PREFERRED
STOCK NEWS
2016
Delivers Higher Returns for Lower Prices -
Finally!
With upward pressure on
rates, new preferred stock issues are
introduced that provide higher income to
preferred stock buyers. And the prices of
older, lower payers tend to drop accordingly
making them more attractive to buyers as
well. By this mechanism, income investors
are provided with increasing returns at
lower prices during a period of rising
interest rates (now).
With historically low interest rates for the
last several years, the market prices of income
securities (preferred stocks, bonds) have been
very high for quite some time.
But in anticipation of a Q4 rate
increase, preferred stock prices finally started
returning toward normal last August. 106
investment grade, call-protected preferreds are
now trading below their $25 par value with an
average price of $23.35 per share.
This Preferred Stock Market Snapshot™ chart
depicts the preferred stock marketplace at the
end of 2016 using two characteristics that are
usually high on the list of considerations for
risk-averse preferred stock investors - current
market price (above and below these securities'
$25 par value) and investment risk (as reflected
by investment grade versus speculative grade
Moody's ratings).
Each diamond represents a
preferred stock. While there are currently 879
preferred stocks trading on U.S. stock
exchanges, 229 meet the criteria listed under
the chart.
The sweet spot of the preferred stock
marketplace is depicted in the green lower-left
quadrant - investment grade preferreds selling
for a market price below their $25 par value.
As prices have come back down since August,
today’s preferred stock marketplace is providing
risk-averse preferred stock investors with the
best buying opportunity that we have seen since
last February.
Source: Preferred stock data,
PreferredStockInvesting.com
Preferred stock prices
When the Fed raised the federal
funds rate a year ago, we saw a very similar
drop in preferred stock prices as income
investors anticipated the introduction of new,
higher paying issues. But by February 2016, it
became apparent that the Fed was unlikely to
continue raising rates as earlier thought;
preferred stock prices went back up accordingly
by spring.
The following chart illustrates
how preferred stock prices dropped as market
participants began to anticipate a Q4 rate
increase, both during 2015 and 2016. In both
cases illustrated here, the price drop was
nearly the same, $1.88 per share for the 2015
case and $1.82 per share (so far) for the
December 2016 rate hike.
The current average market price
of U.S.-traded preferred stocks is $24.58 per
share (see selection criteria under chart).
Is the price drop enjoyed by
today’s preferred stock buyers sustainable?
There are at least two reasons to be
skeptical.
First, several foreign central banks are
continuing with their zero-to-negative rate
policy, pushing foreign investors into U.S.
income securities, putting upward pressure
on prices here; nothing has changed in this
respect.
Second, remember that the federal funds rate
is the interest rate that member banks are
charged for overnight loans when they need
some cash to boost their regulatory
reserves. With relatively tight federal loan
restrictions still in place, U.S. banks are
currently holding over $2 trillion in excess
reserves above and beyond the inflated 2010
Dodd-Frank requirements. Changing the
federal funds rate does not have nearly the
impact that it would otherwise.
Persistent high demand from foreign
investors and the huge amounts of excess
cash in our banking system make it more
difficult to sustain the return to more
normal prices. But for at least the next
several months, the December increase in the
federal funds rate is putting upward
pressure on rates and, commensurately,
downward pressure on prices.
Sources: foreign demand,
Here’s why 10-year
Treasury may still drop below 1%; excess
reserves,
Fed Worries About Deflation But
Pays Banks Billions Not To Lend QE Proceeds.
Preferred stock yield
Many things affect the market
prices of these securities such as the
proximity to their call or maturity date,
proximity to their next ex-dividend date,
industry and/or overall health of the issuer
(think Greek shippers), perceived direction
of interest rates, pending government
regulatory or policy changes, cumulative
versus non-cumulative dividends and tax
treatment of dividend payments.
So what we really need to
look at is current yield, which calculates
the average annual dividend yield per dollar
invested (without considering re-invested
dividend return or any future capital gain
or loss). Current yield is a
“bang-for-your-buck” measure of value that
normalizes differences in coupon rate and
price to give us a single, comparable
metric.
The average current yield
provided by U.S. preferred stocks reached
6.8 percent as 2016 came to a close. You can
see how preferred stock investors have
benefited from dropping prices since August,
as yields have steadily climbed since then.
Source: Preferred stock data,
PreferredStockInvesting.com
The long-awaited drop in preferred stock prices
has finally arrived, providing today’s preferred
stock buyers with more high quality choices
offering higher returns at lower prices.
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