Speculators Are Back

by: Avi Morris

Markets are coming off their greatest run in history as the S&P 500 is approaching double its March lows last year. Some stocks have done far better, including many high yield securities. Higher prices on junk bond funds caused yields on junk bond funds to plunge from over 25% to under 10%. Markets have been rising (especially for high yield securities) on the basic assumption that a strong economic recovery will create a rising tide which will lift all ships.

Ambac (ABK), a former highly regarded bond insurer, has fallen on hard times. Its stock had been lumbering along above 50¢ in 2010. But in the last couple of weeks the stock exploded, going above $3 and then settled back to $1.75 even though this is still a "has been" company which traded above 90 three years ago. A mediocre earnings release got a lot of speculative interest while the possibility that ABK might have to file Chapter 11 next year was ignored.

This story is not an isolated case. Once glorious Fannie Mae (FNM), now a dollar stock, has risen to over $1.30 this year. AIG (NYSE:AIG) at $39 (not a dollar stock because of a major reverse split), is almost double its 2010 low with daily swings of 10+%. Less volatile, high yield securities have continued rising in 2010.

Investors, especially new ones, having been buying on hopes that an improving economy will keep default rates low for junk bonds. A desire to earn high current income with a tax advantage is also bringing new investors to MLPs taking the yield on the Alerian MLP Index down 6.8%.

Then came Friday (April 16) when the Goldman Sachs (NYSE:GS) story broke. This has the potential to do serious damage to the markets including high yield securities because of their extraordinary gains. Goldman was charged (but not indicted) by the SEC with civil fraud, defrauding investors for failure to release vital information. The issues are complicated, blurry and difficult to understand.

But at a time of high unemployment with no significant changes expected in the short run, stories about a few, highly paid financial execs making huge amounts of money, will be dealt with harshly. Over the weekend, the UK and Germany are starting new investigations of GS. Risk traders have been dealt a serious blow while risk averse has just gotten a boost.

Despite the spike in speculative interest in stocks, bulls would say it has not reached extreme levels at previous market highs. Perhaps, but after Goldman dropped 23 on Friday and is facing more investigations, markets could be under more pressure. Rapidly rising high yielding securities can be expected to lead any subsequent decline.

Meanwhile S&P 500 Dividend Aristocrats have largely been forgotten and ignored. By definition, their dividends have been or are being increased this year. They also received little attention when the markets sold off badly in 2008, allowing them to outperform market averages. Investors looking for defensive securities might take another look at this elite group of 43 including:

Abbott Labs (NYSE:ABT)
Clorox (NYSE:CLX)
Coca Cola (NYSE:KO)
Eli Lilly (NYSE:LLY)
Exxon Mobil (NYSE:XOM)
Johnson & Johnson (NYSE:JNJ)
Kimberly Clark (NYSE:KMB)
Merck (NYSE:MRK)
Procter & Gamble (NYSE:PG)
Walgreens (WAG)
Wal-Mart (NYSE:WMT)

Disclosure: Author long KO, LLY