Quality Preferred Stocks Continue Move Higher, REITs and Utilities Pause

Even though interest rates, as measured by the 10 year treasury, continue to slowly tick higher, quality preferred stock issues are in high demand. When looking at investment grade preferred issues we see that they have moved higher by 2% over the last month or so.  The junkier preferred issues are generally down-this includes those issued by shipping companies, upstream MLPs and a few of the junkier REITS. 

A move to quality is what we are seeing in the preferred markets–quality is trumping the minor moves higher in interest rates. Honestly this is no surprise to us–we have been harping the quality mantra for months.  There is a pall hanging over world economic conditions–forget the constant march higher in common stocks, while the ride is nice there are so many potential ‘black swan’ events around every corner only perfection (or maybe a gaggle of Wall Street crooks and thieves) will power common stocks much higher.

Income investors continue on the hunt for yield–this never ends and quality preferreds have benefited. Utilities don’t fill the bill so well–they have an average yield in the 3.75% area and you are left with plenty of risk. REITs do fill the bill quite well, but there is a tremendous amount of price risk as they were off today by 1% even though the SP500 was up 1/4%. Unfortunately for REITs, investors pound the prices lower each time interest rates rise–even though the rise today was a measly 3 basis points. We have noticed this trend for months now–REITs are overly sensitive to interest rate moves. Make no mistake though that we are not saying REITs are immune from higher interest rate caused damage–we are just saying that good REITs will not be fundamentally harmed by rates that are 1/8% or 1/4% higher.

So what is one to do right know?  Mostly nothing–as usual. If contemplating new monetary commitments one should focus on the quality issues.  If looking at REITs buy the sector leaders–i.e. Realty Income (ticker:O) in the triple net sector, Digital Realty in the data centers etc.  If looking at preferred stocks look at the investment grade issues–the same goes for exchange traded debt. If you are looking at utilities the same holds true.

Here is what we think we are facing.  The U.S. economy, while putting on a good show todate, is teetering on the edge of a cliff. The most recent daggers being stuck in the heart of the U.S. economy are skyrocketing health care insurance premiums (for many) and a ag economy that is very sick after another year of low commodity prices.  Yes, we are aware that auto sales are booming, but just like the foolish financing that Fannie Mae is pushing to home buyers (little to no money down), the continuing trend toward lending to poor credit customers will bring with it a future price to be paid-and it won’t be pretty.

We won’t drone on further–but there is again dramatic danger in equity markets in the U.S. It was only 5 weeks ago that the SP500 was 5% lower.  A level that to us seemed to be appropriate–let’s call it a more comfortable level. We are not of the belief that Facebook and Netflix will prop up equity markets forever.  While we don’t do much common stock investments we are more concerned with the contagion damage that will be done to all markets when common stocks take the inevitable plunge.