Calm Markets Lull You Into a Sense of Security

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Over the last 90 days interest rates, as measured by the 10 year treasury, have marched higher by 40 basis points from a low of around 1.37% on July 8th to a high of 1.79% on October 14th and for the most part income investors have barely noticed the losses they have incurred in preferred stocks and baby bonds.  Through this period of time as one receives dividends on a monthly or quarterly basis they overlook the 1% capital loss in their portfolio.  According to our measurement, which is simply an average price of $25 issue prices, it looks like the average share price is off 25 cents since July.  During this time you probably received 30, 40 or 50 cents in dividends/interests and thus the net result is that you have gained over this time frame.  Honestly this is great–this is how we like the market to operate.

Previously we have had panics in the income investing arena when interest rates move 25 or 30 basis points.  Years ago we wrote many, many times about the pricing on preferred stocks and baby bonds and how the absolute level of share pricing is determined not just by the movement of interest rates, but the speed in which they move.  As one reviews the movements of the 10 year treasury in the last 3 months you will note that the days of the largest moves have been around 7 basis points.  This movement does not “spook” investors, although the slower march up in interest rates has affected pricing very modestly–as pointed out above 25 cents of share price has dissipated in the last 3 months as rates climbed a total of around 40 basis points.  These are not panic moves, but just orderly repricing–it has been the kind of market we like, but for those who are a bit hyper it has been boring.

With the above information in mind it would seem that income issues have “built in” a fed funds rate hike in December.  With a 25 basis point rate hike expected and the 10 year treasury already up 40 basis points one has to believe, rightly or wrongly, that the fed funds rate hike is built in and the odds that we will have a panic sell off are quite low.  This is the assumption that we are taking as we move forward ahead–right or wrong.


So as we have “boring” income issue markets we see quite a few income investors spending their time scalping quarters on new issues, scalping 50 cents here and 50 there on issues that fall for no reason at all (illiquid preferreds and baby bonds can take quite a tumble when a big seller enters the marketplace to liquidate a position). In our opinion this is a reasonable use of time—it adds a few dollars to the account most of the time and keeps one from unnecessarily trading account positions that should be held.  We have personally traded numerous new issues in the last 30-60 days–in fact we sold 4 or 5 issues one day as we had 1-2% new issue profits.  We trade these with the cash we hold as “dry powder” awaiting the next panic (which may or may not come in the next 6 months–who knows?) opportunity.

We have had some questions of actions to take (or not take) when election time rolls around.  We can say firmly that we will take NO action in portfolios related to the elections–we wouldn’t know whether to buy or sell.  I guess a person could sell everything they have now and repurchase after the election, but these kind of actions seldom result in positive results.  Markets will go up and markets will go down–when any reader figures out how to know exactly what will happen please quit your day job and start a timing service.

One item we will spend some time doing in the next week is going through all of our income issues to see which issues are trading way above $25/share and making sure that we are not holding issues that are likely to be called when they have significant premium that would be lost.  There are times when 1st redemption dates sneak up on you while you hold an issue trading at $26 or $27/share and when they are called for redemption you take a quick, hard hit to your capital.  While large losses have seldom happened to us, we have forgone 25 or 50 cents profit when we were snoozing.  On the other hand sometimes you have to take a risk and hold an issue with premium built into the share price because the coupon is too good to let go–you hold because there is nothing else better available paying a “fair” yield.  This is a legitimate risk to take in many cases–the pickings are so slim for good yield that some risk of call must be taken.

Talking about fair yield we have been watching some of the latest preferred stock offerings from Public Storage (NYSE:PSA).  Recall that PSA has sold 2 low coupon preferreds in the last 90 days.  PSA-D which carries a coupon of 4.95% was sold on 7/15/2016.  PSA-E with a coupon of 4.90% was sold on 10/6/2016.  Both issues are trading below $25 with the series D issue trading around $24.90 and the Series E shares trading around $24.45.  Seems to me that the 5% area is the correct level for a quality issue like PSA–income investors are not willing to accept current yields on investment grade REITs much below 5%–we hope (and believe) this is a floor for REIT preferred coupons.

We could go on and on but will wrap our musings up for now.  We would urge investors to stay engaged in some fashion – any fashion that will keep you somewhat in tune to the day to day activities of the market.


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Tim McPartland

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Tim McPartland
Tim McPartland is a private investor with over 45 years of investing experience. His analysis, research and writing is devoted to the hunt for income producing securities of all types, but in particular specializing in preferred stocks, exchange traded debt and Master Limited Partnerships.
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