Has Prudent Income Investing Become Extinct?

Includes: AGNC, BAC, C, GLD, JPM, SPGI, T, VZ, WFC
by: Todd Johnson

I posit today that U.S. citizens can no longer prudently invest for income. I write this article as a former income investor. I intend to argue that options for the "income investor" have been synthetically removed from the U.S. financial markets.

The Federal Government, the Federal Reserve, and our leadership have created an environment where income investors are forced to take improper portfolio risk. It's a sad day when retirees have zero options other than buying risky assets. Here are the factors that have led us to this conclusion.

Quantitative Easing (pdf). The Federal Reserve's decision to implement quantitative easing (QE) has been a financial disaster. It is true QE bailed out the too-big-to-fail institutions. Bank of America (NYSE:BAC), Citigroup (NYSE:C), Wells Fargo (NYSE:WFC), JP Morgan (NYSE:JPM) now stand proudly due to QE. Unemployment has increased and housing values and purchasing power for the average citizen have decreased.

The Fed's decision to artificially decrease interest rates allowed failed U.S. banks to borrow cheaply via the Fed Funds rate. The banks then could invest, via a carry-trade, in a higher yielding asset class and have risk-free profits. Who can forget BOA CEO Ken Lewis, in February 2009, stating BOA would not need any additional funding? This month we find out that BOA may need another $50-billion to get through the difficult times. Oh what will we do?

Failed banks should be allowed to fail. Banks that are properly managed should be allowed to succeed. If only common sense were allowed to exist.

Governmental Intervention with Credit Agencies. On August 5, Standard & Poor's issued a U.S. Debt downgrade. The Federal debt, the current annual Federal deficit, Medicare, Social Security all add up to a sizable amount of money. The Federal government simply operates in a system where revenue does not have to match expenditures. Checking Book Principles 101 do not apply to the government. The amounts are so extreme that the debt can never be repaid unless the dollar is devalued. Thus we have gold trading near $1,900 in a deflationary economic environment.

Perhaps coincidences do happen. I will let the reader decide. Here are three actions that have occurred since the August 5th decision by McGraw-Hill (MHP) subsidiary Standard & Poor's to downgrade the U.S. debt:

  1. The Department of Justice, on August 18, announces it is probing Standard and Poor's mortgage ratings.
  2. On August 23, the Standard & Poor's president, Deven Sharma, resigns.
  3. On August 23, Standard & Poor's announces it is replacing Sharma with Citibank's (C) chief operating officer, Douglas Peterson. Citibank is one of the banks that was too big to fail.

In my opinion, the above moves indicate the U.S. Debt ratings will increase to their "rightful" AAA in 45-days.

Treasury Bill and Treasury Bond Markets. A retiree, and most investors, should have Treasury Bonds in their portfolios. This has been the asset allocation mantra for years. The investor should own stocks and bonds. Retirees were told to allocate a higher percentage of their portfolio to bonds. The rationale was simple: retirees are no longer working and have only one nest egg. They cannot afford to lose money in the up and down swings of the stock market.

(Click chart to expand)

The reader can see the above Treasury Bill and Treasury Bond rates. A 7-Year Treasury Bond must be purchased if an income investor wants a yield above 1%. This yield, influenced by the Fed's QE, forces the income investor to seek higher risk assets to achieve financial goals.

In my opinion, investing in AT&T (NYSE:T) and Verizon (NYSE:VZ) are very risky. They have between 30%-50% of enterprise value in debt obligations. New communication services, such as Skype, could potentially hurt their earnings.

Advising a client to put money into American Capital Agency (NASDAQ:AGNC) pales in comparison with the reliability of a trustworthy U.S. Treasury Bond with a reasonable yield. Income investors are forced to decide what is safe outside the U.S. Treasury markets. This puts retirees and portfolio allocations at the kind of risk in terms of options, not found in prior generations.

In my view, the Federal Reserve has rewarded the failed banks of the U.S.A. and ignored the needs of the typical U.S. income investor. Dreams have been shattered and the damage is permanent.

Disclosure: I am long AGNC.

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