It’s happening again.
Everyone is clamoring over the Fed’s upcoming FOMC meeting, set to take place next week.
The big question on investors’ minds: Will the Fed finally abandon its zero interest rate policy and raise rates?
As you can see in today’s chart, our current monetary policy is unprecedented. Abnormal. Insane even. No doubt, it will have its own chapter in the history books.
But we believe this “easy money” world is the new norm. And it’s directly impacting the markets.
As our Chief Investment Strategist Alexander Green recently penned:
“We are now in a period of ‘administrative markets’ where stock returns are affected as much by government policies as they are by economic growth and corporate profits.
“In the last few years we’ve seen bailouts, fiscal stimulus, quantitative easing, zero interest rates, heavy-handed regulation, and sharply higher taxes on income, dividends and capital gains.
“This is distorting markets... and lately equity investors have been paying the price.”
The market has been on a wild ride. Investors are getting seasick from the waves of volatility. But the bigger concern is how to steer the boat when another financial tsunami hits the bow...
As Alex noted, “In the past, when the economy (and the stock market) went into the tank, the traditional policy response was to stimulate the economy with lower interest rates and deficit spending.
“But interest rates are already at zero. And under the Obama administration, the national debt has soared from $7.4 trillion to $18.4 trillion.”
Out of Ammo?
So what can the monetary puppeteers do if another recessions hits?
Allowing negative interest rates is one option. But if you’ve been following Europe’s troubles, you know it’s not for a healthy option.
That leaves more quantitative easing... more deficit spending... or a combination of all three.
In the end, no one knows what the future holds. All we know is that the monetary policy tool box has been emptied. And that’s one of the reasons many expect the Fed will raise rates soon. This way, it will still have some ammo in the chamber in case of another downturn.
However, even if the Fed raises rates, it will likely be a measly quarter-point hike. The “easy money” world will carry on.
The good news? There is a way to generate high income in this low-rate world. And it comes with an elevated level of safety over common stocks.
I’m talking about preferred shares.
An Asset Class of Their Own
Preferred shares are your ticket to greater yields and safety - now. In fact, Alex recently included these instruments among his core group of high-income ideas here.
You can think of preferreds as a hybrid between stocks and bonds. According to the latest numbers from the S&P U.S. Preferred Stock Index, they average a yield of 6.26%.
And as far as what makes them safe, that can be broken down into three points...
- Preferreds have a dividend that must be paid before dividends are paid to common stockholders.
- Preferreds have a higher claim on assets over common stockholders (in case a company goes bankrupt).
- They are a highly uncorrelated asset.
That last point is key. To build a safe, profitable and well-balanced portfolio, a mix of uncorrelated assets is essential.
As you can see in the chart above, preferreds have only a 0.52 correlation with stocks - and 0.35 correlation with bonds. (A correlation of 1.00 means the assets move perfectly in tandem, while a correlation of 0.00 means the assets move entirely independently.)
So if rates move up or down - and the stock market boat rocks with the changing seas - preferreds will see a lot less volatility. Think of them as a Dramamine pill that will help keep you from getting seasick.
Only this pill pays a hefty dividend while you weather the storm.
According to Alex, the best hands-off selection here is the iShares US Preferred Stock (NYSE:PFF), which currently boasts a yield of 6.14%. No other preferred stock ETF has its size or low expense ratio, making it an obvious choice in this category.