PREFERRED
STOCK NEWS
Preferred
Stock Buyers – History Suggests that June
Could Bring Higher Returns for Lower Prices
In
anticipation of an increase in interest
rates, market prices of high quality
preferred stocks have been dropping very
gradually since the end of January. While
still above the $25 par value of these
securities, the average market price of high
quality preferred stocks has fallen by $0.40
over the last four months.
I define “high
quality” here as those issues that are able to
meet criteria that are commonly viewed as
lowering the risk of these securities such as
those that offer investment grade ratings and
pay cumulative quarterly dividends.
Buyer’s market
approaches
As interest rates
fluctuate, your preferred stock portfolio will
swing from favoring dividend income (during
higher rate/lower price periods) back to
favoring capital gain income (once rates fall
again, pushing up the price of your shares).
It is for this reason that most preferred stock
investors are long-term investors, taking
advantage of the known inverse relationship
between rates and prices over time.
Those trying to apply the shorter-term investing
strategies of a value investor (buy low, sell
high) to an income investment (preferred stocks)
frequently exclude themselves from the
opportunity to take advantage of longer term
rate and price changes.
For most long-term
income investors, a period of falling prices is
therefore a time to buy new shares, rather than
sell existing holdings. So, for savvy preferred
stock buyers, knowing when the Fed is going to
start increasing interest rates becomes
important since higher rates will bring higher
returns at lower market prices—a classic
“buyer’s market.”
Learn from history
In recent history,
the Fed has announced a policy to increase
interest rates on two occasions— June 2004 and
December 2013—with the announcement coming a
month in advance of the actual Fed action. In
both cases, for as much as twelve months prior
to any actual policy implementation, pundits and
economists were telling us that a rate increase
was imminent.
Sound familiar?
The following two
charts illustrate the movement of the average
market price of high quality preferred stocks
before and after the 2004 and 2013
announcements. The 2004 event was a direct 0.25
percent increase in the federal funds rate while
the 2013 event was the announcement of a tapered
withdrawal from the Fed’s Quantitative Easing
program (widely accepted at the time to produce
a rate increase).
Looking at the
2004 chart, notice how fearful sellers reached
their tipping point and started selling their
shares in March, three months prior to the
actual June 2004 announcement.
But those
sellers, probably fearing a more massive
rate increase, overreacted. Elated buyers
stepped in and prices actually increased
once the announcement was made in June. For
several months thereafter, preferred stock
prices and the federal funds rate were both
increasing at the same time due to the
initial over-reaction by sellers.
Now look at the 2013 chart.
Once we
remember how 2013 unfolded with respect to
the Fed and monetary policy, it is stunning
how similar the behavior of preferred stock
prices was to 2004.
Throughout late-2012 and into early-2013,
the pundits were at it again with forecasts
of a nasty rate increase due any minute.
High quality preferred stock prices remained
in the high-$26 range (just like 2004) but
the resolve of fearful sellers began to
weaken in May. Their expectations were
confirmed when several FOMC members made
public comments strongly implying that the
Fed was likely to announce a tapered
withdrawal from their QE program at their
upcoming September 17-18 meeting,
solidifying a four month price drop.
As it turned out, the expected September
announcement was delayed until December. The
downward price trend that we had seen since
May resumed right where it left off in
September as fearful sellers, once again,
overreacted. Elated buyers jumped back in
and prices increased once the announcement
was made in December (and never stopped, as
it became apparent that the QE taper was not
going to produce the expected increase in
rates after all).
In both 2004
and again in 2013, fearful sellers started
(over-) selling their shares three to four
months prior to an announcement of
increasing rates by the Fed.
(Sources: FOMC
meeting minutes:
FederalReserve.gov; preferred stock
data: CDx3 Notification Service database,
PreferredStockInvesting.com).
What’s next?
On Wednesday, May 2o, 2015 the
meeting minutes from the April 28-29
FOMC meeting were released and included two
changes that are of particular interest to
preferred stock investors. First, the phrase
“...we can continue to be patient,” was
removed from the five places it appeared in
the prior meeting’s minutes. Secondly, the
May 20 minutes stated that the startling
weakness of the U.S. economy during the
first quarter of this year was “transitory,”
the implication being that those who had
concluded that the weakness may imply a
delay in raising the federal funds rate
should stop feeling that way.
But even more clarity was provided by Fed
Chair Janet Yellen two days later. During a
speech on Friday, May 22 Yellen specifically
stated “If the economy continues to
improve as I expect, I think it will be
appropriate at some point this year to take
the initial step to raise the federal funds
rate.”
While no one,
including Yellen, knows with certainty what
unemployment and inflation will look like in
the future, these statements by the Fed are
as specific as they ever get, short of an
actual policy announcement. Most analysts
are now forecasting an increase in the
federal funds rate after the FOMC’s
September 16-17 or December 15-16 meeting.
Preferred stock sellers started selling
their shares three to four months prior to
an actual Fed announcement for the last two
such occurrences. If the Fed is going to
announce a rate increase this coming
September, we could see the market prices of
high quality preferred stocks start to drop
as June payers clear their June ex-dividend
dates. We’ll see just how touchy sellers are
as June unfolds but it’s time for preferred
stock buyers to start paying attention.
|
to the