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I continue to read with great interest new SA articles addressing dividend strategies. It is certainly beneficial that more folks are becoming concerned about generating income for their retirement years.

Unfortunately, I have not come across too many that truthfully address what could happen to our holdings should the U.S. (and/or world) economies fall off of a cliff in the coming year(s).

Anyone who remains current with economic data probably would agree with the following points:

  • No country can remain unaffected by a monetary policy that is based upon printing new currency 24/7.
  • "Real" inflation is far above the number published by government agencies (just ask your wives about grocery and gas prices).
  • "Real" unemployment remains in double-digit territory regardless of what the Bureau of Labor Statistics or any other agency claims it to be. (A glance at declining labor force participation rates and the number of unemployed that have just given up supports this thesis.)
  • Europe remains in the world of hurt.

Unless a series of fiscal miracles occurs, the results of the seemingly accepted policy of "kicking the can down the road" will, at some point have adverse ramifications on the markets. Whether this happens in 2013, or later - it probably will happen and we all need to determine its impact on our portfolios.

One Possible Market Scenario

I have been an active investor since the early 1970s, so I have been through the debacle of the Carter years, the 1987 crash, and most recently the 2008 - 2009 DOW collapse from the 14000 range to the mid-6000's. One takeaway from each of these bear markets is that in a bear market ALL stocks will drop - it is just a question of how much. Of course, inverse index funds, ETF's and bear market mutual funds can generate positive returns during these periods, but one's timing has to be sharp to buy close to market tops.

A fair percentage of my research time is spent trying to develop a defensive strategy for positioning the Protected Principal Retirement portfolio, should we have a repeat of a bear market similar to those mentioned above. My personal belief is that the bulleted items above could present the potential for a 50 percent drop in market averages in the immediate future (emphasis on "could"). I am not an oddsmaker, but I think there is better than a 50 percent chance of this happening in the next few years, maybe 70 percent if the current White House occupant is re-elected.

How Did Stocks React

At present, the Protected Principal Retirement portfolio is about 85 percent invested. Our largest holdings are in the energy sector, consisting of master limited partnerships [MLPs], U.S., and Canadian royalty trusts.

In recent weeks we have added initial positions in Ship Finance International (NYSE:SFL), and in PetroLogistics (NYSE:PDH), both of which have fairly high yields.

Our other positions remain at approximately the same levels as they were when I crafted the first several articles in this series.

I believe that the greatest chance for a decline could mirror that of 2008 - 2009, so I re-visited those years to review this bear market's impact on each of our portfolio's asset classes.

First, the bad news. The mortgage real estate investment trusts (mREITs) were absolutely massacred. Equity real estate investment trusts (eREITs) were hammered (but not as badly), business development companies [BDCs], royalty trusts, commodities and foreign stocks pretty much mirrored the DOW and S&P averages, falling around 50 percent from their highs.

Now, the not so bad news (and I use this term loosely). During the period from October 9, 2007 (DOW high close of 14,164) to March 9, 2009 (DOW low close of 6,547) most of the master limited partnerships, while being beaten down in price, continued to increase distributions. The Table which follows illustrates this and includes data for several of the larger MLPs.

SymbolPrice 10/9/07Price 3/9/09Q. Distr. 10/07Q. Distr. 3/09
CPNO37.5312.13.47.575
DPM39.8010.20.55.60
EPD31.7417.95.49.538
EVEP35.6212.78.56.75
GEL25.518.63.27.338
KMP50.4841.15.881.05
LINE29.4916.95.57.63
MWE30.729.50.55.64
NGLS26.957.51.338.517
PAA55.3035.30.42.453
PVR27.849.65.43.47
TLP32.0015.26.50.59

Note: I did not purposely search for only those MLPs that increased distributions. I reviewed 30 of the largest MLPs, 29 of which increased distributions during this period.

No one desires to ride stocks down during a bear market. The point I am trying to make with the MLP asset class is that during a downturn they continued to increase income for shareholders. In fact, with two exceptions, all of the above today are significantly above their price on October 9, 2007, when the DOW hit all-time highs. The following are today's prices:

CPNO - $33.50

DPM - $46.66

EPD - $54.93

EVEP - $62.32

GEL - $33.76

KMP - $85.61

LINE - $42.00

MWE - $55.43

NGLS - $42.84

PAA - $45.99

PVR - $25.74

TLP - $36.61

Strategy Then, Strategy Now

During the 2008 - 2009 debacle I sold portfolio positions in mREITs, eREITs, and BDCs with some profits/some losses, retained positions in foreign utilities and added to MLP positions at much lower prices. At that time the portfolio had few positions in royalty trusts and commodities.

I will admit that this was a harrowing time; however, as the bear market progressed it was a relief to watch as the MLPs continued to increase quarterly distributions. This is one reason why the portfolio continues to have a significant exposure to this asset class.

Looking ahead (with some trepidation), in the event that the markets duplicate their performance of 2008 - 2009 I intend to take the following steps:

  • Liquidate the mREIT positions
  • Reduce eREIT holdings, except for those with exposure to Canadian, Asian and Australasian countries
  • Hold royalty trust positions only where hedging is in place for a three to four year time period
  • Increase MLP holdings to at least 60 - 70 percent of the portfolio value
  • Initiate additional long positions in foreign utilities
  • Initiate/increase holdings in commodity positions such as GGN, RJA and BCX
  • Initiate a long position in MUSFX (Merk Currency Enhanced Fund) which has a 22 percent return year to date

While this might be far from a perfect strategy, I believe that it will minimize losses, and has the potential to increase income earned by the portfolio.

I would appreciate any comments/suggestions that readers might have that might enhance the strategy.

Source: Protected Principal Retirement Strategy: What If?

Additional disclosure: The information provided in this article does not constitute either buy or sell recommendations.