High Yield Securities Need to Refresh

The stock market has had one of its biggest rallies in history. In three months, Dow rose 2200 points (from a depressed level) by one third. Not bad, but it has been stalling in the last few weeks.

The high yield sector in particular appears to be getting over extended. MLPs, REITs and junk bond funds have had stronger recoveries from their lows. The Alerian MLP Index story is repeated in the other sectors. The premium of the yield on MLPs over the 10 year Treasury bond yield narrowed from over 1200 basis points at the lows last year to only 500 points.

By way of comparison, the traditional premium was considered to be 200. The statistics for REITs and junk bond funds are not as good, but the story is similar. Rising stock prices have dramatically reduced their yields while Treasury bond yields have been rising, reducing the yield spread.

The economy seems to have bottomed and is looking for ways to recover. But the rebound may be slow. Housing remains in the dumps and its depressed state may drag on with rising mortgage rates. The auto industry will have to adjust to significant downsizing. Retail sales are sluggish at best. Unemployment shot up to 9.4% and will probably go significantly higher before declining at a slow rate.

Adding to economic worries is the recent rise in the 10 year Treasury bond yield. Early this year it had fallen to record levels approaching 2%, providing a major help to the economy. Government borrowing costs were reduced, of significant value when the Treasury has to borrow trillions to finance huge deficits. In addition many mortgages are tied to the Treasury yield, allowing mortgages rates to fall to record lows. Not any more.

It is important to remember that the high yield sector has not yet gone through its difficult period. Junk bond defaults will increase. The first wave is hitting now after the bankruptcy of General Motors (GMGMQ.PK) and Chrysler. REITs will see higher vacancy rates, estimated to go into double digits.

The rise in MLP index is probably better justified as the industry has had only a few reduce distributions. Most have not had trouble securing additional financing for capital investments or extending debt maturities. But factors driving earnings, and, more importantly, distributable cash flow, are less clear. A sluggish economy may hurt them more than can presently be anticipated.

At this stage of recovery in the markets, a pause to retrench is needed to let investors better assess how the economic recovery will proceed and the impact of the increased government debt load. MLPs, REITs and junk bond funds continue to offer significant yield spreads to cover added risk associated with these investments. But the recent narrowing of spreads looks like it got ahead of itself.

Comments

[velvet:]

Does this mean I have to get rid of LINE ?

Jun 09 08:46 AM

[YoYoMama:]

You never "get rid" of any stock (or take a position) based on just one article on Seeking Alpha. You conduct your own due diligence first, looking at company fundamentals and looking at a variety of opinions and sources.

On Jun 09 08:46 AM velvet wrote:

> Does this mean I have to get rid of LINE ?

Jun 09 10:15 AM

[tc1:]

Velvet,
Linn Energy (LINE) is a very solid company, and was recommended in two Barron's pieces back in late Dec. 2008 and also recently promoted by Jim Cramer (and bought by his hordes of followers) after Cramer interviewed CEO Michael Linn in May.

The stock has been a consistent winner since i bought it low in early Dec.

It might be a bit overbought right now and, technically speaking, is testing the $20 price level as a breakthrough price-point for a new support level.

Yet all of this could change if oil prices sag significantly in the coming days/weeks. For, even though LINE's oil and gas prices are well-hedged into the medium-term future, the stock has some volatility due to its being tied to the masses' buying or selling of oil-related stocks contingent upon oil's price in the marketplace.

If you or others don't want to be invested just in one MLP or LLC in this sector, you can invest in KYN, TYG, FEN, etc which in turn invest in a "basket" of oil/gas MLPs. They pay fairly good dividends
in the 7-10% range.

Jun 09 10:58 AM

[mplaut:]

Even at $20 LINE is yielding over 12%.

It is impossible to know what will happen in the next few months, but over the long run LINE looks as good as ever. The next distribution payment is in August, so you might want to wait and hope for a pullback, but then again it may go higher by then.

LINE is good value at $20 and that is the best way to look at it, but if you want to check the prices daily, then, as tc1 says, it may be a bit overbought.

Jun 09 11:37 AM

[searcher:]

With these stocks, if the dividend is secure, you do nothing. If you think you'll have the guts, then you could sell a little into cash and, market permitting, buy more of the same if it backs off.

Jun 09 07:57 PM

[BestInvestIdea:]

high yield continues higher, now fueled more on speculation rather than justifiable spread contraction. I would be taking profits from this group with the idea to buy back after a correction. High yield can be a great stock market indicator and so far it continues to give the all clear signal even though logic would indicate otherwise.

Jun 12 12:28 AM