Stocks That Offer Good Yields Plus Likely Growth
Thursday, August 30th, 2012 @ 10:30AM
In This Issue:
The Stock Market Is Showing Remarkable Resilience
Why Nervous Investors Are Still Buying Stocks
The Lure Of QE3
Stocks That Offer Good Yields Plus Likely Growth
Watch Out For High Yield Traps
Money Market Mutual Funds Come Under Scrutiny
The Bottom Line
The slow rebound from the spring stock market correction continued through late July. The advance then ground to a halt as new economic problems made investors more cautious. By July 25, the Dow and the Nasdaq were up only 0.6% and 0.2% respectively from last month.
The Stock Market Is Showing Remarkable Resilience
At first glance, the modest advance the stock market made recently was not remarkable. But that’s not the case when you look at the amount of negative news that investors had to deal with.
The biggest worry is the European debt crisis and the recession that grips the region. Prime Minister Antonis Samaras of Greece told former U.S. President Bill Clinton that his country is actually entering another Great Depression similar to what the world endured in the 1930s. Since Spain isn’t in much better financial shape, the dire economic outlook may soon apply to that country as well.
Globally, the economic outlook is better. However, nearly every industrial country is suffering from a decline in growth. The main concern is about China. If its powerful growth engine drops to an idle, the slowdown will spread around the world.
The outlook for the U.S. economy is also less than rosy. Earlier this month, Fed chairman Bernanke warned that growth may decline from 1.9% in the first quarter to just 1.7% in the second half of the year.
On July 22, economics correspondent Alan Wheatley summed up the economic situation best when he said, “Faster, Higher, Stronger” is the motto of the Olympics, but “Slower, Lower, Weaker” more nearly describes the economies of most countries that are competing in the event.
Why Nervous Investors Are Still Buying Stocks
The resilience of stock prices in the face of so many economic problems may make it appear that investors are basically optimistic about the future. We don’t think that’s actually the case. Instead, we think investors are buying stocks because the safer alternative, fixed income investments, offers abysmal returns.
Many of the world’s finest companies have dividend yields that are twice what Treasury bonds pay. The yield on some blue chips is three or four times Uncle Sam’s rate.
The difference in the annual payouts offered by stocks and bonds can have a big impact on a person’s life. The interest Uncle Sam pays on 10-year Treasuries is currently just 1.53%. At that rate, a retired person with a million dollars in bonds would earn only $15,300 a year, barely enough for a room in a flop house.
By contrast, thanks to its 3.60% dividend yield, $1 million in Johnson & Johnson (JNJ) would generate $36,000 a year. Not enough? At its current 5.70% yield, leading pipeline company Kinder Morgan Energy Partners (KMP) would pay $57,000. It’s no wonder that good dividend stocks are in demand.
The Lure Of QE3
Savvy investors also know that putting money into stocks will give them a stake in an expected new Federal quantative easing (QE3) program. A great deal of the Fed’s stimulus money always finds its way into the stock market where it pushes prices up. Investors who want their share of the windfall know they must be in line ahead of time.
So far, the Fed has declined to launch QE3 because Mr. Bernanke doesn’t think the economy needs intensive care, at least not yet. But with growth slipping from bad to worse, a QE3 booster shot is probably not far away.
With QE3 waiting on the sidelines, we have what appears to be a contradiction. Investors usually buy stocks because they think the economy is improving. This time, stocks are popular because the economy is slowing down enough to trigger another Fed handout. It’s a strange new world we live in.
Stocks That Offer Good Yields Plus Likely Growth
Of the 14 principal blue chip stocks we recommended over the past two years, all but Alcoa and Goldman Sachs are up in price. The two lowest gainers are Procter & Gamble and Johnson & Johnson. The two top stocks are Coca-Cola andExxonMobil.
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The AIA Advocate Select Blue Chip Portfolio
For An Emphasis On Current Income:
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We think all our stocks, including Alcoa and Goldman Sachs, still look attractive for long term accounts. However, a few companies appear to have especially good prospects. That group includes Coca-Cola (KO) that sells affordable luxuries throughout the world, Colgate Palmolive (CL) and Procter & Gamble (PG) that have global customers for their personal hygiene and housewares products, and Johnson & Johnson (JNJ) that markets its pharmaceutical and related products in nearly every country. We think the four companies have the ability to increase their profits even as the global economy slows down.
With bond interest rates nearly on the floor, our three current income investments look even better than they did when we purchased them. The outlook should remain good for Consolidated Edison (ED), Eli Lilly (LLY) and Kinder Morgan Energy Partners (KMP), all of which have yields that are far higher than Treasuries offer.
Watch Out For High Yield Traps
Speaking of income, many investors who were burned during the 2008 stock market swoon won’t buy shares no matter how sweet the dividends may be. Instead, the nervous investors are searching for the highest yields they can find from fixed income securities that they assume are much safer.
In many cases, however, the high yield instruments that savers are being offered carry far more risk than those they are avoiding in the stock market. We worry that many high yield investors will suffer substantial losses if the risky securities default, as some will surely do.
It is good to remember that the reason a security offers a high yield is because it carries a proportionately high risk. High yield securities will rarely be insured, and will usually be backed by little or no collateral. If the security fails, the investor will probably be out of luck.
We urge our readers to leave high yield securities to experts. The great majority of investors will do much better, and stay safer, with a diversified portfolio of reliable dividend stocks, such as those we have been recommending.
If you don’t want to build a portfolio of your own, we suggest the iShares Dow Jones Select Dividend Index (DVY), an ETF that tracks the 100 highest-yielding securities (excluding REITs) in the Dow Jones U.S. Total Market Index.http://finance.yahoo.com/q/pr?s=DVY+Profile The fund is ideally positioned to benefit from the market’s preference for large, stable, dividend stocks.
Money Market Mutual Funds Come Under Scrutiny
Far safer than high yield fixed income securities, but not risk free, are much lower yielding money market funds offered by banks and brokers.
It is important to understand that money market funds are mutual funds, not deposit accounts that are FDIC insured. When you put money into a money market fund you are actually buying shares that are managed so that each one is worth a dollar.
Only rarely are money market shares in danger of falling below a dollar (called “breaking the buck”). But since many money market funds hold European debt, the assumption of safety may no longer be justified.
The risk that a money market mutual fund will fail is still quite small, but it is no longer essentially zero. In our opinion, the interest rates the funds pay are too low to justify taking any risk at all. As a result, we think you should consider switching to a money market fund that invests exclusively in U.S. government-backed securities. All major brokerage companies offer them.
Alternately, put your cash in a FDIC-insured money market account or CD from your bank.
The Bottom Line
The stock market is doing better than might be expected given the amount of disturbing economic news we have today. We think stocks are holding up because the best of them currently offer considerably better returns than bonds. Investors are also looking ahead to another round of quantitative easing from the Fed that should boost stock prices.
Most of our blue chip recommendations have been doing very well over the past two years. We think they will continue to reward long term investors.
Until Next Time
The AIA “Advocate For Absolute Returns”, a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn’t? Many sources report these issues as abstract facts. We feel that’s not enough. The AIA Advocate’s job is to warn you of what’s important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time…
Posted by AIA Research & Editorial Staff
Categories: AIA Newsletter
Executive Director
John M. Casson
Mr. Casson has been Executive Director of The Association for Investor Awareness, Inc., since inception. He also serves as President/CEO of Casson Media Group, Inc., a publishing, media and communications holding company.