In August IBM raised $1.5 billion from the sale of 3-year notes yielding…one percent.  That IBM was able to sell a billion and a half dollars of a bond paying a record low one percent certainly says something about the depressing state of today’s fixed income choices.  With 5-year CDs paying around two percent and money market funds near zero, the alternatives are few.

Investors today have very little tolerance for risk and have increasingly turned to fixed income securities. Demand for fixed income securities is so great that companies with strong credit ratings, like IBM and Microsoft, can issue debt at record low interest rates.  We have found only one solution to this investment dilemma, trust preferred securities.

Trust Preferred Securities

In this environment, it is remarkable that trust preferred securities, issued by the largest US and European banks, continue to yield upwards of 7 percent.  Because of these historically wide spreads, we find our Defensive Growth Strategy using Trust Preferred Securities vastly superior to any combination of CDs, cash, money markets, muni-bonds, corporate or government securities. 

While we have been highlighting the benefits of trust preferreds for two years now, the Dodd-Frank Financial Reform Bill adds a unique and attractive feature to these securities.  The Reform Bill, over the next five years, requires trust preferred securities to be phased out as a component of bank regulatory capital.   As a result, we expect most banks to repurchase the trust preferreds, since they will not want to pay such high dividends on securities that will no longer count toward regulatory capital. 

Trust preferreds only can be repurchased by the banks at the par value of $25 per share.  Most of the trust preferred shares we buy are trading at or below par and pay an annual dividend of 7 – 7.5 percent.  Therefore, we are able to lock-in a compelling annual dividend plus appreciation over the next five years.  Our search for yield has uncovered no investment that has anything near this total return at a relatively low level of risk. 

Some investors view this strategy as an alternative to low-yielding cash investments, while others, uncertain about the direction of the equity market, have used it as a holding place until economic data indicate a sustainable recovery.  Either way, we find trust preferreds offer the highest probability of solid returns.

With the Dodd-Frank Bill effectively converting our Trust Preferred Strategy into a short to medium-term fixed income alternative and the Fed determined to keep forcing interest rates lower, there is still a great opportunity for investors – individuals or institutions – to lock-in these attractive yields.

Stocks: An Uncertain Alternative

The stock market has benefited from an impressive rally that began in early September.  While this upward move is welcome, we fear it is not supported by economic data and thus not sustainable. In September, for example, 95,000 jobs were lost, the most since early summer, and the unemployment rate remained stuck at 9.6 percent.  Housing inventory, a key indicator of demand, has twelve months of supply  on hand.  A heathly housing sector should have only five months of supply.  Finally, consumers, who account for about two-thirds of US GDP, face increased taxes on flat income.  This weak economic data may be reflected in company earnings reports soon.  The fact of the matter is, with few economic underpinnings to support revenue and profit growth, stocks have unpredictable returns.

Portfolio Sectors

 

Although we are negative on the broader stock market over the next 24 months, we do like two sectors:

 

Oil & Natural Gas:  Energy prices have had a more muted rally than that of the stock market, an indication that energy investors don’t expect a full-fledged economic recovery in the short-term.   Portfolios with energy exposure will be well-positioned for recovery if economic data surprises to the upside.

Index Funds:  We believe select Latin American and Asia-Pacific countries will continue to exhibit strong economic growth.  Their stock markets, over the long-term, should outperform the US market.    

Visit our website - www.ullandinvestment.com.

Performance figures are subject to revision.

On July 1, 1997, Ulland Investment Advisors started offering the Intelligent Growth style to the public.  On July 1, 1998, Ulland Investment Advisors started offering the Intelligent Blend style.  Performance is calculated following  GIPS standards.  Only annual performance will be verified.  Annual performance may vary when the verification process is complete. Performance is shown on a time-weighted basis as calculated on Axys portfolio software. 

 

(c) Ulland Investment Advisors

www.ullandinvestment.com