Insights & Advice

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The Name of the Game: Dividends & Interest

Last week, I advised investors to “wait for the bounce” before getting more defensive. We’ve had three bounces this week, so by now you are either out of your most aggressive investments or nearly so. Stay defensive.

Never has the Dow Jones Industrial Average experienced the kind of swings we have witnessed this week. With 400-500 point swings a day, up and down, it is clear to me that high frequency trading owns the stock market right now. It is no place for the individual investor.

“Have we put in a low?” asks a client from northern Berkshire County.

It seems so, but only time will tell. I know that is a iffy answer but here’s why. The S&P 500 Index has bounced off 1,100 twice this week, giving technical analysts some hope that we have found a level where buyers are willing to step in. Since then we have climbed almost 100 points or 6 % in just two days. Normally, the next reaction will be a retest of the lows. That will determine whether 1,100 truly is the low. If it breaks—look out below. We could easily drop another 50-100 points.

Now you will probably agree that for most of us, that isn’t a bet we are willing to make, especially if your portfolio is still fairly aggressive. That’s why I am suggesting that you take a more defensive stance. Switch to large cap dividend socks, corporate bonds and, if you have the risk appetite, high yield bonds as well. There are dozens of exchange traded and mutual funds that offer plenty of choices; just watch out for high expense ratios and front load sales charges.

“Why not go to cash?”

That is a question I’ve heard repeatedly this week from clients throughout the Northeast.

In general, I wouldn’t forsake the stock market quite yet. The jury is still out on whether we are heading for a recession. If we continue to wallow along in our slow growth, low interest rate, high unemployment economy, then the stock market is not going to decline much further. On the other hand, it won’t be going up much either.

In that kind of environment, you want to find the highest dividend and interest income bearing investments around. Think of it this way: if the stock market provides sub-par returns for the next year or two (1-2-3%) than capturing interest and income returns of 3-6% will be a great way of beating the market and reducing your risk.

Fortunately, thanks to the market selloff, you can pick up great deals in that area right now. Those large cap companies that have a large part of their business overseas and pay large dividends are ideal candidates. But don’t forget preferred stocks, they are a great way of both participating in any upside in the market while enjoying a healthy stream of income.

The risk of a spike in interest rates has receded. Now that the Federal Reserve Bank has assured investors this week that they will keep interest rates low until the middle of 2013. Investors have been given a window of opportunity to hunt for higher yielding alternatives to U.S. Treasury bonds. So over on the bond side, corporate bonds– both investment grade and high yield– make sense.

The wild card in this strategy is that the Obama Administration or the Fed surprises us with another program to stimulate the economy. After all, there are some uncanny similarities between what is happening right now and what happened during this same time period last year. The stock market has declined by about the same amount. Investors were greatly concerned last August (as they are now) that the economy was slipping back into recession.

In late August of last year Fed Chairman Ben Bernanke announced QE II at the Fed’s annual meeting in Jackson Hole, Wyoming. Bernanke will speak again on August 26 at the same meeting. Some hope he will announce a second market propping program to further stimulate the economy, something we now know the central bank is at least discussing. That belief stems from the following sentence buried in this week’s FOMC statement

“The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.”

That statement, although short, was significant, but was largely overlooked as the news of the Fed’s decision to extend their low interest rates policy to 2013 took precedence among the nation’s media. Now, just because the open market committee is discussing these things doesn’t mean they are ready to act. Nonetheless, it is a possibility. Be forewarned that the volatility in the markets will continue as more participants move to the sidelines, leaving only high frequency traders and their computers to battle it out minute by minute.

Posted in A Few Dollars More, At the Market