Fly Me To The Moon

Fly me to the moon.  The Dow Jones Industrials ignored the risk alarms coming from Italy and rocketed to close at a new all time high.  The index was propelled by continued good feelings from the new USMCA deal (NAFTA 2.0) and rises in Intel, Caterpillar, and Boeing (all of which are trade sensitive stocks).  The Dow rose +0.5% in yesterday’s trade leading the other major indices closing off its high but in new territory while the S&P500 closed down slightly after losing altitude late in the session. The VIX index remains in the complacency zone with the index trading at an 11 handle indicating smooth sailing but don’t be fooled by this.  When the VIX spends significant time at these levels, corrections tend to be more extreme as tension build-up drives selloffs.   Both the S&P500 and Dow remain constructive.  The NASDAQ 100 closed off slightly after once again flirting with all time highs early in the session.  The index is constructive but is losing momentum as investors continue to favor the more defensive stocks that are not typical of the growth-oriented index.  The small cap Russell 2000 was the outlier as what appeared to be panic selling pushed the index further into negative territory.  The Index crashed through support at 1663 but managed to hold the 1652 support level.  The Fibonacci retracement line at 1676 will be the next level of support for the index which is neutral.  Traders will be looking to buy stocks on sale at these levels but may find that they have to wait out earnings season to see positive results.  The Dollar was stronger yesterday due to renewed good trade feelings and weakness in the Eurozone.  The Dollar index managed to cross over and close above its Fibonacci line at 95 (see chart 13 in my attached daily chartbook).  Bonds traded up in similar fashion pushing 10 year yields down to 3.06%, which still represents competitive yields.  Speaking of yields, I have spent the last two Wednesday’s talking about them.  I covered  bond yield to maturity, then equity dividend yield.  Because it is geek-out Wednesday, I would like to continue with the trend and delve a bit more into the third type of yield which can be earned from Preferred stocks.

First of all, what is a preferred stock?  A preferred stock is an equity security which has many features found in bonds which makes it somewhat of a hybrid between stocks and bonds.  The first thing to know is that in a liquidation, preferred shareholders are subordinate (that means they get paid after) to bonds but are senior to common shareholders (that means common stock holders get paid last, after preferred).  Preferred Stocks are typically issued at par, which is $25 and they pay dividends which are also senior to dividend payments made to common stockholders and may be cumulative. What that means is that a preferred dividend must be paid before common dividends are distributed and if they are missed they may (depending on the issue) accumulate and pay out all missed payments when payments resume.  Preferred dividends are generally fixed (but they can be variable and tied to an index) and can be paid monthly or quarterly. Many preferred stocks have either no maturities or very long ones and they may be callable.  A callable preferred can be bought back by the company at par value usually after a pre-described time period.  Similar to bonds, Preferred stocks are rated by rating agencies which assess the issuer’s financial health and ability to continue to pay dividends.  As such preferred issues with lower ratings must pay higher dividends due to their higher risk.  That all sounds very much like a subordinate bond, doesn’t it?  One must remember that preferred shares are still equities and they can and will move up and down with equity markets but are not typically as volatile as their common relatives (sounds like a soap opera).  So how should one assess a preferred stock?  As preferred stocks are rated, investors must first decide if the current yield is consistent with its rating (current yield is simply the annual dividend divided by the share price).  Ratings may change if a company’s financial strength changes, so if a rating is downgraded the stock will lose value. Similar to stocks and bonds, an investor should assess the future prospects of a company as well as strength of its sector.  Finally, an investor must look at the specifics of the preferred issue itself. For example, many companies issue more than one class of preferred which are also ranked in order of liquidation and dividend preference.  Shares that are lower in the pecking order should pay higher yields due to the greater risk.  So if you are still following me you should be thinking that preferred stocks seem like a really good way to earn more income with less volatility than common stocks.  They are like bonds but without the hassles typically experienced by retail investors buying odd lots (in most cases retail investors buying less than $1mm worth of bonds will pay a very large odd lot premium significantly diminishing its yield to maturity).  Additionally, preferred dividends, if qualified, are taxed like a qualified dividend (0%, 15%, or 20% based on the investor’s tax bracket).  There are limitations however.  Investors typically buy equities for principle growth and preferred stocks offer very limited upside for growth.  So, preferred stocks present a really attractive alternative for investors looking for income and they typically offer greater, more predictable dividend streams than equity.  Additionally, they are far less volatile than either equities or corporate bonds.  With investment grade preferred’s currently yielding anywhere from 5% to 7% (depending on risk and specifics of the issue, of course), investors seeking current income should consider including them in a fixed income portfolio. Investors seeking a diversified portfolio should also consider including preferred stocks.  If you are interested in preferred stocks, you should contact your advisor who can offer you further advice as well as show you options for investing in them.

This morning we received the ADP Employment change number which can give a hint about the Bureau of Labor Statistics number which comes out on Friday.  The number came in at 230k versus the expected 184k jobs which is consistent with the narrative that the economy remains strong (bullish for stocks, not so much bonds).   Today we will also have a packed Fed speaker calendar with no fewer than five fed ministers speaking capped off by Fed Chairman Powell later this afternoon.  Analysts will continue to search for clues about the Fed’s likely path for further rate hikes.  Barring any crazy new revelations, markets will be dominated by more good feelings about trade where we might see what Fall is like on Jupiter or Mars.

daily chartbook 2018-10-03