Sometimes investors get caught looking at their feet and not at the road ahead, especially in markets like we're in now. But it's crucial to navigate the dangers before they're upon you, counsels Stephen Leeb of Leeb Income Performance.
It’s not an overstatement to say that the ranks of income investors are growing every day. In the US, about 70,000 baby-boomers retire each week.
And this is not a short-term event: Just as the baby-boomers shaped the country when they were all in their prime, 77 million strong, they will surely influence the investment markets—as well as entire sectors of the economy—as they stop working.
Their investment impact will be both direct and indirect. The challenges of Social Security and Medicare, coupled with the ever-smaller role of company-sponsored benefit plans, will continue to push ever more people into funding their own retirements, via 401(k)s, IRAs, brokerage and savings accounts. In turn, this will create massive additional demand for securities that can provide for their income needs, while ideally also generating some growth.
One important consequence: Equities will be the investment of choice, thanks to their long-term history of outperforming all other asset classes. A long-term case can also be made for US stocks in that they have the advantage of being the most investable class of equities in the world. Demand from abroad for US stocks will likely be strong.
The market’s behavior, on the other hand, is also influenced by short-term factors. One immediate concern is Europe. The Eurozone is a monetary union without a fiscal union to match. The combination is unsustainable over the long term, a fact that has become all too obvious in the last two years.
Another shorter-term but omnipresent factor is the slowing US recovery. Still reeling from the consequences of the Great Recession, our economy is also in danger of contracting Europe’s fever. This explains the renewed flight to safety, expressed in US Treasury bond yields falling to near-record lows.
While fixed income remains an important investment class, the ultra-low yields from the safest bonds—which, after taxes and inflation, generate negative real returns, will drive investors into risky assets, i.e. stocks.
While certain categories of fixed income—corporate and municipal bonds—do generate greater interest than you can earn on US Treasuries, only stocks can create a growing income stream. This is their biggest advantage over any fixed-income security.
But don’t buy a stock just because it offers a high dividend. In an economy that remains persistently weak, the strong are much more likely to remain in business and grow, while the chances for the weak (the highest yielders) to fail are also on the rise. This amplifies the need for both scrupulous research and well-thought-out diversification in this environment.
Of course, as income investors, we primarily concentrate on dividend-generating equities. The good news is that the demand for such investments is on the rise.
This demand can create a potential problem in a liquidity-driven event, when the market heads south and all stocks are being sold with no regard for their long-term fundamentals. On the plus side, a disciplined investor can even benefit from the market’s irrationality. But that is a conversation for another day.
In the meantime, this is what we like for the second half of 2012:
- Dividend-paying stocks. About 80% of S&P 500 companies now pay a dividend, with the index now yielding 2.1%, more than the benchmark ten-year Treasury note. But we don’t recommend the index itself; we like high-quality stocks with strong businesses, good balance sheets, and the ability to increase dividends over time.
- Master Limited Partnerships (MLPs). Technically not equities, this investment class has demonstrated remarkable strength in this market. In addition to the strong income generated by its shares—also known as units—MLPs can offer significant tax advantages, if used properly.
- Real Estate Investment Trusts (REITs). REITs continue to outpace the stock market, outperforming both year-to-date and on an annual basis.
- Securities from emerging markets and markets leveraged to emerging markets. Exposure to this large and growing market will be beneficial for long-term health of your portfolio, although you need to be quite selective with your picks.
- Select fixed income. Our recommendations here vary from a mortgage-backed securities mutual fund to individual positions.
Subscribe to Leeb Income Performance here...
Related Reading:
