The Coming Corporate Debt Cliff

Written by Rob Copeland | 12 November 2019

Smart investors are always on the lookout for coming trends that could broadly impact the economy and the stock market.

That's why we've seen endless headlines about the trade war, the impeachment battle and decisions by the Federal Reserve. Less attention has been paid to a trend that is at least as important: the corporate debt cliff.

The exceptionally low interest rates of the past decade have prompted businesses to borrow trillions of dollars. But they'll soon have to pay the piper: Some $4 trillion of corporate debt will come due in the next five years – and the fallout could affect the economy as well as your investment portfolio.

For that reason, now is a good time to reevaluate what you own, and to make sure your portfolio gives you a chance to withstand or even capitalize on what lies ahead.

So-called growth stocks, which appreciate faster than the general market and usually don't pay dividends, have enjoyed a decade-long bull market. But tech companies and other growth stocks have fueled themselves with huge amounts of debt, and in many cases they're not profitable.

Behind much of this corporate debt are regular investors looking for decent yield in a super low interest rate environment.

Here's the bad news: Even as they take on more and more debt, U.S. companies' profits are declining. Inevitably, weaker companies will start to struggle to keep up with their debt payments, especially if economic growth continues to slow.

And as they look to issue new bonds to pay off the expiring ones – this is the $4-trillion debt cliff -- they may find fewer investors willing to lend to them. That's a very real scenario particularly because credit-rating firms have already downgraded debt for many of the companies in question to near junk-bond status.

If weaker companies are unable to sell enough new bonds to refinance their maturing ones, they could either default or be forced to sell off business divisions to raise money. That could hurt earnings, lead to layoffs and even help fuel a recession.

The corporate bond cliff and the heavy debt of many growth stocks create a good opportunity to reassess your portfolio. It may be time to sell corporate bonds and growth stocks and look at alternative ways to potentially earn growth and income.

The opportunities include so-called value companies that are profitable, don't carry heavy debt and are better positioned to navigate an economic slowdown. These companies generally pay a steady or rising dividend, unlike growth companies. And their stocks are at one of the cheapest levels relative to growth stocks in decades.

Mortgage-backed securities are another interesting opportunity. They're yielding in the range of 4% to 7% right now. Together, the right value stocks and mortgage-backed securities can serve as a good replacement for corporate bonds.

Bear in mind that any investment decision needs to fit your long-term goals, your level of risk tolerance and other factors. Please consult your financial advisor for professional investment guidance. Don't hesitate to call us if you'd like to discuss your portfolio.

Progress in the Trade War

Written by Rob Copeland | 14 October 2019

In May, the prospects for a trade deal between the U.S. and China looked grim. As trade negotiations broke down and President Trump raised tariffs further, the S&P 500 plunged 2.5% from May 6 through May 9. 

At that time, I wrote that it’s most likely that the two countries will ultimately reach an agreement. Nobody, I pointed out, wins in a trade war. Now there are signs of progress.

On Friday the U.S. and China reached a modest preliminary deal in principle. It suspends the U.S. tariff increase that was scheduled for Oct. 15. In return, China agreed to buy up to $50 billion of U.S. crops and remove limits on foreign ownership of its financial-services businesses. The S&P on Friday rose 1.1%, to 2,970.

President Trump described the agreement as phase one, suggesting that other areas of disagreement would be tackled in subsequent rounds of negotiations. Negotiations remain delicate, and there could easily be more setbacks and detours.  Thorny issues like intellectual property protections and copyright and trademark issues still lie ahead.

But as I wrote in May, both the U.S. and China ultimately need to get a deal done. Trump, who is now facing an impeachment inquiry, needs a win to shore up his 2020 re-election effort. 

Chinese president Xi Jinping is also under pressure: Even though he isn’t facing an upcoming election, China’s economy is being hurt by the trade war because it’s become more expensive for American consumers to buy the country’s exports. Chinese leaders are aware that economic trouble can lead to social instability, and they seek to avoid at all costs. 

For investors, the trade war has hurt industrial and technology companies. If the U.S. and China are starting to replace tit-for-tat tariffs with incremental agreements, stocks of companies in those sectors could start to recover. 

For now, it’s important to continue seeking out exposure to stocks that aren’t exposed to the trade war, that have strong, durable earnings, and that are reasonably priced. Choosing individual stocks with the help of an expert investment advisor can, in a situation like the current one, give you a chance to outperform broad index-based funds. 

Finally, it’s a good bet that there will be more posturing, rhetoric and scary headlines as the U.S. and China seek leverage for future negotiations. The key is to remain patient, choose stocks carefully and watch for progress. If you’d like to review your investment strategy and holdings, don’t hesitate to get in touch with us. 

Bond Yields Are Low – So Where Do You Find Income?

Written by Rob Copeland | 12 September 2019

It's difficult to find good income opportunities in the bond market right now. The 10-year Treasury, which was yielding more than 3% last fall, is heading into this fall at 1.7%. That's even less than the rate of inflation.

As my clients' bonds mature, I'm advising them to consider some other opportunities with more attractive yields. One is an old standby – high-quality dividend-paying stocks. I look for stocks with rising dividends above the 10-year Treasury rate. Owning such stocks allows you to take advantage of price appreciation, but also to get paid while you wait.

It's true that the trade war and other pressures could hit companies' profits and force them to freeze or lower dividends. The key is to analyze and identify companies that are poised to continue growing their dividend payments over the long term.

Three dividend stocks that are worth a look right now are Discover Financial Services, which is yielding 2.1% and up 42% this year; Western Union, yielding 3.4% and up 41%, and Hawaiian Airlines' holding company, which is yielding 1.7% and up nearly 4%.

For something that may be completely different, income hunters might consider investing directly in real estate. Drawing on my own experience as a residential and commercial landlord, I wrote about real estate's pros and cons here. 

Owning and managing real estate properties is a longer-term commitment because it's obviously harder to sell a building than it is to sell a stock or bond. But if you do it right, it's reasonable to expect a 6% or 7% net profit year in and year out.

Finally, there's the opportunity to earn a solid yield with instruments called non-agency residential mortgage-backed securities. Specifically, I like RMBS that are backed by non-conforming loans. These pay higher yields – currently between 4% and 7% with duration under 5 years. The range is based on several variables, including prepayments and defaults of the underlying mortgages, as well as projected valuations of defaulted properties.

Non-agency RMBS can also be bought at a discount to their original price, which may increase the yield. The key is having the knowledge to track down opportunities that are discounted but also are high-enough credit quality to avoid a default.

So while bonds aren't a very encouraging place to be right now, fixed-income investors shouldn't lose hope. If you'd like to discuss the best way to add yield opportunities to your investment portfolio, don't hesitate to contact us.

Time to Invest Smarter

Written by Rob Copeland | 12 August 2019

Over the past couple of weeks, there's been a lot of talk about the trade war with China, stock market volatility, and the possibility of a recession.

In this blog we'll look at what's behind all the headlines, and how you might respond as an investor. The spoiler is this: There's no need to panic, but it's increasingly necessary to be thoughtful and selective in choosing stocks.

Here's some of the backstory. A day after the Federal Reserve's July 31 announcement that it was cutting interest rates for the first time since 2008,
President Trump announced additional new tariffs on a huge range of imported goods from China.

Within a few days, China let its currency, the yuan, fall to its lowest value since 2008. That prompted the U.S. Treasury Department to label China a "currency manipulator." Market watchers are concerned about the effect on stocks of the trade war and of a possible currency war. And they point to recession indicators such as the "inverted yield curve."

A recession, which could create a significant market impact, is no sure thing however. Jobless claims are very low, wage growth is decent, and corporate earnings are still pretty good as well. If a recession does end up occurring, I believe it will be a mild one, because the economy hasn't seen the type of distortions that led to the dot-com and housing busts. For that reason, a bear market also seems unlikely.

Still, the stock market is likely to be very volatile for the foreseeable future, and certain types of companies will be hurt by the trade war with China. Those facing pressure include big-box retail companies: Because of tariffs, they'll have to jack up prices or accept lower profits. Agricultural and tech companies will probably suffer as well, for similar reasons.

On the other hand, selected financial technology firms like PayPal and payment processors Discover and American Express are worth a look. With incomes on the rise, travel and leisure companies, as well as airlines, could also be good bets.

There's always a way to make money in stock market, whether it's a roaring bull market or a grinding bear market -- or anything in between. What's going on right now is that the broad, easy gains that investors collected in the first several years of the recovery are gone. Going forward, you'll have to dig into the research to find companies that are poised to do well. If you'd like to talk about your investments, don't hesitate to give us a call.