With the U.S. economy sinking and the Euro in crises, what’s an investor to do?
With the recent market drop, there is a lot of talk about this being similar to last year’s correction. This is not Déjà vu all over again. The global economy is slowing and the global debt crisis is getting more intense, and it’s not just a U.S. problem either. It is a global problem, particularly amongst the developed world. So, it’s not just us that is bankrupt, but Europe as well. It started with Greece, recently spreading through Italy and Spain and Tuesday morning reaching France. Our banking crises of a couple of years ago is rocking through Europe which will eventually reverberate back here.
These issues and more are exactly what I write about in my book, Facing Goliath: How to Triumph in the Dangerous Market Ahead. My son, Josh recently asked me how it felt to be right in predicting what is going on in the economy and the markets. What a question. How do you explain the bittersweet joy and pain to a kid?
Last week’s Federal Reserve statement was remarkably blunt, admitting that our economy was slowing more than previously expected and that monetary easing would continue until the cows come home. I was pleased that they will continue with QE Mini-Me and leave rates at zero through 2013. I was disappointed, however, that they didn’t come through with a new asset purchase program or a full blown QE3. Unfortunately, only a new QE program can save this market, and we’re likely to get one next week from Jackson Hole.
The current uncertainty is creating tremendous opportunities in income producing investments and especially short term corporate bonds (not bond funds), with yields now exceeding 10-12%. Even when the market has been down, many of our dividend stocks and preferreds are up. Corporate bonds got hit as hedge funds were forced to liquidate bonds to meet margin calls to cover the money they lost on stocks. (Paulson’s hedge fund announced that they are down 31% this month alone!)
These depressed prices are most likely very temporary and a boon to the “reasonable” investor who simply needs decent returns without all the headaches and heart attacks. After all, if you can get a 10-12% yield per year and get your principal back in just a just a year or two, why take all the risk of the stock market? Invest for need, not for greed.
The lack of a QE3 is not good news for the stock market, and we have implemented selective portfolio hedges through inverse funds which go up when the market goes down. The next few days are critical. If we do not see a true bottom formed with a strong rally, not just a “relief rally” with increased demand and good volume, we will begin to implement our safety control stop exit strategy for growth stocks. As discussed above, bonds should be held and added to, even if their prices drop along with the stock market. At current prices, they represent tremendous value and offer a very good possibility for appreciation in addition to the interest payments. However, even if they don’t appreciate, all you have to do is wait a couple of years until maturity. Plus, they are always very liquid.
Investors should focus on the sweet spot in the market and try to avoid the “all in or all out” mentality of investments that simply track the stock market. Right now that sweet spot is dividend stocks, MLPs, preferreds and corporate bonds. These got hit in the decline but offer phenomenal yields.
The Ally bank (GMAC) 7.3% pfd trading at $21 yields about 8%. That’s about 80% of the stock market’s average annual return, but with practically no risk, as they are largely owned by the US Treasury. MLP opportunities include BreitBurn Energy (BBEP), Legacy Reserves (NASDAQ:LGCY) and Vanguard Natural Resources (NYSE:VNR) which yield between 8-10%.
Terra Nitrogen (NYSE:TNH) is another way to get great returns with less risk. They produce agricultural products such as fertilizer and crop protection and yield over 9%. Farm land and agricultural products are hot right now, and offer less risk than the stock market with inflation protection.
There are several lower rated corporate bonds that are a steal right now, as many dropped with the market as investors panicked in many cases by “throwing the baby out with the bathwater”. Issues such as Solo Cup’s (those red keg cups at every frat party) 8.5% of 2014 yielding 13+%, Edison Mission Energy’s 7.75% of 2016 yielding 14% and Colt Defense’s (the gun maker) 8.75% of 2018 yielding 16+%, present great opportunities at current levels. Remember, as a bond holder you don’t care how the shareholders do. Your only interest is in the company staying in business.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.