How to Invest for Income in 2024

Income Investing, Investing Strategies

2024 is upon us.

By the time this hits your inbox, the ball will have fallen, “Auld Lang Syne” will have been packed away for another 364 days, and my dogs will almost have recovered from the sedative we have to give them because of the massive fireworks display our neighbors put on every year.

If the ball bounces right, Texas will have beaten Washington State, Michigan will have fallen to Alabama, and we will be looking at a barnburner of a national title game that hopefully culminates in a chorus of “The Eyes of Texas Are Upon You.”

[Editor’s Note: alas, the ball did not bounce right.]

Those of us with interest in the markets know that the final round of the production game is also looming in the form of the Barron’s Roundtable that will be published over the next several weeks.

But for investments that will actually make you money, you’ll have to look elsewhere. Let me explain…

Man climbing stacks of coins in concrete room

We have already seen dozens of forecasts, including an article suggesting various income strategies investors should embrace for the New Year, published in Barron’s this past week. I have been a Barron’s subscriber for a very long time, but to call this article awful is a kindness. I hope ChatGPT wrote the piece because there appeared to be little thought used to select the suggested investments.

Income-seeking investors would be much better off using strategies like the ones fellow Investors Alley editor Tim Plaehn and I have developed. At least we did some actual research into our ideas and understand how to properly use income-producing investments in the real world.

I do not make predictions about what the markets may or may not do. If stocks are cheap and have a margin of safety, I believe it is time to be a buyer. If the stocks are overpriced and everyone loves them, it is a good idea to be a seller.

The cheapest stocks with a considerable margin of safety right now are small community banks.

In 2024, I expect to see two things that will lead to a massive rally in bank stocks, especially the smaller institutions.

One is the return of merger and acquisition (M&A) activity. Even to the over-educated progressive thinkers appointed to regulatory agencies in recent years, it is becoming increasingly apparent that healthy bank M&A is suitable for both banks and consumers. The fact that investors might make profits from M&A can no longer be the controlling factor in the decision-making process. We have already seen an uptick in announced deals, which will accelerate as the year progresses.

The end of the interest rate cycle will also provide a considerable boost for bank stocks in 2024. If we just get higher-for-longer rates, with no more hikes, bankers can reinvest coupon payments and maturing securities at higher rates. Banks with adequate capital levels will be able to book the losses in low coupon securities and reinvest with a pick up of several hundred basis points of yield.

We have seen several banks’ sales-leaseback transactions involving branches where the building was sold and then leased from the buyer on a long-term deal. This type of arrangement frees up cash that the banks can use to cover the losses involved in the repositioning process.

A lot went wrong for banks in 2023. Rising deposit costs pressured profit margins. Falling bond prices crushed the value of securities portfolios. Headlines generated by people who know more about manipulating public opinion than they do about banking caused waves of selling to hit some bank stocks. Loan demand slowed.

One thing that did not happen will surprise most folks who pay attention to the financial media and headline hunters.

Remember how all the deposits were supposed to leave the banking system and be switched to money markets, buy gold, or just stock in a tin can?

They went nowhere.

If you look at the latest Fed H.8 filed last Friday, total deposits at small banks are $5.3 trillion. A year ago, deposits at smaller banks were $5.3 trillion. For commercial banks, deposits are currently $16.3 trillion. A year ago, they were $16.4 billion.

That is not exactly the crisis that was predicted.

Banks are much healthier than the fearmongers and doomsayers are telling you, and the stocks are cheap. We can now buy potential takeover targets with tons of capital for less than 80% of book value.

Even in the current subdued environment for bank M&A activity, average deal multiples are close to 130% of tangible book value. As the market for bank stocks improves, multiples will move close to the long average of more than 160%, thanks to the end of rate hikes. If the Fed lowers interest rates in 2024, book value will recover by 10% or more at many small banks.

Income investors have the choice of banks with high dividend yields and low P/E ratios that should deliver market-beating returns over time.

High-yielding banks’ preferred stocks and bond issues also have the potential to deliver outsized total returns in 2024.

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