The Best Answer to Rising Rates and a Runaway Stock Market (MS.PA)

We are now witnessing the 1970’s television drama version of the equity market.

You remember the 1970’s, don’t you?

Seems like every episode of every TV show had two regular elements – chloroform and a car chase. It simply wasn’t drama without them. Some bad guy chloroforms a lanky blonde right before Starsky or Magnum or the Mod Squad jumps in to their souped-up GTO to give chase.

EQUITY-MARKET-2015

And we’re living it again today through our stock investments.

The drug of choice today, of course, is the USD. Thanks to the generous folk who operate the world’s central banks, its availability (along with that of every other world fiat paper) has translated into a globally diagnosable, addictive desire to acquire ever more wealth via stock ownership.

And it appears we’re now ratcheting up the speed of our purchases as we head toward the proverbial chicken shed, where all of these car chases inevitably ended up.

Avoiding the Chase

That in mind, we offer you something of an offbeat trade idea today – one that’s less involved in the drugged-up, high speed market race that obtains today.

But first, we want to digress for a moment to address the abundance of correspondence that arrived after last week’s letter, Three Mysteries of the Market, Examined. You guys are great. And to our first question of why the Transportation stocks weren’t making mincemeat of the market while oil prices plummeted, we got a number of interesting answers. By far the most convincing came from industry participants themselves, who reported (to quote one reader) –

“…diesel fuel (upon which the trucking industry depends) barely budged off the $3.50 price point. My theory is that the stubbornly high price of diesel kept the DJTA flat…”

And we like that theory. Thanks to Auric for writing.

One more hat tip (and clarification) to reader David Reppert, who wrote on a separate issue –

I do not think the S & P 500 has averaged a 30% annual gain for the past 6 years as you state. That would mean it would have compounded to about 5 fold. In reality it has compounded 3 times or about a 20% annual return. Still pretty good.

An embarrassing mistake on our part, David.  And you’re right – As the chart below shows, the S&P 500 climbed from just under 700 at its bear market bottom to its current 2106 level.

SP500-2009-2015

That’s a total gain of 200%, which we simply divided by six years to get our 30%+ annual figure. But, alas, it doesn’t work that way. We forgot our compounding tables altogether.

It won’t happen again.

When the liquid rises, you simply float with it.

The recommendation we want you to consider today is a stock/bond hybrid which trades like a stock, but whose movements track interest rates.

As you’re aware, we’ve been pushing the bond bear story for some time now. Our contention, though, that the bull market in Treasuries has run its course, and that higher rates are now expected, is not ours alone. A swath of new issuance from the corporate sector supports our view that we’re headed for a longer period of lower bond prices, and with it, lower prices for preferred shares as well.

Preferred shares are rate sensitive. They carry a fixed payout that more or less aligns with both prevailing interest rates as well as that particular company’s current credit standing.

But there’s another, less well-known investment niche in the preferred realm that operates in the opposite direction – they’re called floating rate preferred shares and they’re structured to gain in value as interest rates rise.

Here’s a smattering of issues that are currently available, though for a more complete listing check here and here.

In no particular order, they are –

  1. HSBC Preferred F and G Series (NYSE:HUSI.PF and HUSI.PG) ,

  2. Goldman Sachs Preferred A and D Series (NYSE:GS.PA and GS.PD),

  3. Metropolitan Life Preferred A Series (NYSE:MET.PA),

  4. Morgan Stanley Preferred A Series (NYSE:MS.PA),

  5. Bank of America Preferred E Series (NYSE:BAC.PE),

  6. Bank of America/Merrill Lynch Preferred G Series (NYSE:BML.PG)

As far as the best yields go, the brokerages take the blue ribbon, with Goldman’s offerings currently yielding 4.86 and 4.66% and Morgan Stanley’s MS.PA paying 4.73% per annum. After that, Bank of America’s E Series pays 4.50%. The rest pay 4.00% or less, with everything tied to perceived risk levels. The big banks with their deposits are obviously considered safer bets, and therefore provide less of a return.

We believe the time is right to make these stocks a meaningful part of your overall portfolio.  We would suggest up to ten percent of your holdings be devoted to them, split between at least three separate issuers. We would add that most preferred mutual funds have already started loading up on these issues, as the countdown to a Fed rate hike draws nearer. [EDITORS NOTE: Of course, make sure to speak with your personal broker to make sure this idea is right for you]

For our part, we’re partial to the Morgan Stanley (MS.PA) offering, whose run-up in price at the beginning of the year looks to be cooling somewhat. They’re now offering a reasonable entry point for anyone interested in buying.

See here –

MS.PA-RISING

Dig in.

Many happy returns,

Matt McAbby, Normandy Research

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