lies ahead with the economy. US unemployment is still rising, though arguably at a slower pace, evidenced by this week’s unexpectedly large increase in first time claims for state unemployment insurance. That’s certain to continue to impact consumer dependent industries, like retail, automobiles and even home buying.
Many businesses have held their ground thus far in this recession. They populate my Utility Forecaster Portfolio (the July issue will be available Saturday morning) as well as the Personal Finance Income Portfolio, Canadian Edge, New World 3.0 and MLP Profits, which I co-edit with my colleague Elliott Gue.
There will, however, no doubt be other business meltdowns in the coming months. And we’ll start to get a preview of those as second quarter earnings warnings start to come in over the next couple of weeks, with actual hard numbers to follow.
At this point, I’m not expecting any of our holdings to falter. But that’s always a possibility to be prepared for. And with the market recovering sharply from the March 9 lows, those that do falter seriously are likely to be punished severely in the market place.
What to Do Now
So how do you prepare yourself? First, diversify and balance. Every successful investor has their own unique strategy that fits their needs and temperament. But the principles of diversifying among sectors and investments and balancing your holdings transcend most strategies that are successful long-term. And that’s essential if you’re going to live off your investments.
Second, make sure you’re invested in the best representatives of the sectors and investment types you choose. That boils down to the health of underlying businesses of the companies themselves. I follow a simple rule of never buying a preferred stock or bond of any company in which I wouldn’t want to own the common stock. And I assess companies on financial strength, revenue security and strategy every time they issue earnings numbers.
Over the next couple weeks, larger companies will be guiding expectations for their second quarter numbers. Some will pre-warn that numbers won’t meet current expectations, while others will do the opposite. That could have a major impact on share prices in the near term, particularly of those that disappoint. But the key is what the final numbers tell us about the health and direction of the business, not whether a “whisper number” was met.
Here’s a brief look at each sector income investors should have positions in now, along with what I’m looking for in my favorites, as we approach the mid-year mark and Fourth of July holiday weekend.
Power Utilities. It’s now clear that the Obama administration, the Democratic Congress and the US power industry have reached an accord on carbon regulation, which is reflected in the bills now speeding through the House and Senate.
The crux of their plan is a vast increase in spending on renewable energy–including nuclear power–and energy efficiency through “smart grid” investments. These investments can easily be passed into utility rate bases and therefore increase earnings.
The pleasant surprise for investors is the plan is light on punishment for coal-burning utilities, which have been given a long lead time without financial penalty for reducing carbon dioxide (CO2) emissions. That should limit any potential rate shock for consumers, and resulting regulatory risk for utilities.
The best electric utilities to own now are those that are ramping up renewable energy, either in regulated rate base or through unregulated units such as FPL Group’s (NYSE: FPL) NextEra Energy. Alternatively, traditional utilities in favorable regulatory climates will also be able to boost earnings by investing to reduce carbon, including Southern Company (NYSE: SO).
Communications. Keep your eye on wireless data growth. If this continues to be robust, big telecoms like AT&T (NYSE: T) and Verizon Communications (NYSE: VZ) will be headed for an unexpectedly strong rest of the year and beyond.
As for high-yielding rural wireline companies, bigger is better. There will be customer losses in this recessionary environment, but free cash flow is the key metric.
Water Utilities. There are no problems here with recession, and the stocks are exceptionally cheap.
Master Limited Partnerships. The best of these are virtually as safe as utilities, drawing cash flow from fees earned from vital energy related assets. They’re also growing rapidly, adding to assets and therefore cash flow and dividends.
My favorites are those involved with energy infrastructure like Enterprise Products Partners (NYSE: EPD). Note that my colleague Elliott Gue and I have launched a comprehensive advisory on MLPs, MLP Profits. We offer buy/hold/sell advice on every US MLP, of which there are more than 100 at present.
Real Estate Investment Trusts. Apartment REITs like Home Properties (NYSE: HME) can be hurt by vacancies and bad debt expense in weak economies like this one. But they’re also benefiting from tight credit and its impact on the housing market, as more would-be home buyers elect to rent instead.
Canadian REITs have been run far more conservatively than their US counterparts in recent years and so also have higher occupancy, stronger rent growth, lower bad debt and better balance sheets, despite the economic downturn.
In contrast, commercial REITs in the US are only just beginning to feel the impact of a weaker economy on balance sheets and dividends. The risk of more Kimco Realty Corp (NYSE: KIM) situations–the retail REIT effectively gutted its dividend to shore up finances–has rarely been higher.
Municipal Bonds. If I’m bearish on any income vehicle, it’s this, insured municipal bonds in particular.
These bonds have credit ratings that depend on the health of the insurance company rather than the underlying asset or government entity. A default anywhere, increasingly possible given the strain on state and local finances, will threaten that insurance and therefore all insured munis.
If you’re going to own in this sector, stick with a diversified open-end fund like Vanguard’s, or else do your homework carefully on the government you’re lending to.
Diversified Income Mutual Funds. Some of the so-called equity income funds have solid track records. And I would encourage fund investors to check out the research of my colleague Ben Shepherd, editor of Louis Rukeyser’s Mutual Funds and manager of the Personal Finance Fund Portfolio. Generally, though, I prefer to buy individual securities, as you usually get bigger yields by avoiding management fees and you always know what you own.
Energy Producers. These were generally left out in the cold in the Democrats’ deal with power utilities over carbon regulation. But with oil, gas and even coal prices well below reserve replacement costs and demand elsewhere in the world apparently picking up (read: Asia), that hardly matters.
Energy prices will drive inflation, so producers are also the ultimate inflation hedges. Every portfolio should have some, with the choice depending on how conservative the investor is.
Super Oils are generally safest and wildcat producers and energy services companies riskiest. In between there are Canadian trusts and utilities attached to production companies, such as Energen Corp (NYSE: EGN).
Treasury Bonds. Unless you’re speculating on the future of interest rates, these are best avoided. The lack of credit risk is more than offset by total vulnerability to inflation and yields are still paltry.
Corporate Bonds. I like bonds of companies that are shedding credit risk by getting stronger financially and are therefore positioned to benefit from a narrowing of yield spreads with risk-free Treasuries.
Utility bonds have the best record of always paying, with even those filing bankruptcy in recent years eventually making bondholders whole. Sticking to maturities of five years or less doesn’t sacrifice much in the way of yield, and it takes away the vast majority of inflation risk as well.
Preferred Stocks. These pay quarterly dividends like stocks that must be made good on before a dime of common dividend can be.
My strategy is the same as with corporate bonds (see above), though I’m particularly attracted to convertibles, which can be swapped for common stock at the right price and therefore have tremendous upside potential.
Canadian Income Trusts. Oil and gas producer trusts are selling at discounts of 50 percent and more to net asset value, the value of their reserves in the ground. Dividends and share prices have been buffeted by volatile energy prices over the past year but are now at a very conservative level for the best.
These are great inflation plays, as dividends rise with energy prices. In addition, the Canadian dollar is effectively a petro currency, which rises and falls with oil prices. As a result, rising inflation and rising energy prices mean a surging Canadian dollar or, loonie, which in turn raises the US dollar value of Canadian trust dividends and share prices. The loonie also makes inflation beneficiaries out of trusts that don’t produce energy.
Another attraction of trusts is that they still trade at a sizeable discount due to uncertainty about how their dividend will be affected by the 2011 trust tax and their likely conversion to corporations.
To date, the perception has been that big dividend cuts were inevitable. But a growing number of trusts are converting early without cutting dividends. Others are stating they’ll hold dividends when they convert in late 2010. As a result, we’re likely to see some solid gains for trusts in coming months from no-cut conversions.
For more, visit Canadian Edge, and/or sign up for the complimentary Maple Leaf Memo.
High-Yielding Industrials. This is a group that’s been hit very hard with dividend cuts. Until this recession ends, they’re not a good place to look for income, as businesses continue to suffer from the recession.
Financials. There are some big yields in this group. But aside from regional banks like Arrow Financial (NSDQ: AROW) and the big Canadian banks–which have largely sailed through the recession and credit crunch–the group is still too weak to be counted on for income.
Speaking Engagements
Eight score and one year ago, with the onset of the California Gold Rush, San Francisco earned a reputation as a prospector’s town. It’s time again to seek paths to prosperity–and to enjoy one of the most beautiful natural settings in the US, if not the world.
Venture west for the San Francisco Money Show Aug. 21-23, 2009, at the The San Francisco Marriott and discover how Roger Conrad, Elliott Gue and GS Early can help you profit in these adventurous times.
Roger will discuss utilities, Canadian income and royalty trusts as well as his new service focused on exploiting the greatest spending boom in history, New World 3.0. Elliott will detail the new direction for Personal Finance and provide his forecast on energy markets for 2009. GS, a constant at PF for two decades, will be there to speak on emerging tech, nanotech and defense tech.
Click here or call 800-970-4355 and refer to priority code 014310 to register as a guest of U&I.
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