Despite being one who has some familiarity with cruising, I'm not sure I could truly identify with the fright passengers on Royal Caribbean's (NYSE:RCL) Anthem of the Seas must have experienced over the weekend. Though I've felt severe rocking and have gone through a thunderstorm that panicked my family for about 20 minutes on another RCCL ship about 4 years ago, I could not imagine a 12-hour ordeal through basically hurricane force conditions and variable ship listing.
RCCL's Anthem of the Seas in slightly calmer waters
At this point, long-term investors must be feeling like they're sitting in the middle of an Anthem-like storm as well, albeit on less life-threatening terra firma. This particular correction will represent the longest duration pullback of any since the financial crisis. Believe it or not, however, at about a 15% decline (2015 peak to the recent trough in SPY), we have yet to eclipse the eurozone-inspired sell-off that transpired during the latter portion of 2011.
After the trough of that 20% correction, however, stocks regained higher highs in fairly quick course before the Spring of 2012. I would opine it doubtful that we'll have an awe-inspiring rally of that nature this time around. Certainly, anything is possible, but frankly, it's been no secret that the market has been running on bullish fumes, consisting of high value and probably, at best, mixed economic fundamentals. If you are surprised at the current pullback, I'd argue you really shouldn't have been.
But What Now?
Like the captain of Anthem, I can issue comforting thoughts and tell you everything will be all right on the other side of the storm. Unfortunately, I can't be absolutely certain of that fact, and in hindsight, neither could he. While there's a lot to be concerned with on a macroeconomic level, asset toxicity doesn't seem to be nearly as troublesome as it was during the financial crisis. However, I opined two months ago that the Fed made a mistake by raising rates and should be whistled for a false start. I stick to that contention and the prediction that they take back the hike probably by the middle of the year.
Wall Street, in my opinion, has not necessary been very reflective of Main Street over the past several years. Whether we look at statistical data showing the middle glass spinning its wheels, the seemingly underappreciated public pension crisis, growing political gridlock both on a state and national level, or the potential domino impact of a new petroleum price normal, there are plenty of headwinds obstructing the path of wholesale economic growth.
Looking past the macroeconomy and more at income investing strategy, there's probably much more that can be accomplished on a pullback than might be first thought. While I've already made my general thoughts on a cash raise known in another article, investors should take the opportunity to thoroughly sort through their portfolios.
While I wouldn't necessarily make near-term decisions based on a worst-case scenario, the less tolerance for risk you have, the more circumspect and particular you need to be with that which you own. Many investors probably thought they had developed iron constitutions during the past many years. Now that the light on our bull run has run rather dim, I suspect many are starting to wonder if they can really digest all the hot sauce they splashed on their portfolios.
Keys To Sleeping Well At Night
As I've noted in the past, if you are tossing and turning at night or watching too many 2 AM infomercials, your discomfort may be more related to your overall portfolio allocation than necessarily to that which you own. Bonds and cash have developed something of a pariah-like reputation, given their limited reward, since the financial crisis. However, I've probably heard or read the platitude "cash is king" more times in the past week than I had heard it uttered in the past five years.
Of course, bonds haven't exactly been a secret over the past few months either. Ten-year Treasury yield has spiked significantly lower since the Fed raised rates, and seems destined to bump up against the 1.5% mark - something we haven't seen since 2012.
If you possess a thoughtfully laid out allocation, it's possible that recent market action has not made you blink. While some investors might be scrambling around deciding whether to raise cash, buy bonds, or something else off the wall, those well allocated might be actually thinking of adding to equity stakes or generally not stressing over their portfolios.
Poor diversification may have also lead you to recently caffeine-filled nights. If you were heavily weighted to energy stocks, for example - a not-so-uncommon portfolio trait - you've become rudely indoctrinated into the "when you least expect it, expect it" club over the past 18 months.
Asset and sector diversification are really the only two "freebies" that investors can take advantage of. Take advantage of them, and don't assume your crystal ball is better (or worse) than anyone else's.
Drill Down Your Stocks
If you consider yourself well allocated and diversified, the quality of your equity stakes may be in question. If you've adopted some sort of high-yield concentrated strategy - a fairly common thing since the onset of ZIRP - odds are you may be in a world of pain right now. Most Business Development Companies, mortgage REITs, and MLPs have suffered for a whole laundry list of reasons. At the end of the day, high yield may not always be a harbinger of higher risk, but given the capital destruction that has occurred in many of these corners over the past few years, it has been a generally good indicator of such.
Companies with external management deals with suspect shareholder alignment have been hit the worst, and probably for good reason. While their yields have spiked to dreamboat levels, with prices well below NAV, low stock prices are stifling these entities' abilities to raise capital and grow. As management fees suck the life out of the company, in many cases dividends have been forced lower.
If we are only part of the way through the storm, despite the big hit on many of them already, it's possible some of these companies taking on water may ultimately end up being shipwrecks.
For those of you not wishing to play hero through the storm, here's a laundry list of equity income attributes that, while not necessarily fail-safe, might be considered safer than others:
- Investment-grade credit ratings, typically with low nominal amounts of debt and higher than typical amounts of cash on the balance sheet.
- Business models not dependent or implicated by any one commodity.
- Managements that are clearly aligned with shareholders through high internal equity ownership - incentivized to increase share price and grow the dividend, not grow assets under management.
- Low payout ratios with well-covered or otherwise recession-resistant dividends that might be able to grow during a longer-than-usual economic malaise.
- Low valuations relative to the expected growth rate (PEG).
What Specifically To Own
The types of stocks that appeal to each investor right now will certainly vary. In my last article, I mentioned Cisco (NASDAQ:CSCO) prior to earnings, which ended up being a decent near-term call. It beat and raised the dividend by a handsome amount, something I had been anticipating, but not to the eye-catching 26 percent it did. While many are concerned with the company's demise relative to commoditized products, I think that concern is well over-dramatized.
Still, Cisco's balance sheet is really a picture-perfect example of a type the more defensive income investor should strive to own.
I also mentioned Pfizer (NYSE:PFE). Healthcare, like consumer products, is a good place to hide in an economic downturn, although a Sanders or Clinton presidency would pressure the group, especially if Congress gravitates back to a Democratically-controlled look.
On a bit more cyclical level, I took advantage of the recent downdraft in Masco (NYSE:MAS) to start a position. The parent of Kraft-Maid and Merillat cabinetry, Delta faucets, as well as Behr and Kilz coatings, amongst other brands, had a very good quarter. While not cheap on an EPS level, the company is increasing efficiency and appears well positioned for growth. It has more than $1 billion in cash (on $8B market cap), a low payout and plenty of room to raise the dividend, which, for now, isn't an eye-catcher at 1.5 percent.
Overview of Masco's Products
On the cheap side of cyclical, there's General Motors (NYSE:GM), which now yields better than 5.5 percent. I also think Aircastle (NYSE:AYR), which is probably the most astute and nimble of the aircraft leasing companies, selling below book at an almost 6% yield is a good deal.
Financials, in general, seem to have been hit overly hard, which probably serves up an opportunity to begin or add to positions. Prudential Financial (NYSE:PRU), a solid, diversified franchise with a 4.5% yield is cheap, although the company's best days of growth are behind it. Meanwhile, with rates slugging lower, it won't mean great things for those that live off of a spread. Although, it will be great for those still looking to bring down their cost of capital.
For those who think the market continues to edge lower, I continue to pound the table on the option income funds, which overlay portfolios of equities with call strategies. These are really the "safest" upper-single digit or, in some cases, double-digit payouts that the income investor can access. Selling calls on your own is also an option, but you will need to give your portfolio adequate attention if you become fully or even partially engaged.
While the current correction has certainly become meaningful on a historical level, there's not a lot of reason to believe we are imminently ready to exit into calmer waters. Whether the malaise lasts another week, month, year, or decade, your ability to ride it out is much reliant on your ability to efficiently and thoughtfully allocate assets to match your needs and downside tolerance.
If we are closer to the end of the storm than the beginning, a mad rush from equity into bonds and cash may not be the shrewdest move to make. Unfortunately, you'll only know what the best move was in hindsight. Still, if you remain poorly allocated or overly aggressive in your equity choices, you will spend the rest of your investing life second-guessing yourself each and every time volatility or harsh downside ensues.
Overly aggressive choices led to two of the biggest maritime disasters in history, namely the Titanic and Costa Concordia. Royal Caribbean should feel fortunate, as should its passengers, that it didn't become part of that list. Take the proper steps to get yourself safely through the rest of this storm and through subsequent ones. Don't become an income shipwreck or your own victim of thoughtless or otherwise ill-advised decision making.
Disclosure: I am/we are long AYR, CSCO,PFE, GM,MAS,RCL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.