How To Invest In Limbo

by: John Gerard Lewis

Economic indicators are currently a mixed bag.

"Exceptionally low" returns are forecast.

There are still beneficial ways to invest.

The musical query for Limbo-dancing partiers, "How low can you go?," is the same one that investors are posing to the Fed these days, with less frolicking and considerably more trepidation.

The Fed has for years now deliberately suppressed interest rates for the express purpose of spurring an increase in economic growth. It has expressly not worked. The nation's gross domestic product in March was up by just 0.1%, down a full percentage point from the same month last year. Housing starts were up 13% in April, but a survey released May 15 showed confidence among single-family home builders fell to a one-year low this month. And recent reports for industrial production, retail sales and vehicle sales have all been disappointing.

But it's not all bad. Unemployment fell to 6.3% in April (although that's probably an artificially deflated number because the "discouraged worker" component is never factored in). Jobless claims fell to their lowest level in seven years during the week ending May 10. And recent reports from the Institute for Supply Management, the National Federation of Independent Business and the Federal Reserve Bank of New York have been encouraging.

Corporate earnings have looked pretty good, with almost 70% of S&P 500 companies beating analysts' estimates in the first quarter. But a record number of those companies issued negative guidance prior to earnings season.

What this means, of course, is that investors should therefore…

A Florida investment advisor spoke for just about everybody when he said, in the May 15 Wall Street Journal, that "we just don't know what to do as investors."

Investors aren't playing Limbo. They're in Limbo.

You could decide to more or less forsake any short term success and focus on a longer term, although it might be a lengthier "longer term" than you think. The folks at Pimco, for example, expect "exceptionally low" returns over the next several years. And after five years of stimulus with almost no positive results, who knows how long such low returns could continue?

But, well, when in Limbo, do as the Limboans do, I suppose, so here's what I think they would do to optimize their investment results:

They would be very careful about interest-rate sensitive holdings, because rates are so low that they are more likely to someday go up than down. Principal values will decline when that happens, with longer maturities suffering more than shorter ones. The best measure of rate-sensitivity is the investment's "duration," so you want to buy fixed-income funds that have low durations.

I've recommended for many months now the PowerShares Senior Loan Portfolio ETF (NYSEARCA:BKLN), and I still do. This fund's high credit risk (roughly equivalent to a junk bond fund, in my view) is countered by a duration of virtually zero, because the rates on the underlying commercial loans are re-set every 30 to 60 days. The yield (based on annualizing the most recent monthly dividend) was 3.93% on May 15, and it was selling at a discount to net asset value of 0.52%.

I also continue to recommend the Guggenheim BulletShares 2014 High-Yield Corporate Bond ETF (NYSEARCA:BSJE) and its companion 2015 fund (NYSEARCA:BSJF). These, too, have a high credit-risk profile, but there's a limited time for anything to go bad (defaults) because the effective maturities of the underlying bonds are Dec. 31 of 2014 and 2015, which also serve to limit interest-rate risk. They're exposed to rate risk only until those dates, which aren't very far away. And each is highly diversified, further mitigating the default risk. The May 15 yield (annualizing the most recent dividend) for was 2.54% for BSJE, and 3.56% for BSJF.

Another way to address today's interest-rate risk is to buy investment-grade corporate bonds and hold them to maturity. If you're willing to hold up to five years, you can get the following yields to maturity (as of May 15):

Prospect Capital Corp. (NASDAQ:PSEC): 4.61% (yield to worst, if called, 1.15%)

Superior Energy Sources Inc. (NYSE:SPN): 4.381% (YTW 0.425%)

Royal Bank of Scotland Group (NYSE:RBS): 4.036%

Icahn Enterprises (NYSE:IEP): 3.945% (YTW 3.682%)

Best Buy (NYSE:BBY): 3.724%

Avon Products (NYSE:AVP): 3.619%

If you can hold for up to 10 years, these yields are available:

Anglogold Ashanti Holdings (NYSE:AU): 5.862% (YTW 4.723%)

Wynn Las Vegas (NASDAQ:WYNN): 5.745% (YTW 0.757%)

Prospect Capital Corp.: 5.601% (YTW 4.565%)

Braskem Finance (NYSE:BAK): 5.372%

Petrobras Global (NYSE:PBR): 5.194%

Icahn Enterprises: 5.116 (YTW 4.903%)

Of course, you can also go much more conservative with Treasuries, ultra-short bond funds or bank CDs.

Stocks? Well, let's think about this. The S&P 500 was up 32% last year, it's been beaten by the bond market so far this year, and "exceptionally low" returns are said to be in prospect.

I wouldn't go out on a limb.

What I would do with any equity exposure is take the least risky approach: value investing. Two quality value funds, that are less volatile than the stock market, itself, are the Weitz Partners III Opportunity Fund (WPOPX) and the GoodHaven Fund (GOODX). The holdings in these funds would theoretically be undervalued and therefore more prone to price appreciation as a result of intrinsic characteristics, rather than overall market conditions.

Disclosure: I am long BKLN, BSJF, BSJE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. I'm also long WPOPX and GOODX.