Where is the Skepticism?

Dividend Investing, ETFs, Funds

Editor’s Note: It’s now early March and the market appears to be collapsing around us. I wrote this article about six weeks ago saying that the market had become complacent and a shock would come sooner than we expect. I never would have dreamed it would be just a month later. However, the stocks I recommended then are perfect for income investors trying to weather this storm right now.

Fifteen months ago, during the final months of 2018, the financial news was full of predictions of an economic recession in 2019. Now in hindsight, it is obvious all of those “experts” were wrong. Through 2019 the economy maintained a path of steady growth, and the stock markets gained almost 30%.

Now at the beginning of 2020, the majority of stock market predictions I hear forecast market gains of 10% to 20%, or even higher, up to 30% year for the major market indexes. There is almost no talk of an economic recession. It’s a goldilocks investing world, and everyone will be richer and happier at the end of 2020.

If the expert forecasts were so wrong a year ago, what makes them better forecasters this year. As the Yogi Berra attributed quote goes, “It’s tough to make predictions, especially about the future.” What I have observed is that the usual predictions extrapolate the past into the future, with little thought that current trends may change or reverse. One of my earliest observations in life was that everything goes in cycles. The only exception is that future forecasts rarely predict reversals in the current trend.

A stock market correction is defined as a 10% or greater decline in the major stock market indexes. If the indexes drop by more than 20%, it officially becomes a bear market. History shows that market corrections occur on average once a year, and the average correcting decline is 13%. The market did not experience a correction in 2019. While I am not predicting one, I will not be surprised if the investing world gets surprised by an “average” correction this year.

Even an average 13% drop will be a huge shock for an investing public that thinks stock prices will continue to march higher as they did in 2019. The drop will produce panic selling, and I predict if a market correction occurs, it will be steep and deep.

Currently, I recommend to my newsletter subscribers that they build up some dry powder in the form of cash in a money market fund or short term bond funds. If the stock indexes drop by 13% to 15%, I will be advised to invest on the drop into our favorite income stocks.

If you are looking for some investment ideas that will provide reasonable returns through a market correction (or no correction) and are more conservative, consider preferred stock shares or convertible bonds. Preferred shares are income securities that have priority over common stock dividends. Convertible bonds give the benefit of stock price appreciation with a floor provided by the bond interest payments. A preferred stock/convertible bond exchange-traded fund (ETF) will be less volatile than the overall stock market. Here are three to consider:

The iShares Preferred and Income Securities ETF (PFF) is the largest preferred stock ETF, with $17.5 billion in assets. The ETF launched in March 2007.

The PFF expense ratio is 0.46%. Side note: Earning half a percent a year on $17 billion of other peoples’ money is nice work if you can find it.

Top holdings are preferred shares from Broadcom, Wells Fargo, Bank of America and GMAC Capital Trust.

The fund pays monthly dividends and currently yields 5.25%.

The Invesco Financial Preferred ETF (PGF) invests at least 90% of its total assets in preferred securities of financial institutions. Top holdings are preferreds issued by PNC Financial Services Group, Wells Fargo, JP Morgan Chase, and Citigroup.

Banks and other financial companies are among the largest issuers of preferred stock shares.

PFG has assets of $1.6 billion and an expense ratio of 0.62%.

Dividends are paid monthly, and the current yield is 5.1%.

The InfraCap REIT Preferred ETF (PFFR) owns a portfolio of preferred stocks issued by real estate investment trusts (REITs).

By investing the preferred shares issued by REITs, the PFFR income is ultimately backed by rents paid from leases on commercial properties.

This strategy may provide a higher level of safety in an economic slowdown or financial crisis. PFFR has $46 million in assets and an expense ratio of 0.45%.

Dividends are paid monthly, and the current yield is 5.6%.

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