An Article–A Warning

Today ChuckP posted an article that is currently on Barrons. It is not unlike many we have seen in the past and most of us that have been investing in baby bonds and preferred stocks are well aware of the risk that is out there.

We are posting this because it is a reminder that markets are dangerous and even if you own bonds and preferred stocks there is danger. Newer investors in these areas need to know that it isn’t just about earning an easy (although modest) return by collecting interest and dividends.

Essentially it is reminding investors that chasing yield is getting a bit carried away—of course most of us know that, but it has been going on for years–when does the music stop?

Here is the article “Ponzi Market”. I believe Barrons will allow you to read this once only before the paywall comes up.

33 thoughts on “An Article–A Warning”

  1. With this Barron’s article having quoted Scott Minerd of Guggenheim Investments, here’s a link to his most recent musings – https://www.guggenheiminvestments.com/perspectives/macroeconomic-research/10-macro-themes-to-watch-in-2020?utm_source=pardot&utm_medium=email&utm_campaign=2020%macro%themes&utm_content=macroeconomic%20research

    For the record, he’s been beating this drum for at least 8 months and it’s hurt the performance of Guggenheim Macro Opportunities Fund, GIOPX during this period…

  2. Interest rate risk and default risk are the fixed income investors two biggest worries. Default risk can be managed through prudent diversification and credit analysis. Interest rate risk is a lot trickier. Keeping durations short sacrifices yield, but mitigates declines in rising rate environments. Be wary of too much exposure in perpetual pfds. the downside in a long upward rate cycle can be severe. It just doesn’t pay to stretch for yield here, we’re just picking up nickels in front of a steam roller.

  3. Most readers know this, but I like to remind myself every now and then of how low Preferreds usually are in a company’s capital structure.

    Meaning that in the event of default, your claim will be worth next to nothing.

    The senior note holders take the cake and everyone else ends up fighting over crumbs

    1. In the event of default, you’re likely to get very little for sr unsecured notes as well. Sure, average recovery after exiting Chap 11 might be 35% but at the start of Chap 11 (when you should be selling any sr unsecureds if you’re a retail investor), you’ll only get like 15%. If you don’t sell your unsecureds at the start, there’s a good chance you’ll get crammed down with an exchange that only institutional investors can participate in.

  4. I just want to give a big “Shout Out” and a “BIG THANK YOU” to Tim for pointing out what I tried to alert everybody about. Let me just say a couple of things. I have been investing now daily for 49 years–Yes, Iam ANCIENT. Also I always like to say I think after all those decades that I have learned a thing or 30. LOL Anyway, I truly have been to this movie a couple of times now and “eventually” when Powell does start to raise rates (yes, I know it could be over a year away) these lower yielding coupons and lower rated preferreds are going to get repriced substantially LOWER. If you have not gone thru this rate cycle before some of you will actually be quite shocked how badly these things can fall in a very southerly direction. I don’t mind telling you guys that I have a very large portfolio of Corp. bonds, preferreds, Nebraska Double Tax Exempt paper and about 16% individual stocks. Again, I say thank you to Tim for sharing with everybody what I posted about the article over on Barrons. One last thing, I read literally everything I can get my hands on about investing. So if anyone out there wants to share ideas or notes on specific issues let me know. I currently own over 60 Corp. bonds and around 35 preferreds. Its crazy how these bonds are now priced. I have a Walmart 6.5% bond that is priced at over $150. Now thats crazy, but I love it.

    1. Chuck,
      >you will actually be quite shocked how badly these things can fall

      Dec. 2018 was not that long ago… And truthfully the shock was tolerable compared to 2008. As long as I don’t have to sell, being stuck with 4.75% in too big to fail banks like JPM is tolerable and it will be a long time if ever treasuries can yield that much.

      H

      1. Hello hyster; There is one fallacy in your statement about Dec. of 2018. I remember that month well as I went on a buying spree with common stocks. BUT, that has absolutely nothing to do with what Iam talking about. Iam referring to the time “WHEN THE TIDE TURNS” meaning they go on a regular basis of “Raising Interest Rates”. Then watch your coupon of 4.75% with J. P. Morgan reprice at around $18 to $21. I’ve been to this party before and I’ve seen well known companies sell off much more than people think. Have a good one.

        1. ChuckP-
          When you assert, “watch your coupon of 4.75% with J. P. Morgan reprice at around $18 to $21,” do you mean the “share price” as quoted or the callable price which is normally $25.00? If the latter, then you still collect your divvy quarterly, it is just your equity/principle that is lower?

          I am a long term investor (since ’84) but new to the modern preferreds and have added many to my IRA in the last 2 years. I focus on investment grade for the most part with reputable companies. I do venture very small into some high yield at times (5-8% of portfolio). I also made a rule not to pay more than $25.25 for the $25.00 issues.

          This site is awesome so thank you for whomever is responsible for it. It’s just what the doctor ordered for me to better understand this preferred landscape. Words of wisdom are welcome and appreciated.

          1. Hello Yazzer; What I was saying to hyster is this simple fact. Bond and preferreds travel inverse of what rates are doing. We are in a very low environment at the present time and at some point down the road that will change. No “specifically” when you start chasing “Low Yield Coupons” of these companies you will get hurt when rates start to rise. Lets take that JPM 4.75% at $25. No they probably will NEVER DEFAULT. Iam not worrying about that. But let me ask you this: Move the clock forward 18 to 24 months and lets just say that JPM comes out with a 5.5% preferred at $25 with their usual call protection of 5 years. Do you know what will happen to your issue that pays 4.75%??? It will drop well below the issue price of $25. How much will depend upon how much rates are rising but also “perception”. Like I’ve said before “I’ve been to this movie before”. It ends badly for many that do not know how these things work. Yes, it could easily fall to $20 a share. You will still collect your coupon of $1.1875 annually but unfortunately you now have lost maybe 20% or more of your principal that you started with. I hope this helps you and many others. Thank You for the question.

        2. I guess with the perpetual, one could be stuck with a yield lower than inflation “forever” meaning the price can stay depressed for a prolonged period of time. I have noticed all my “investment grade” issues have risen from my buy levels from $24.50s to $25.25 into the $26-$27 range…kind of spooky.

        3. Chuck,

          I’ve got a few decades to wait things out and collect at which point 4.75% is going to be a juicy yield again. Those JPM shares are not going to drop to $18 in a day. The Fed can only raise interest rates tenatively and slowly in this crazy leveraged environment. At the first whiff of interest rate changing, there will be an upset in ALL fixed income portfolios- but it’s not a jump out the window right away. There’s small cuts and a slow bleed.

          It’s end of the credit cycle I fear more than the fed raising in which case stuff can implode.

          1. Hster, I am not of the panic type myself. But not everything can go as planned. Remember the 2013 “Taper Tantrum”? The Fed was still stuck on 0%, yet the 10 year bond went its own way, heading over 3% with that 0% Funds rate anyways. Sometimes the train leaves the station without the Fed. 5.1% high quality IPLDP was issued a few months before the “Tantrum”. In a couple short months it went from $25 to near $20. Most arent aware of this because most have no 2013 charts because most of those have been redeemed already.
            Im not losing sleep on this, but it bears knowing. Ironically during the Tantrum the the high quality low yielding issues got hammered but the higher yielding issues did not incur the rout. Of course the march towards normalization withered on the vine, and things then reverted back to present low yield course.

            1. Thanks Gridbird for the historical context. A slide down to $20 taking a few months is ample time to take action. I guess I don’t think of roughing it out @$20 is so terrible I’ll sell at a loss. I held 80% losses during dot com bubble and they didn’t even pay me like these preferreds do! But I’m less than 10% preferreds diversified so losing 2% is not that scary. It sucks to be under obviously but being paid and facing a 20% decline or 4.2 year recovery time is a tolerable enough risk.

              1. Hster, see as long as you know and arent worried about capital impairment its all fine. Heck, my dad when he was around told me, “I dont care if they drop to a dollar as long as I am getting my 6%”. His only concern was income stream. One just needs to know their comfort zone and awareness.
                As an anecdotal opinion, it appears many here are a bit attuned to capital preservation with these. But others are fine with income stream and annuity like residual value to be redeemed whenever, or never. There really isnt a right or wrong method, one just needs to match their goals and expectations to the correct investing instrument being whatever that may be.

                1. Grid- that’s good advise. We’ve always had the market come back after recessions. Some took longer than others to get back to even. I follow some smart Elliot Wave guys and they are sure we are in the 5th wave and last wave that started from the crash of the Great Depression. What takes place after the 5th wave is exactly what was experienced in the ‘30’s, not something I want to ride out. The Fibonacci extensions should take us to 3600-4000 Spx. I will be tightening stops at that point. ATB.

                2. GRID-
                  Agree completely with you in that there are different sets of objectives and the key for an investor is to understand his own goals and desires. The difference in approach is what makes the market.One man’s buy is another man’s sell. Clearly stated. thanks SC

      2. Hi.
        You probably know that your jpm are non-cumulative (like all banks prefs) and there is a possibility that dividends will be lost in case of serious troubles. Does this fact not worry you?

        1. Hi, Yurly. I don’t own any JPM prefs, but if and when non-cum becomes an issue for JPM, then I think I might have way bigger problems to worry about at that time.

          Perhaps that is a naive view, but at this point in my life cycle, any large problems with banks, especially the too-big-to-fail likes of the JPMs of the world, are not very high on my worry list. So, while I don’t own JPM, I do hold many bank prefs, including BAC-L, CBKLP, FIISO, SBNCM, & WFC-L.

          They’re all safely tucked away in my vault, with only CBKLP being callable. I’ll sleep well with any other risks they might have.

          JMO

          1. Camroc, you and aarod being fellow SBNCM owners may appreciate this history. SBNCM went “dark” in 2005 buy having to reduce shareholders to stay under threshold of numbers of people owning. This way the insiders (as I have mentioned before) can go about their business.
            They forced smaller share count owners to liquidate their common and SBNCM shares. But they treated them very fairly, offering $14.85 back in 2005.
            Interesting little letter worthy of read.

            Since 1986, when Southern registered its Series B Preferred Stock with the SEC, Southern has been a public company under the federal securities laws. As a public company, we must comply with extensive disclosure and reporting requirements. These requirements include the preparation and filing of numerous reports with the SEC regarding our financial condition, operations, management and other aspects of our business, all of which must be reviewed by our outside counsel and our independent auditors. The Sarbanes-Oxley Act of 2002 (SOX) significantly increased these reporting requirements……

            Under this proposed transaction, record holders of less than 35 common shares would receive $780.00 in cash for each common share that they hold at the transaction date, and record holders of less than 400 Series B Preferred Shares would receive $14.85 in cash for each Series B Preferred share they hold at the transaction date. Holders of 35 or more common shares and 400 or more Series B shares would continue to hold their shares after the transaction. The cash out price for each of the common shares and the Series B shares was established by the Board of Directors based on an independent valuation prepared by our financial consultant, Howe Barnes Investments, Inc.

            Those shareholders who hold their shares in “street name” with a broker will be exempt from the cash-out purchase, provided the broker holds, in the aggregate for all of its customers, more than the threshold amount. For example, if a broker holds more than 34 common shares, those shares will remain outstanding, even if they are owned beneficially by individual customers of the broker who own 34 or fewer common shares.

            https://www.sec.gov/Archives/edgar/data/703904/000119312505183606/dex991.htm

            1. Grid… your writings never cease to amaze me with the facts and figures. You’re some kind of investment savant. 🙂

              1. Mr. Lucky, except I cant remember where I laid my glasses down at or the purpose for walking into a room, ha. I have always owned some obscure preferred issues. And for some reason it always has intrigued me to find out the genesis and history of their origination.

                1. It’s the history teacher in you, Grid, and teacher teacher for which we thank you…. now where did I put my Buy button????

                  1. 2WR, we gotta find something buy before we have to remember where the buy button is at. But before I can find the buy button, I would have to find my spiraled index cards that has all my passwords that I cant remember, ha.

                    1. I managed to wrangle 100 shares from someone for IPWLO for 87. I also had to give them a future grandchild as well. Buying anything from IPxxx is like watching paint dry.

        2. Hi Yuriy- Nope not worried.
          All bank preferreds are non-cumulative since Dodd Frank. And JPM suspending all dividend payments on common first would be a very big deal and would indicate serious problems in our economy/financial system. They cut common shares to a nickle during the ’08 crisis but preferreds got paid.

    2. I think Powell is more likely to lower rates this year than raise them. Industrial Production is still trending lower and if this continues, it will eventually bleed over into rising jobless claims. If global growth doesn’t pick up in a hurry, the nascent recovery in commodities will also reverse and the little uptick we’ve seen in inflation expectations will reverse. Everyone seems to be counting on the trade deal turning global manufacturing data around. Could happen but I’d say risks are still to the downside on growth and inflation.

      Also, whenever the SP500 cracks we could have a big +10% pullback. This will send everyone fleeing into safety, taking rates down. I have a big slug of muni CEFs for that scenario to hedge my allocation to SP500.

  5. Scary articles are constant but I’m not aware of anyone how can predict what will happen in the markets in the short term. If I over reacted to the negative articles a year ago I would not have my significant gains (stocks, preferred and bonds) for the year. That said, those articles are a good reminder that the markets can and will change so watch carefully. Since last year worked out very well I’m slowing moving to a more defensive position. The constant struggle is balancing risk/reward. Thanks Tim and all the contributors for keeping us educated.

  6. There’s been no shortage of such scary articles last two years esp. during the height of recession fears during the summer. How and when these record levels of dicey debt everywhere will unwind, nobody knows. Will bad debt in emerging markets like china and India burst first? Will the triple Cs crater first? This article was a bit tame compared to Gundlach’s interviews, and if the bond king himself is doom and gloom about corporate bonds- the risk is real.

    I live in California where the threat of the big one is constantly hovering over our heads. The longer we go without one, our odds increase. But the longer we go without one, we get more complacent.

    The article ends with a dampening:
    “He doesn’t see a recession on the immediate horizon, but noted that increased defaults and wider credit spreads predated the 2001-2002 recession by three years.“

  7. You need to copy the URL into Outline.com. That works. Good article, but nothing we do not already know.

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