After a tumultuous few weeks in the markets, the steady income offered by yield-focused investments looks very attractive.
And the recent selloff has created a bounty of opportunities in both stocks and bonds that are among the most promising in years.
Income plays that now look particularly appealing include high-dividend stocks in the U.S. and overseas markets, master limited partnerships, junk bonds, and preferred stock. In these sectors, investors can get yields from 3% to 10% through individual securities, mutual funds, exchange-traded funds, and a hard-hit group of closed-end funds.
In our seventh annual look at income-producing investments, Barron’s assessed 11 different sectors and ranked them in order of preference.
Our favorite for 2019 is a group of MLPs focused on U.S. energy infrastructure that have been battered in the past two months as oil prices tumbled. Big MLPs trade like energy stocks, despite their modest commodity exposure. The benchmark index for MLPs, the Alerian index, was off 19% last year, bringing it near its 2016 low and yielding almost 9%.
Investors seeking 3.5% yields in stocks don’t have to look far. The Vanguard High Dividend Yield ETF (VYM), which holds high-yielding blue chips like Johnson & Johnson (JNJ), Exxon Mobil (XOM), and JPMorgan Chase (JPM), recently hit a 3.5% yield.
European stocks, down 17% in dollar terms in 2018, yield an average of 4% based on the broad Vanguard FTSE Europe ETF (VGK), whose largest investments include Nestlé (NSRGY), Novartis (NVS), and Royal Dutch Shell (RDS/A) (RDS/B).
Credit-sensitive parts of the bond market, mainly junk debt, have been buffeted of late. Junk bonds now have an average yield of nearly 8%, up from a low of 5.5% in early 2018. Preferred stock, mostly issued by banks, has also come under pressure. As a result, issues from Bank of America (BAC), Wells Fargo (WFC), and JPMorgan yield 6% or more.
Treasuries, yielding 2.3% to 2.9%, were a haven during the recent stock market turmoil. But with inflation still around 2%, they don’t look enticing. Muni bonds don’t look bad in the 1.5%-to-3.5% range, but offer little or no inflation-adjusted yields except for longer maturities.
In the stock market, real estate investment trusts are yielding an average of almost 5% after a recent pullback. They look tempting. Electric utilities, on the other hand, look rich after three years of positive performance. The telecommunications sector offers high dividends globally, with the U.S. leaders AT&T (T) and Verizon Communications (VZ) at 6.9% and 4.3%, respectively.
The outlook for the 11 sectors depends on the direction of interest rates and stocks. We weren’t defensive enough in our choices for 2018, when we favored MLPs and high dividend-paying stocks in both the U.S. and overseas. Our picks for 2017, however, were pretty much right on the mark.
Here are the 11 sectors ranked in the order of their appeal:
Many retail investors swore off MLPs after a 55% decline in the benchmark Alerian index from the 2014 peak and dividend cuts from the likes of Kinder Morgan (KMI) and Plains All American Pipeline (PAA).
This could be a good time to reconsider the sector, which has an average yield of 9%. The energy-pipeline industry is probably in its best shape ever, thanks to growing cash flow, rising domestic energy production, and improving corporate governance.
“The group is reacting more to energy prices than it should,” says Greg Reid, president of the MLP complex at Salient, a Houston investment firm. He does caution that growth in U.S. oil and gas output could slow in 2019 because of lower prices. Still, Reid is encouraged by more comfortable dividend-coverage ratios, lower financial leverage, and greater use of internally generated funds to finance capital projects.
The group used to be dominated by MLPs that generate the complex Schedule K-1 tax forms dreaded by many individual investors. Yet Williams (WMB) and Kinder Morgan consolidated their public entities under a corporate structure. Corporations account for about 40% of the market capitalization of pipeline operators.
Barron’s recently highlighted the appeal of hard-hit MLP closed-end funds, which fell as much as 30% last year. Kayne Anderson MLP/Midstream Investment (KYN), the largest in the sector at $2 billion, fell 28% last year. At $14, it yields 10%. The smaller Salient Midstream & MLP (SMM) was down 33% in 2018. At about $7.50, it yields 9%. The Salient fund trades at one of the wider discounts to net asset value in the sector, at 15%.
2. Junk bonds
The average yield has risen to almost 8% from around 6% at the start of the fourth quarter amid the rout in stocks, concerns about the global economy, and outflows from junk funds and ETFs.
“There are a lot more opportunities than there have been in a while,” says Andrew Susser, manager of the $8 billion MainStay MacKay High Yield Corporate Bond fund (MKHCX). He thinks rising yields will attract pension funds seeking to reach 7.5% annual return targets. He sees potential returns of 10%-plus in 2019.
Focusing on companies whose estimated asset value comfortably exceeds the value of their debt, Susser likes Mattel ’s (MAT) 6¾ notes due in 2025 and now yielding almost 9% because of the value of popular brands like Barbie and Hot Wheels. He is also partial to auto-parts maker Tenneco ’s (TEN) 5% notes due in 2026, yielding 9%.
The most speculative part of the market—bonds rated CCC—yield almost 14%, up from a low of 9.5% earlier this year. Some of the debt of leading CCC-rated issuer Frontier Communications (FTR) has fallen 20% since Sept. 30, to yield more than 20%.
The leading junk ETF, iShares iBoxx High Yield Corporate (HYG), now trades around $80 and yields 5.6%. Even-higher yields are available among depressed closed-end funds. BlackRock Corporate High Yield (HYT) trades around $9 and yields 9.1%. Nuveen Credit Strategies Income (JQC), which invests in loans to highly leveraged companies, changes hands at about $7 and yields 6.5%.
Like most income-oriented closed-end funds, these use leverage to increase yields, resulting in greater risk. And both languish at a discount of more than 10% to their net asset value.
3. European dividend stocks and funds
The Continent has been a tough place to invest for more than a decade. The Vanguard FTSE Europe ETF (VGK) is below where it traded in 2006, while the S&P 500 (.SPX) has doubled over the same period.
For those looking for yield, however, Europe beckons because of the combination of depressed valuations and a longstanding preference among corporations and investors for dividends rather than share buybacks.
European stocks trade for an average of 12 times projected 2019 earnings, compared with 14 times for the S&P 500.
The average dividend yield in Europe is 4% and is even higher in Britain, at 5%. Anglophiles can get exposure through the iShares MSCI United Kingdom (EWU), which is dominated by high-yielding companies like BP (BP), HSBC (HSBC), GlaxoSmithKline (GSK), and Royal Dutch Shell.
Leading European consumer stocks like Danone (DANOY) and Unilever (UN) (UL) yield over 3%, as does Cie. Financière Richemont (CFRUY), the luxury-goods maker that owns Cartier and Van Cleef & Arpels.
4. U.S. dividend stocks and funds
High-yielding stocks were no haven for investors last year as the Vanguard High Dividend Yield ETF, down 9% last year, lagged behind the SPDR S&P 500 ETF (SPY) by about three percentage points. Investors can get 3%-plus yields—above the S&P 500’s 2.2%—in a range of stocks.
In the hard-hit financial sector, JPMorgan, Wells Fargo, Citigroup (C), and Morgan Stanley (MS) yield more than 3%. Citigroup and Morgan Stanley both have 2018 price/earnings ratios of just eight and trade below book value. Industry leader JPMorgan has a P/E of 10.
Berkshire Hathaway CEO Warren Buffett is bullish on big banks, having plowed more than $13 billion into the sector during the third quarter, including a new $4 billion holding in JPMorgan. Buffett has a phenomenal record, but he was too early with the big banks, given the sector’s nearly 20% pullback since Sept. 30.
In the depressed energy group, Exxon Mobil and Chevron (CVX) yield 4.8% and 4.1%, respectively, but their ability to cover their dividends becomes more difficult if the price of Brent crude oil, the international benchmark, drops below $50 a barrel. (Brent traded at $55 last week.) Big industrials Caterpillar (CAT) and United Technologies (UTX) have close-to-3% yields.
Besides Vanguard High Dividend, other dividend-oriented ETFs include the iShares Select Dividend ETF (DVY), which yields 3.6%, and the ProShares S&P 500 Dividend Aristocrats (NOBL), at 2.8%. Equity-oriented closed-end funds with nice yields include Tri-Continental (TY). It yields 4.3% and trades at a 11% discount to its NAV. Tri-Continental, which began in 1929, holds a group of blue-chip stocks like JPMorgan, Alphabet (GOOGL), Cisco Systems (CSCO), and Boeing (BA), plus a roughly 30% weighting in convertible debt, bonds, and preferred stock.
5. Preferred stock
The sector is near a 52-week low after decoupling from a stronger Treasury market in recent months. “The market looks cheap,” says Allen Hassan, managing director at Ziegler Capital Markets in New York. He thinks that concerns about corporate earnings and tax-loss selling have dampened prices.
Reflecting the losses, the iShares US Preferred Stock ETF (PFF) declined 5% last year. At around $34, it yields 6.3%. Major bank preferreds like the Bank of America 5⅞% series K (BAC Pr K), Wells Fargo 5.5% series X (WFC Pr X), and JPMorgan 5¾% series D (JPM Pr D) all yield around 6%.
The yield gap of three percentage points between the bank preferreds and long-term Treasuries is ample, considering the improving bank balance sheets and record profits. Dividends on bank preferreds and those of most other issuers benefit from preferential tax rates, like those on common dividends, because preferred is a form of equity.
There is a risk: Preferred stock can be very sensitive to changes in long-term rates, because most preferreds have no maturity dates, effectively making them perpetual securities. Issuers, however, can generally redeem preferreds at face value five years after issuance. Some preferreds are down by as much as 20% in the past 18 months, as interest rates have risen.
Hassan is partial to alternative-asset manager Carlyle Group’s 5.875% series A issue (TCGP), which yields more than 7%, and Regions Financial 6.375% series A (RF Pr A), at 6.4%.
A group of closed-end funds trade at discounts to NAV, including the category’s largest, the $1.7 billion Nuveen Preferred & Income Securities (JPS), now yielding 8% at a price of $8. Its discount to NAV is 6%.
As investment hybrids, real estate investment trusts, or REITs, have a bondlike sensitivity to rates and equity-like exposure to the economy. Lately, the group has traded more like stocks. Vanguard Real Estate (VNQ), the leading ETF, is off about 10% from its August high and yields almost 5%.
Wall Street is somewhat optimistic for 2019. J.P. Morgan analysts last month forecast a 10% total return for REITs in 2019, driven by 3% growth in funds from operations, a REIT cash-flow measure. That forecast came when the Vanguard REIT ETF was above current levels.
One bullish sign is that REITs generally trade below private-market values. And REITs, which own some of the best real estate in the country, offer an alternative to high-fee private real estate funds that are all the rage among endowments and pension funds. REITs own property like office buildings, shopping malls, and apartment buildings, as well as cellphone towers and data centers.
Industry leaders include Boston Properties (BXP), at $109, and AvalonBay Communities (AVB), at $172, both with yields of about 3.5%. American Tower (AMT), at $155, yields 2%. There is a group of higher-yielding closed-end funds like Cohen & Steers Quality Income Realty (RQI), at $10, and Nuveen Real Estate Income (JRS), at about $8. Both yield around 10% and trade for 10% discounts to NAV.
Verizon and AT&T have never diverged as widely as they did in 2018. Verizon gained 6% while AT&T fell 27% after touching an eight-year low around Christmas. At $56, Verizon yields 4.3%, and AT&T, at $29, yields 6.9%—one of the highest in the S&P 500.
Both are benefiting from improving conditions in the U.S. wireless market, but AT&T is suffering from concerns about its heavy debt, which totals about $180 billion after its $85 billion cash-and-stock purchase of Time Warner. Longtime AT&T bear Craig Moffett of MoffettNathanson upgraded AT&T to Neutral from Sell in late November, when its stock traded around $29, writing that the risks to AT&T and its dividend were “more appropriately priced in.”
Moffett’s view is that investors are “struggling (and rightly so) with recession risk,” according to a recent note to clients. The risk is that in a downturn, the rating agencies could “demand a more conservative posture, putting the dividend at risk,” he wrote.
AT&T remains committed to both its dividend and debt reduction, arguing that the dividend is amply covered by its free cash flow. And the company increased the quarterly payout by a penny, to 51 cents, in December.
Still, Verizon is the safer play, and that’s reflected in its valuation at 12 times estimated 2019 earnings. AT&T could be near a bottom with its 7% yield and a P/E ratio of eight.
Overseas telecom stocks also carry high yields and varying levels of risk. BCE (BCE) of Canada, at $40, yields 5.6%; the United Kingdom’s Vodafone (VOD), at $20, yields 8.6%; and a cash-rich China Mobile (CHL), at $47, yields 5%. Deutsche Telekom (DTEGY), at $17, yields 4.3% and owns a valuable controlling stake in T-Mobile US (TMUS) worth about $7 per share.
8. Municipal bonds
Munis were one of best U.S. asset classes in 2018, eking out a 1% total return.
Favorable supply-and-demand dynamics helped munis as new issuance fell about 20%, to an estimated $340 billion in 2018, and new rules curbed the early refunding of existing bonds. Next year’s issuance could rise to about $369 billion, according to Alan Schankel, a municipal-bond strategist with Janney Montgomery Scott. “Supply will be higher, but it should be manageable,” he says.
More important, the amount of municipal debt is holding at about $3.8 trillion, as issuance roughly equals maturing issues and redemptions—in contrast with the steadily growing mountain of corporate and Treasury debt. One wild card for 2019 is whether a federal infrastructure bill is passed, which could lead to a flurry of muni issuance.
The bull case is that muni yields generally look desirable relative to Treasuries, high-grade corporate bonds, and other taxable debt against a favorable supply backdrop.
“When people do their taxes in March and April, they’ll see the value in munis on a tax-equivalent basis,” says John Loffredo, a manager of the MainStay MacKay Tax Free Bond fund (MTBAX).
The problem for munis is that outside of the long-term market, absolute yields are low, at 1.75% for triple-A three-year notes and 2.3% for 10-year bonds. Thirty-year debt that carries yields from 3% to 5%—depending on credit quality—is the most appealing.
The largest muni fund is the Vanguard Intermediate-Term Tax-Exempt (VWITX), yielding 2.8%. The Pimco High-Yield Municipal fund (PYMAX), headed by Dave Hammer, has a 4%-plus yield and has outperformed most peers in recent years.
Many closed-end muni funds trade at wide discounts, averaging about 13% to net asset value, resulting in yields of 5% or more. The largest is the Nuveen AMT-Free Quality Municipal Income (NEA), trading at $12.50. It yields 5.1% at a 14% discount to NAV. The BlackRock Municipal 2030 Target Term Trust (BTT), around $21, has a similar discount and yields 3.6%. Its advantage is a scheduled maturity date in 2030 that offers a mechanism for investors to capture the discount to NAV.
Electric companies delivered in 2018 and protected investors as the Utilities Select Sector SPDR ETF (XLU) returned 3.9%, while the S&P 500 was down 4.4%, including dividends.
Utilities, however, aren’t cheap; they are valued at an average of 17 times projected 2019 earnings, a premium to the S&P 500, at about 14. That may make it hard for utilities to best the index in 2019, barring a market collapse. Earnings growth is running at a mid-single-digits yearly pace.
The Utilities SPDR ETF yields 3.4%. Among the leaders, NextEra Energy (NEE), at $170, yields 2.6%; Duke Energy (DUK) at $85, 4.4%; Xcel (XEL), at $48, 3.2%; and Consolidated Edison (ED), at $75, 3.8%.
California utilities PG&E (PCG) and Edison International (EIX) have become special situations after wildfires in the state caused billions of dollars in damages and sent their stocks tumbling. California utilities are subject to “inverse condemnation” laws that hold them financially liable for fire-related losses if their equipment is deemed to have started fires, even if no negligence is proved.
PG&E, whose stock fell 47%, to $23.75, in 2018, is the most exposed and faces bankruptcy risk. Edison’s liability is seen as more limited. Edison is favored by SSR analyst Hugh Wynne, who argues that the company’s liability for the 2017 and 2018 fires will be manageable. He figures that Edison’s 4.3% dividend is secure and that the stock has upside to above $70. The company’s preferreds, including tickers SCE G and SCE L, also look safe and yield about 6.5%.
10. Investment-grade bonds
Credit concerns weren’t limited to junk bonds in 2018. High-grade debt also suffered, including that market’s lowest rung, triple-B-rated debt—the subject of a Barron’s article in the summer.
The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) returned a negative 3.8% in 2018, against a 1% decline in U.S. Treasuries. With the pullback, high-grade debt is starting to look better. The iShares ETF now yields 3.7%. A similar ETF is the Vanguard Intermediate-Term Corporate Bond ETF (VCIT), yielding 3.6%.
There is also a group of “baby bonds” that trade on the New York Stock Exchange as if they were preferred stock, at $25 each, including two senior debt issues from AT&T. These offer a more secure but lower-yielding alternative to AT&T’s common stock. The AT&T 5.35% issue due in 2066 (TBB) trades around $23, and the AT&T 5.625% issue due in 2067 (TBC) fetches about $24. Both yield about 6%, more than long-term debt aimed at institutional buyers. With their long maturity dates, both are also sensitive to rate changes.
They’re the ultimate haven. Buffett keeps the bulk of Berkshire Hathaway’s cash in Treasury bills—some $75 billion as of Sept. 30.
Treasuries can also offer a hedge against market turmoil, and they did so during the market pullback, as the yield on the 30-year Treasury bond dropped to 2.9% from 3.25%.
Treasuries, however, don’t offer much yield, ranging from about 2.3% on short-term bills to 2.9% on 30-year bonds. Given the narrow rate gap between short- and long-term issues, it may pay to stick with two-year debt yielding about 2.4%.
Investors can buy Treasuries at regular auctions through the TreasuryDirect website or major brokerage firms. There also are a group of low-fee ETFs like the iShares 1-3 Year Treasury Bond (SHY), yielding 1.7%, and the iShares 20+Year Treasury Bond (TLT), yielding 2.8%.
|For more news you can use to help guide your financial life, visit our Insights page.|