A Message For The Near-Retiree, Part 2: De-Risking For A Bear Now Requires Your Attention

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Includes: AINV, AMID, AMZN, BBL, CEFL, CLNS, COR, CUBE, D, DEI, DOC, DUK, ENBL, EPD, ETP, FB, FCH, FSC, GOOGL, LADR, LAND, LC, MMP, MO, MORL, NFLX, NRZ, O, PFE, PM, SFL, SHAK, SO, TWO
by: Ted Waller

Summary

Reducing financial risk is an important part of retirement preparation for many portfolios.

A bear market can be especially damaging to individuals nearing retirement depending on their investment holdings.

Near-retirees need to arrange their portfolios to account for the possibility of a bear, even if one doesn’t occur in the next few years.

This is the second of two articles on de-risking for investors near retirement. Part 1 discussed areas to de-risk regardless of what the markets do between now and retirement. Part 2 discusses de-risking to defend against a possible bear market. Although addressed specifically to near-retirees, the ideas may be useful for anyone concerned about market prospects in 2016 or later.

A decision to de-risk doesn't require belief that a bear market is near. Such a belief is mostly irrelevant to the near-retiree. The objective is to achieve a high probability of a desired level of income and assets. This is accomplished by investing in entities that have a relatively high probability of stable or growing dividends and shareholder equity. On the other hand we want to move out of investments which may have more inherent risk. Risk is reduced now regardless of the occurrence of any future event.

The article will first discuss current investment types dangerous for the near-retiree in a bear market, and then give ideas on where money might be allocated more safely.

FANG stocks: The best analogy to today's Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Google (NASDAQ:GOOGL) is 2000. In 2000 there were also four tech stocks that were thought to be on the path of total dominance and consequently no stock price was too high. They were in fact strong companies which are still powerful today, but their stock performance was very different from expectations:

Mkt cap Mar 2000 ($billion)

Mkt cap Jan 2016 ($billion)

Mkt cap change

Max stock price drop

Years to recover high

Microsoft

$526

$418

-21%

-62%

16+

Cisco

$474

$119

-75%

-88%

16+

Intel

$401

$141

-65%

-81%

16+

Oracle

$230

$146

-37%

-82%

16+

The 16+ in the right column means they have not reached their previous high in over 16 years. Near retirees may recall that in 2000 the sentiment towards these stocks was similar to FANG today. It may seem odd to discuss four stocks that pay no dividend in an article about income. However, they are very widely held and for readers lucky enough to own them the recommendation is to sell.

Stocks where yields have blown out based on price declines: I believe that the dominant story for investors in the next few years will turn out to be the reach for yield, similar to overpriced tech in 2000 and housing in 2008. For years investors have been funneled into fixed income and equity for higher yields. These trends don't reverse until they reach a point of extremes. 2016 certainly qualifies. For example:

Creations like the UBS ETRACS Mthly Py 2xLvg Mortg REIT ETN (NYSEARCA:MORL) and UBS ETRACS Mthly Py 2xLvg Closed-End ETN (NYSEARCA:CEFL) that yield 25-30%.

Numerous recommendations on SA and elsewhere for "safe" 10-20% yields. Some with recent recommendations on SA (with current yields) are: New Residential Investment Corp (NYSE:NRZ) (17.2%), BHP Billiton plc (NYSE:BBL) (12.8%), Energy Transfer Partners (NYSE:ETP) (14.0%), Two Harbors Investment Corp. (NYSE:TWO) (14.0), Northstar Realty Finance Corp. (NYSE:NRF) (25.4%), Ship Finance International Limited (NYSE:SFL) (13.7%), Fifth Street Finance (NASDAQ:FSC) (13.7%), Apollo Investment (NASDAQ:AINV) (15.8%).

We might prefer to think that we are in a golden age of yield, that this is a once in a lifetime chance to lock in yields that will double our money every four or five years. But yields like these are most often a market signal that the companies are fraught with risk, and many have already started to resolve to the detriment of the retail investor. All of the above names have had price declines this year that exceed many years of dividends. Income investors can be relatively insensitive to loss of capital, but the trend in many names is past that point. If a near-retiree already owns a name in this situation perhaps it's worth holding for the chance that it will come back, but one should not be tempted by outsized yields to initiate positions.

Companies in which general economic weakness will have a disproportionate impact. The world of unicorns contains many companies in this situation. Unicorns are new tech companies with valuations of over a billion dollars. Their stock prices are often fueled by investor sentiment, which can reverse very quickly. Further, raising new capital becomes difficult and costly in periods of economic weakness. This is problematic for companies with a history of operating losses. Finally, economic weakness reduces the number of consumers with the ability or desire to pay for expensive nonessentials like a $250 GoPro camera or a $100 Fitbit wristband.

Companies that have not been around long enough to experience a recession. There are two dangers here. First, there is no way to know if management has the ability to manage conditions of economic stress successfully. Second, a business created under the extraordinary conditions of ZIRP, QE, and an economy in a recovery may not be built to thrive under very different and adverse conditions. In the first category there are new and exciting companies like GoPro, Fitbit, Lending Club (NYSE:LC) and Shake Shack (NYSE:SHAK), as well as private companies that may go public, like Snapchat, Honest Company, Dose Internet Media, or Appnexus. In the second category are companies that were founded to take advantage of ample cheap capital and a robust sector growth. This includes numerous newer REITs like Physicians Realty Trust (NYSE:DOC), Gladstone Land Corp. (NASDAQ:LAND), and Ladder Capital Corp (NYSE:LADR), and newer MLPs like American Midstream Partners (NYSE:AMID) and Enable Midstream Partners (NYSE:ENBL).

There are certainly new companies that will prosper and reward investors for decades to come. Readers may have already identified them. However, the dangers unique to them as a group at this point in the economic cycle suggest extra caution before committing money to them.

Protection from a bear market.

Some of the best areas to turn to should be familiar to many income-focused investors. None will be unscathed by a big bear, but the mauling will be shallower and shorter.

Aristocrats

Dividend Aristocrats are companies that have increased dividends for at least 25 years, some more than 50. David Fish maintains an authoritative site for these at www.dripinvesting.org, and they are also found at www.dividend.com. Aristocrats with current yields over 4% are:

Name

Symbol

Industry

Yrs on List

Yield

HCP Inc.

HCP

REIT-Health Care

31

6.40

Mercury General Corp.

MCY

Insurance

29

5.34

AT&T Inc.

T

Telecommunications

32

5.32

Universal Health Realty

UHT

REIT-Health Care

29

5.08

Bowl America

BWL-A

Recreation

43

4.76

MDU Resources

MDU

Utility-Gas

25

4.44

Emerson Electric

EMR

Industrial Equipment

59

4.13

Questar Corp.

STR

Utility-Gas

36

4.12

Old Republic International

ORI

Insurance

34

4.09

National Retail Properties

NNN

REIT-Retail

26

4.05

Resilience

Another area of relative safety is stocks that have shown resilience in deteriorated sectors. In the REIT and energy MLP sectors many companies have cut distributions or are at yields that are signaling possible cuts. However, other companies are still increasing distributions and share prices have held up. REITs still increasing dividends include Realty Income (NYSE:O), CoreSite Realty (NYSE:COR), Cube Smart (NYSE:CUBE), Douglas Emmett, Inc. (NYSE:DEI), and FelCor Lodging Trust (NYSE:FCH). MLPs still increasing dividends are Enterprise Products Partners (NYSE:EPD), Magellan Midstream Partners (NYSE:MMP), and EQT Midstream Partners(NYSE:EQM). Brad Kenagy provides good research about MLPs at Seeking Alpha, such as this article.

Hard Shells

Safe income can be found in sectors that are resistant to recession. Gas and electric utilities, pharmaceuticals, tobacco, and liquor companies will see stock price declines in a bear market, but their cash flows will hold up better than most and they will continue delivering reliable income. Dominion Resources (NYSE:D), Duke Energy (NYSE:DUK), Southern (NYSE:SO), Altria (NYSE:MO), Pfizer (NYSE:PFE), and Philip Morris (NYSE:PM) pay very respectable dividends. Stan Stafford has a good review of utilities for 2016.

Summing up

The near-retiree has one core need: Financial resources sufficient to live on your own terms in retirement. This is accomplished with a combination of a reliable income stream and accumulated assets that can be spent down over a remaining lifetime. The danger of missing this goal is magnified by a bear market which causes permanent damage to income and/or capital loss that is not recoverable over an acceptable period. This article suggests actions to reduce the probability of a calamity by allocating resources to investments that have a lower risk of large, long term losses of capital or income.

The degree to which a retiree adheres to this safety-first approach depends on individual circumstances. Persons who won't have enough resources for retirement needs may feel they have no choice but to roll the dice on an MLP yielding 20%. Persons with more than enough money might make a similar bet for very different reasons. In both cases, extra due diligence is the order of the day.

After almost a decade of experimentation by the monetary powers-that-be, many market metrics are at extremes. This has also put individual investments at extremes that are tempting precisely because they are rare. By drawing on their accumulated experience and wisdom, near-retirees are well equipped to assess risk and reward and act in a way that moves them closer to their goals.

Disclosure: I am/we are long D, DUK, PFE, DOC, O, MMP, PM.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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