Tough Times Make It Harder To Buy Yield

We are in a time of troubles, for in Canada, the U. S., Europe and even China, investors are worried that the recovery that began in March, 2009, has lost its legs. Now the search is on for assets that pay dependable income. Trouble is, they are hard to find.

If you have been watching the Toronto and New York stock markets, you’ll probably figure that the odds are we’ll have a pretty poor recovery. Indeed, the economists who follow the labour market in the U. S. say that there won’t be much recovery from the current nine per cent unemployment rate for many years. Worse, the stimulus programs of the Obama administration appear not to be working. American consumers remain mired in debt. Car sales are weak because the driving force behind the consumer boom, especially the boom in cars and durable goods, was driven by folks remortgaging their houses and using them as virtual automatic teller machines. There is no price boom left in American housing and so retail sales, durable goods, groceries, etc. remain weak.

We are better off in Canada, but for how long remains a question. Our stock market is heavily weighted with commodities, so that means we can cash in on demand from China for coal and copper. We sell gold around the world and we can sell energy to our friends in the U. S. who value having a terrorist-free source of fuel for their cars and homes.

BEARISH BONDS

If stocks are not doing well, how about bonds? That’s also a tough story, for yields on government bonds and investment grade corporate bonds are at their lowest levels since the 1950s. Some very bearish market forecasters say that interest rates may drop lower and suggest that 30-year bonds have value. Maybe, but if they are wrong, you may have to wait until 2040 to get your money back. Long bonds remain the domain of insurance companies and pension funds. They are just too risky for ordinary folks. There are fairly attractive yield-to-risk trade offs in bonds with 10-year terms where you can get five to six per cent or a little more in corporate bonds like a 7.25 per cent Fairfax Financial issue due June 22, 2020 that was recently priced to yield 6.22 per cent to maturity, but finding those bonds in a shopped-out market isn’t easy.

What’s left? Stock brokers and mutual fund companies are turning out offerings based on established companies that pay strong or rising dividends. Dynamic Funds, among others, offer variations on the interest rate theme. Nothing wrong with that, but you have to be aware that a stock or fund that pays five per cent can gain or lose that value in a day or two in the market.

A lot of investors think that it is a sin or an error to hold high levels of cash. That is true in the sense that over periods of 20, 30 or 40 years, cash returns inevitably lag bond and stock returns. But for shorter periods, cash can be king. If you are old enough, you can recall the extraordinary days of 1980-82 when interest rates soared, existing bonds lost value to new ones with higher interest almost every day, and stocks stagnated as double-digit inflation eroded the value of earnings.

Holding cash meant you could wait out the storm and then jump in, as astute or lucky investors did. They picked up utility bonds that paid 12 per cent per year and that gave the holder the right to get money back from the issuer. Interest rates peaked in 1982 and then it became clear that they would fall. That began the long-running bull market in bonds that has lasted until 2010 — one of the most sustained and profitable in history.

BETTING ON RECOVERY

Today we are in a weird mirror image of that inflation-driven market. Our interest rates are unappealing to many investors, bond issuers are in no mood to offer money back on demand privileges, and the risks of buying bonds at very low rates are quite high.

The alternative to getting stuck with bonds that lose value as interest rates rise is to shift to common stocks of companies that can participate in a recovery — if and when it happens — and that pay attractive dividends in the meantime. Bank stocks are in a kind of warp in which those that have a lot of business in the U. S. are seen by investors as having a lot of risk of loan losses and, as a result, big writedowns.

Only National Bank has no U. S. exposure. It’s doing exceptionally well, which is an irony considering that its association with Quebec, its base, was once considered a negative. Banks carry a lot of risk, so for dividends, consider regulated public utilities. You need to do some research, but the task can pay handsomely.

Gold, which in metallic form pays no interest or dividends, hits new highs almost every day, recently having crossed the US$1.30-per-ounce mark. The metal has been on a roll for six years or more, but for very long terms, it still is a second cousin to stocks. Investors often choose gold mines, some of which pay dividends — though they are usually quite low. Financial markets obsess over whether gold is in a bubble or if the rally still has legs.

The problem is to manage risk in investments. If you buy a small company’s stock, if it pays no dividends, if there is no options trading in the stock, then the only way out is sale. As the company gets larger, dividends may be paid and there may be ways to do such options as writing covered calls. That allows you to harvest premium income.

You promise to sell the stock to the buyer of the calls. If it rises to the expected price, you lose it, but you have the premium income. There is an art to this and my friend Andy Sirski is a master at this craft.

ETFS

The other way to reduce risk is to diversify through the use of exchange traded funds. Each ETF is a play on a market, such as the S&P 500, on an index like the Dow Jones Industrial Average, on a concept like Canadian value stocks, or on selections of stocks that have rising dividends and good ratios of sales to stock price and so on. ETFs have very low management fees — about a tenth of those for mutual funds on average, they can be bought and sold online with commission a fraction of those charged by traditional full service brokers, and they can be structured to produce a portfolio with relatively limited risk. The idea is that you avoid the risks and complexities of researching stocks and bonds and instead buy into economic trends and markets. This is strategic investing and it is an intelligent

basis for off-farm investments.

It is, in the end, a time for novel thinking about good asset plays. Conventional stocks picked one a time are as risky as picking single numbers in roulette. The difference, of course, is that most people bet more on stocks than on a turn of the wheel.

ETFs allow one to pick sectors and lower the risk of any one at company having a bad year. You can get ETFs of gold mines or metallic gold. The fees for gold ETFs tend to be around 50 basis points — half of one per cent — but you have no storage or assay charges. You can get U. S. corporate bonds hedged to the Canadian dollar. That provides a potentially good interest return with no risk of currency loss — or gain.

Call it a new era of investing, but in a market with no direction for stocks and not much potential gain for bonds, it pays to aim for sustainable dividends or bond income. ETFs that gather suitable assets under various umbrellas lower risk and, given their low fees, are a path that should be explored. There are 4,000 or so ETFs available in Canada that include such exotica as Swiss pharmaceutical companies and Swedish government bonds. Canadian ETF managers such as Claymore, Blackrock and the Bank of Montreal run a few hundred ETFs.

In a troubled market, ETFs are a good place to start shopping to put money you don’t want to leave on the farm into something productive.

AndrewAllentuck’slatestbook,WhenCanI Retire?PlanningYourFinancialLife.AfterWork, waspublishedin2009byVikingCanada.

About the author

Columnist

Andrew Allentuck’s book, “Cherished Fortune: Build Your Portfolio Like Your Own Business,” written with co-author Benoit Poliquin, was recently published by Dundurn Press.

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