Handling Preferred Stocks During Times Of Rising Interest Rates
Well, the Fed finally did it! They upped interest rates ½%, the most since 2020. Yahoo Finance reports:
“Prices have been rising at their fastest pace in 40 years – hitting 8.5% year over year in March as the U.S. comes out of the pandemic.”
Wolf Street weighs in on food prices:
“Food at home” inflation spiked by 1.0% for the month and by 8.5% year-over-year.
Major categories, and their year-over-year spikes in CPI inflation rates:
- Cereals and cereal products: 10.1%
- Beef and veal: 16.0%
- Pork: 15.3% as folks switched to pork from beef.
- Poultry: 13.2% as folks switched to poultry from pork.
- Fish and seafood: 10.9%
- Eggs: 11.2%
- Fresh fruits: 10.1%
- Fresh vegetables: 5.9%
- Dairy and related products: 7.0%
- Coffee: 11.2%
- Fats and oils: 14.9%
- Baby food: 10.8%”
Damn! If we could just train ourselves not to eat, we might be OK.
Here in AZ gas prices have risen over 25% over the last three weeks. That affects the costs of everything we buy; things are going to get even more expensive.
Yahoo Finance added, “At the same time, Fed officials…also announced it plans to begin reducing its bond portfolio starting on June 1.” Gee, I thought they were going to start that in May.
I just read that, at year end, the New York Fed owned 38% of all 10-30 year US Treasuries. When that debt matures, will the market really absorb that much more US debt, in addition to the current deficits?
It’s time to contact expert, Tim Plaehn, who writes The Dividend Hunter. Inflation isn’t going away anytime soon, and we need to deal with it.
I have been very high on preferred stocks. Unlike common stocks, their dividends are fixed and must be paid ahead of common stocks. As interest rates rise, we should expect their stock prices to drop, but NOT their dividends. I looked at our investments in preferred stocks. 80% of them have dropped slightly below what we paid for them. The dividend yield, based on our cost shows one paying 6.7% while the others range between 8% and 8.3%.
I don’t have much faith in the Bureau of Labor Statistics (BLS) inflation numbers, but our preferreds are keeping up with reported inflation for the most part. I’m not planning on selling them, the yields are good, and I don’t see many opportunities elsewhere.
DENNIS: Tim, once again, thanks for taking your time to help our readers. Before we get directly into preferred stocks, you wrote an interesting article, “Why Growth Investors Panic – And I Don’t”.
While preferred stocks move more in relation to interest rates, the stock market itself, even the big boy tech stocks, have taken some huge hits. I read where Bezos lost $20 billion in net worth in one day. Wonder if he felt maybe a twinge! (Sarcasm intended)
Tim, can you fill our readers in on why you don’t panic?
TIM: Dennis, thanks for the opportunity to address your readers. This subject is near to my heart.
I have been in the markets for a long time. Investors, particularly those who focus on betting on stocks always going up, tend to be fear driven, so when they panic, I look for opportunities. Panicking investors/traders don’t discriminate between good and bad investments, so I will be on the watch for good investments and stocks at discounted prices.
I find it interesting that the market goes through this type of downturn, on average every two to three years, and each time, investors as a group, have the same, fear-driven reaction.
And each time the market will recover. If you buy good investments during the downturn your wealth will be significantly improved after the recovery.
DENNIS: You recently issued a sell order for Cedar Realty Preferred B shares. There were some great short-term profits. I found your closing sentence interesting, “I recommend you take the proceeds from selling CDR.PB and spread the money over our other individual preferred stocks.”
How do readers decide which ones? Would we look for stocks that have dropped? 80% of my stocks are paying 8% or more. With their share prices dropping the yield is currently higher.
TIM: In my Dividend Hunter service, I provide a list of 10 to 12 recommended preferred stocks. I recommend trying to own an equal amount of each. I’m encouraging readers to take those profits and rebalance the others they own.
For those new to preferred stocks, I also provide a report that includes details on each of our preferred shares as well as more background on how preferreds work and why investors should own them.
DENNIS: As our preferreds are interest rate sensitive, eventually this should signal a buying opportunity. One of the reasons we did so well last year was taking advantage of buying preferreds below par value.
Are you likely to wait until you think the Fed will begin to reverse their policy, or might there be some circumstances along the way that would warrant readers buying immediately? And vice versa, like Cedar Realty, might we see some sell orders?
TIM: Each investment gets evaluated on its own merits. The outlook for Cedar Realty has changed dramatically, so I decided it was time to get out.
Solid preferred stocks are tied to the interest rate cycles. A year ago, subscribers complained that our preferreds were trading above par (typically $25) and not a good deal. Now they are below par, and I am questioned about what is going on with the preferreds.
I tell subscribers to think of preferreds as buying an indefinite income stream. That stream will most likely end when the preferred shares are called in at par value. It is impossible to predict when a company will decide to redeem the preferreds.
DENNIS: What causes companies to call in their outstanding preferred shares? What effect does rising rates have on their decisions.”
TIM: The most common reason to call in a preferred is because the company can issue new preferred shares at a lower coupon rate. While preferred stocks are callable, that doesn’t mean they have to be called in.
In most cases, they issued preferred shares for financing major operations. If they have an opportunity to refinance at a lower rate, they will call in their preferred shares…or may just issue new preferred shares paying a lower interest rate.
DENNIS: One final question. I’m not too young to remember “Widows and orphans’ stocks.” They were stocks that were bought and likely kept for years. They were solid companies, paying regular dividends, and their stock prices and dividends were true inflation fighters.
Unfortunately, management got greedy at some of those companies. They borrowed billions at low interest rates, paid extra dividends and bought back their stock – paying themselves big bonuses. Now those companies are not so solid anymore.
I know you spend hours researching dividend payers. Do you ever see those type stocks coming back again? How do they fit into the big picture?
TIM: Yes, they can. We had several dividend cuts due to the pandemic, and the better companies have started to grow dividends to get back to the pre-covid payout rates.
As to the big picture…. With interest rates now rising, I don’t expect to see a lot of our preferreds getting called when they become eligible as rates are rising. If the share price is below par, the company may buy back their stock in the open market.
Dennis, readers must understand that preferred shares are more of fixed income. Having a portion of your portfolio in safe preferred stocks that are paying significantly more than they could earn in CDs is a good thing.
At the same time, I encourage readers not to go overboard because preferred stocks also have a cap on potential income as compared to common stocks.
When the market has a major correction (with a little panic to help it along), widows and orphan stocks become very affordable. Mutual funds are forced to liquidate some of their holdings to meet redemptions which helps drive their prices down further. “A really big sale!”
When that happens, we need to be very selective. Just because something is on sale, does not mean we should buy it; finding the real value common stocks that are on sale is the key. This is important because it is the combination of dividends and stock appreciation that will put us in a much better position to fight inflation.
Currently the Dividend Hunter list of preferreds has an average yield of 9.0%. I am comfortable with earning that yield indefinitely. At the same time, we must stay on top of our common share holdings. If their business is affected by the downturn (not just panicky sellers) and their dividend is in jeopardy, then we move on.
Let the investors and stock jockeys panic, while we go shopping for quality common stocks on sale…while our preferred shares continue paying their regular dividends.
Thanks again for the opportunity to address your readers.
Dennis here. I really appreciate Tim’s insights here. Jo and I are not selling any of our preferred shares, enjoying the regular income stream.
It is difficult holding cash in reserve in times of high inflation. I seem to have this constant urge to “do something!” While we may not time the market perfectly, our patience will be rewarded. Tim does a good job of reminding his subscribers to keep things in perspective.
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On The Lighter Side
Thank you to all the kind readers that sent me a note last week wishing me well with my medical issues. Kidney numbers were good this week and I am starting to get more energy.
I hope everyone had a great Memorial Day weekend. I’m hoping for a great summer, and spending some time with the grandchildren in IN. Barring any medical surprises, it will come to pass.
We had some triple digit temperatures here in AZ, but I did manage to get some nap time on the back porch, which I really enjoy. When the sun is down, there are thousands of stars that seem to sparkle. Other than an occasional car, it is quiet, and I call it “daydream city”.
Even in my early teens, on a cool summer night I used to lay out at night on the grass, staring at the stars and the moon, wondering what life will bring. Now, at 82, I’m on a comfortable lounge chair, still gazing into the sky wondering the same things.
I took this shot in Prescott a few years back. I guess it is the simple things, but I never get tired of sitting out at night contemplating the problems of the world and counting my
blessings. Current problems be damned, we have much to be thankful for.
Quote of the Week…
“Satisfaction is not always the fulfillment of what you want; it is the realization of how blessed you are for what you have. We’ve learned not to mourn what cannot be but instead to relish what we have.”
— Suzanne C. Cole
This week’s humor is supplied by friend Chuck B. He titled it, “Things I noticed about aging.”
- I used to be able to do cartwheels, now I trip over my underwear.
- I told my wife she should embrace her mistakes, so she hugged me.
- My wife says I have two faults. I don’t listen and something else.
- I thought growing old would take longer.
- I think the reason we are born with two hands is so we can pet two dogs at once.
- Day 12 without chocolate. Lost hearing in my left eye.
And my favorite:
- If you are happy and you know it, it’s your meds…
Until next time…
“Economic independence is the foundation of the only sort of freedom worth a damn.” – H. L. Mencken
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