Receiving Income from Investments

A few week’s ago Bill Gross, PIMCO's "bond king," said his $236 billion Total Return Fund no longer holds any U.S. Treasurys. Selling his position was a gutsy business decision, one for which he may take some heat, but from an investment standpoint he was right. Not owning U.S. Treasurys now is a no-brainer.

I won't go so far as to say there was or is a "bubble" (think tulip bulbs and dot-com stocks) in the Treasury market, because holders know exactly what they will receive at maturity and there is no risk if they simply hold on. Bond funds, however, do not mature, so investors have risks holders of individual issues do not. For example, those who bought the iShares U.S. Treasury ETF (TLT) last August have already lost 17 percent. They'll lose more.

I, too, am avoiding U.S. Treasurys in my Reduced Risk Income portfolio. There are better vehicles with higher yields. Specifically, preferred stocks, emerging market debt funds and high yielding equities make more sense.

Preferred stocks represent an equity investment in a company, as do common shares, but rank higher in the corporate pecking order when it comes to dividends or assets (in bankruptcy). Like bonds they pay dividends regularly with yields for many today of approximately seven percent. They are primarily income vehicles, so there will be little if any price appreciation. One of our favorites the JP Morgan Chase 7% Capital Securities Series J.

Emerging market debt funds invest in bonds from less-developed countries. Their bonds have lower credit ratings than other sovereign debt, because of the increased political and economic risks. As a result, they reward investors with a higher yield and capital gains potential. The asset class is attractive now because emerging economies are growing faster than those in the developed world. You can invest through several ETFs. PowerShares Emerging Markets Debt (PCY) and Western Asset Emerging Markets Debt (ESD) are two. I like the latter, which yields seven percent.

When you think of high yielding equities utility stocks often come to mind. Utility stocks have lagged the market the past year, but investors have been rewarded with yields of four or five percent and dividend growth. Some consider utilities a safe haven and to some extent that is true. Most are monopolies with a guaranteed return on capital. That is not to say they are risk free. If interest rates rise their yields will be less attractive, so their prices will fall. Many are also heavy borrowers. Rising rates will raise their costs. The Select Sector Utility SPDR (XLU) is a good way to invest. It owns all the utilities in the S&P 500 Index.

Other equities have high yields as well. Many drug stocks have been out of favor and have yields as high as utilities. My favorite is Pfizer (PFE).

All income vehicles have risks, some specific to them and others common to all. Among the latter, the most important is the level of interest rates. When rates are rising more than a little, income vehicles give ground (the reverse happens when they fall). While that day is coming, it's not coming soon...except for U.S. Treasurys. I agree with Bill Gross. For income investors there are better places to be.

— David Vomund is an Incline Village-based Registered Investment Adviser. Information on his money management service is found at www.ETFportfolios.net or by calling 775-832-8555. Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.

First Quarter Review

Stocks posted their best quarterly gain in 13 years and the first quarter was one of our best thanks to energy issues. Had you known three months ago what was soon to be in the news (Japan, Egypt, Libya, the dollar, soaring commodities prices, etc.), you would surely have expected tough sledding ahead for stocks, maybe even much lower prices.

One can't help but wonder what it would take to undermine stock prices since neither war, nor revolutions, high unemployment, the ongoing housing recession, or natural disasters seems to do it. I can answer that. A downturn in the outlook for economic and profit growth would surely do it. An increasing likelihood of a sharp rise in interest rates would do it, too, but that is not in the cards for months unless inflation accelerates. I for one worry less about inflation even though commodity prices have soared. Commodities are a very small (10 percent) component of the inflation calculation. The day will come when inflation will be two or three percent and interest rates will be higher. No doubt about it. But not soon.

Investing is all about the economy and future earnings, and that explains why stock prices are rising. The outlook on both fronts is improving. GDP rose at a 3.1 percent rate in the fourth quarter, faster than previously estimated. Little noticed was that had it not been for an inventory draw down, growth would have been more than double that rate. That’s a strong economy. When inventories are rebuilt, which is inevitable of course, look for GDP growth to top 4 percent.

The economy and strong corporate profits explains why 117 companies in the S&P 500 raised dividends in the first quarter by a record $16.6 billion. Last year only 78 raised theirs. Companies have $940 billion in cash on their balance sheets. Expect more good news on dividends.

The drivers of the bull market are solidly in place. Those are earnings growth, cash being put to work, stocks’ attractive valuations relative to other investments, and the Fed’s injections of liquidity. As for he last, there is an old (and time-tested) adage: “Don’t fight the Fed.” That was good advice two years ago; it’s good advice now.

Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.