The environment for high yield equities continues to look favorable with the FED clearly intent on keeping interest rates at current record low levels, at least for the near term. High yielding Real Estate Investment Trusts (REITs), Business Development Companies (BDCs), and oil/gas Master Limited Partnerships (MLPs), all do best with declining and low interest rates. All of these sectors have done well during the past year and will continue to do so until the market perceives that interest rates will begin to rise. The market generally anticipates the future by 6 to 12 months, and therefore will begin to respond to what it thinks the FED will do well before the FED actually takes any action. While generally all ships move up and down with the tide, there are individual equities within the above groups that will have hedged against rising interest rates better than others, and it is at times like these that understanding what you own and doing proper due diligence are more important than ever.
Technically the recession has been over for a year at this point, nevertheless unemployment remains at 9+% and housing prices continue to drop in many parts of the country. This Christmas would seem to indicate that the consumer is back buying and retailers are showing signs of life. Many large corporations are showing significant year over year increases in profitability due to earlier layoffs and improved productivity, in addition to the fact that the bar set last year was generally quite low. However, the FED has indicated that they believe the recovery is very fragile and has implemented QE2 (second round of quantitative easing) which stimulates the economy by giving bankers more money to lend, but could result in inflation, which due to the recession, cheap goods from overseas, and a weaker dollar, has not been a problem over the past couple of years. These seemingly contradictory factors mean that it is very hard for anyone, even the very best economists, to accurately predict what will happen to the US economy in the short term future. Add on top of that the unknowns related to the international scene, and one could say it is virtually impossible to predict what will happen next. However, if we build upon what we do know and base our investment decisions on that, it is possible to make good judgments and at least avoid catastrophic errors.
Based on what the FED has said, and equally importantly on the actions that they have taken, it is very likely that they will keep interest rates where they are for the next 9 to 12 months. Further, based on the current trend (slowly declining unemployment), the continuing stimulus from the FED, and the extension of the Bush tax cuts, it would appear that we are not going to go into a double dip recession. Further, the economy will likely continue to improve, ultimately resulting in improved employment figures and subsequently a reversal in housing prices which will level off and then begin to rise again. This means that eventually (12 months - 18 months) the FED will conclude that the economy is no longer as fragile as it is now, and will once again start to raise interest rates to avoid inflation. This will clearly have an impact on the most interest rate sensitive equities as mentioned above.
As we enter 2011, if you have been heavily weighted in REITs, Mortgage REITs, BDC's and MLPs, now would be a good time to evaluate how well they are prepared for an eventual increase in interest rates. Diversification and asset allocation are always valuable tools in protecting principal, and now is no exception. While REITs (and particularly MREITs), BDC's and MLP's are offering exceptional yields, it is important to recognize these yields are due to high perceived risk, as the market looks to future interest rate increases. There are many other options which offer lower yields but do not have as high an exposure to loss of principal when interest rates go up. Other categories to look at for diversification in the high yield arena would include telecommunications, tobacco, utilities, and high yielding foreign equities to name a few.
Remember, no one cares more about your money than you do! Know what you own. Make buy/sell decisions based on your own due diligence. Use common sense and don't invest in anything that you don't understand. By taking an active role in your own investments, staying up to date on what is happening in the economy, making mid-stream adjustments in your portfolio as necessary, and staying within your own tolerance level for risk, you will feel confident that you are managing your portfolio appropriately, and sleep well at night.
Copyright 2011 Boyd Investment Holdings LLC. All rights reserved worldwide.
Bob Boyd invites you to visit the High Yield Equity Stock Report for further articles and a regularly updated high yield dividend stock list: This site is dedicated to assisting investors with their due diligence in the highly volatile and often misunderstood category of high yield dividend investing as part of a diversified investment program.
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