Quality Rules!!!!

For those out there that have been delving into the really junky part of the perpetual preferred marketplace you have likely already experienced the thrashing that has been occurring in that sector.

We have reached a point in the economic cycle where the marketplace is beginnning to sniff out some global economic weakness. Forget that the FED is still targeting a rate hike in the near future (we think September). This global weakness is not something that has been hidden–it has been right there for anyone to see. The newer addition to the global weakness is the continuation of the slowdown in China. With Chinese growth now at its lowest level since 2009 there is almost a guarantee that the U.S. will be affected–directly or indirectly.

Key commodity items such as oil and gas have had prices held at such low levels–and falling lower daily, because global demand has been soft, while production climbed. Forget that fictitious story of the ‘tax cuts’ consumers would receive from low fuel costs which would power the U.S. consumer. Baloney!! We had never bought that line and instead contended that there would be more harm than benefit from low energy prices.  Similtaneously we have had massive drops in commodity prices for such materials as iron ore and copper creating massive layoff potential. Just last Friday British giant miner Anglo American announced layoffs of 53,000!!  On a global basis we are destroying high paying jobs while those losing those jobs are forced to eventually take a position for which they are overqualified.

Now we realize that this scenario is in sharp contrast to Yellen planning to raise short interest rates, but honestly we don’t care. The markets are now beginning to accept that there is a potential recession ahead and investors are placing their ‘bets’ on the various sectors and last week they made their feelings known.

Last week perpetual preferreds of many low quality companies took a drubbing like we haven’t seen for a while.  High Yield preferreds from companies such as Greenhunter Resources (ticker:GRH), Magnum Hunter (ticker:MHR), Gastar Exploration (ticker:GST), Safe Bulkers (ticker:SB), RAIT Investment Trust (ticker:RAS) as well as many other took very sizable hits. Some like Greenhunter preferreds fell from around $19 to $9. We believe the movement from low quality issues to higer quality has just barely gotten underway and in the weeks ahead we may well see the movement continue with the perpetual preferreds of the lower quality REITs beginning to take losses. In addition while many of the energy related issues have held up to some degree we will see bunches of pain in the months ahead as hedges ‘roll off’ and prices continue their softness.

We interestingly note that investment grade perpetual preferreds and exchange traded debt have held up well and for those investors bound and determined to remain invested in perpetual preferreds we would be buying in the quality issues OR prepare yourself mentally for capital losses which will far outweigh any potential dividends you will receive. We realize there are many investors that ‘invest for income’ and claim they are not concerned with capital drawdowns–they will have the opportunity to prove it in the months ahead. Remember we are now facing potentially 2 negative factors for low quality issues–higher rates and a softening economy.

We are not reacting now as we have already positioned ourselves quite well–BUT we will continue a tweak here or there in the weeks ahead.