December 11th, 2010 10:33 EST
Income Investing News: What, Me Worry!
Whoa! Stop! Hang on a minute. There is absolutely nothing unusual going on in the income securities markets. There is nothing to be particularly concerned about or afraid of. Relax, take a few deep breaths, and read on.
Falling income security prices are all the buzz in the financial media these days, but why does this translate into such fear and confusion? I saw a news report the other day that encouraged investors to abandon their income ship and sail away on a stock market steamer that has been cruising steadily higher for twenty months --- the IGVSI equaled its September 2007 high on the 8th of December.
And lest we forget, the over-riding papoose of investing in income securities is, after all, the generation of income. That`s income, Alice, not growth in market value. Just income.
Income securities, as measured by an index of high quality closed end funds (CEFs), remain roughly 50% above where they were at the bottom of the financial crisis and, more importantly, precisely within their normal price range of the past ten years. The most conservative CEFs are yielding from 6% tax-free to 8% taxable.
There are at least eight reasonable explanations for recent price weakness --- there are at least eight excellent reasons why investors should be viewing this weakness as a buying opportunity. Clearly, the financial press has not attended any of my seminars on income investing. Lower prices and higher yields are good news for income investors!
One: Income security prices vary inversely with interest rate expectations (IRE) --- eighth grade finance. After nearly two years of historical (hysterical) lows, the world expects interest rates to rise.
Two: Rising IRE, regardless of its impact on the price of fixed income securities, has absolutely no impact whatsoever on the income generated by existing securities. In fact, in CEFs, it will eventually lead to higher payout levels when managers have access to higher yielding instruments.
Three: The surging stock market has outsmarted most mutual fund managers, and rather than look stupid by holding income securities, they are taking losses in that area and "window dressing" their portfolios with equities that MCIM (Market Cycle Investment Management) investors are taking profits on. Inexperienced investors too, and too often, move from income to equity at precisely the wrong time.
Four: Rumors about the weakness of individual state treasuries may lead to some downgrading of their bond offerings, and this certainly has added some pressure to municipal bond pricing --- but there hasn`t been a significant Municipal Bond default since the WHOOPS fiasco of the early 1980s.
CEFs contain hundreds of different issues, and defaults are not likely to occur when so many other fiscal alternatives are available. Perhaps the state employee unions will be forced to weaken their stranglehold on private sector worker pocketbooks.
Five: As any MCIM practitioner would explain, income CEFs have been a bountiful landscape for profit taking as they rebounded from the price "haircut" of the financial crisis. By adding to positions during the 24-month decline, profits were quick to appear as prices rose to normal levels very quickly --- profit taking has been replaced by other investors` irrational loss taking, as CEF income continues unabated.
Think of it like a sale at Target, but with bargain prices still 50% above where they were less than two years ago!
Six: Recent speculation that Congress would raise income taxes led to increased demand for tax-free securities. Now, with that specter less likely, demand has lessened. As an aside, do you think they know (arguably) that every major tax cut in history has led to increased government revenues?
Concurrently, State and Municipal bodies have been taking advantage of a new Federal government taxpayer pocket-picking program by issuing, taxable "Build America" bonds. Although they are forced to pay investors a higher rate of interest, the Fed picks up a third of it.
This program reduced the supply of tax-free bonds, just when the potential tax increase was increasing demand. With a republican controlled house, it is less likely that this program will be continued, increasing the supply and reducing prices once again.
Seven: CEFs, and the securities they own, are much less liquid than equities. Consequently, when there are more sellers than buyers (for whatever reason), prices will fall more quickly --- and the impact on income? Nadda.
Eight: During December and January each year, most CEF managements disburse their accumulated capital gains. This welcomed "bump-up" in income to investors is recorded in the market as a reduction in price as the cash is distributed to shareholders.
So now you know why closed-end income fund prices, particularly for tax-exempt issues, have weakened. I look at it as a double Holiday bonus (or "gelt", for those of you who know). Whether it is profit taking by MCIM aficionados, or loss taking by window-dressers; whether it is irrational "priceaholism" or simple issues of supply and demand --- history tells us what to do about it.
When prices rise, we take our profits, reinvest and increase our cash flow. When prices fall, we reinvest our unaffected (even increased) earnings, reducing cost basis while increasing yield on investment. Double your holiday pleasure with increased distributions and lower priced shares to choose from.
Have you ever had so much fun? Who says income investing is boring!
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read"