Pondering the Year Ahead

By: ,

We again have reached that time when we start to ponder the year ahead. Of course, we constantly are trying to decipher our “crystal ball,” which always seems to be cloudy. But now we try to formulate our thoughts so we can structure our strategy for the next year.

Our initial thoughts on 2016 are as scary as our thoughts at this time last year, but for very different reasons. A year ago, our thoughts were focused almost exclusively on higher interest rates — it seemed a certainty that interest rates would be higher by 50 to 100 basis points (1/2% to 1%) by now. It didn’t happen. On December 31, 2014, the 10-year treasury was at 2.17% and today it is at 2.22%. Since we started 2015 expecting higher interest rates, we moved to concentrate our holdings into shorter duration securities. (Use of short duration securities reduces the time an investor must wait until maturity.) With shorter durations and baby bonds, which are bonds with par value of less than $1,000, comes a somewhat reduced coupon (the interest or dividend percentage), since these securities are perceived to have less risk. The net result of moving into these less risky securities is that we likely gave up 1/2 to 1% return — certainly no disaster. But just the same,we wish we had those extra returns in our portfolio.

For 2016, we are gazing into a weak economy — not just globally, but domestically. Generally, we are no longer in fear of much higher interest rates — the economy simply will not support dramatically higher rates (we believe that the Fed will hike rates 1/4 to 1/2% more through 2016 which we consider very mild rate hikes). We fail to understand how the U.S. economy can remain positive when countries on a global basis are in such poor economic condition. For years, the talk was of how no county could stand alone — we were a “global” economy. Now we continually hear the talking heads describe how we are the positive economic engine standing alone. We are highly skeptical that the United States can “stand alone.”  Most recently we have done some reading on the Canadian economy and it is down right frightening. Canada is much more chained to energy than the United States, but it is just one more country that is hurting badly and it happens to be our largest trading partner.  We will be watching closely for signs of further contagion of weakness into the U.S. economy.  At this point in time, we are not willing to say there will be a recession in the United States, but it certainly is a possibility later in 2016. This risk is our No. 1 concern for 2016.  There are so many parts and pieces to this story on a global basis that it is simply foolhardy to make a call either way, although we will watch closely with each economic news release.

----ADVERTISEMENT----

Looking at the energy arena (upstream producers), we believe that prices will remain below $50/barrel which we think will bring dozens of companies to their knees (if they are not already there) as the hedges that energy companies have in place at higher prices ($70.00, $80.00 or more) continue to run off and there will be fewer gains from liquidation of hedges to cushion the fall. Energy will remain a speculative “bet” for the most part. While there are income investors that like to try to lock into some high yields with upstream energy preferreds, we will likely stay away from this area in 2016.

As we have continued to review the performance and portfolios of the business development companies (BDCs), we get more and more concerned with the quality of their holdings. We always have noted that we do not want to be invested in BDCs or their debt if we are heading into a recession. While we can’t see a recession today, we are thinking it is wise to remain lightly invested in this area. As most of you know, BDCs lend to riskier companies at interest rates that are very lucrative. Unfortunately if we move into a recession in any fashion (whether shallow or deep), the credit quality of BDC portfolios are likely to worsen and potentially endanger any positive returns.

Select REITs (Real Estate Investment Trusts) should perform fairly well in 2016. We think that many of the apartment REITs should perform well as there continues to be good demand at high rental rates in spite of significant new construction.   Marginal REITs tied to retail or offices could have a much rougher ride if we move into a recession or softening economy later in 2016. While the specter of higher interest rates has been rough on the REITs in 2015, we don’t believe that moderately higher rates will have long-lasting affects on the quality companies. 

As we give some thought to the MLP segment, we find ourselves amazed at what we believe are true values in the larger midstream companies like Enbridge Energy Partners (NYSE:EEP) or Energy Transfer Partners (NYSE:ETP) sure look like values at current prices, but there is no use being a hero. But just maybe, even super conservative investors such as ourselves should stake out a small position in one of these giants.

While we began 2015 with interest rate concerns and the need to remain in shorter durations with term preferreds and baby bonds, we end 2015 with somewhat less concern in this area. We very likely will devote more resources to some perpetual preferred stocks early in 2016. In conjunction with our lessening concern with duration, we have personally also started to shift our priority to income generation with a lessening emphasis on capital drawdowns. We have always hated seeing our capital drawn down — no one likes to see capital drawn down, but we are reaching the point where we can tolerate some draw down as long as the income stream remains adequate and steady. We haven’t quite figured out the direction we want to go yet — but when we put a pencil to paper, we will hone in on exactly what we are willing to own for the long haul in the perpetual preferreds.

----ADVERTISEMENT----

So in summary, these are just a few of our thoughts on the upcoming year. We may be totally off base, but we have had good success in the last couple of years (success is a relative measurement) and we are bound and determined to be smarter in 2016 than we were in 2015 and to succeed in investing.

We will wrap up 2015 in the next couple of days and as of this moment our 2015 Blended Income Portfolio shows a gain of 2.27%. While not stellar, that performance in a down market is a success. Undoubtably, we have learned a lot during 2015 and our personal knowledge has expanded 10-fold since we began writing in 2006. That is what our website is all about — learning for you and learning for us.

X
Search Dividend Investor