by Neil George | November 1, 2010 11:51 am
How do you like to invest? Do you prefer to hear and buy into a great story and then follow with the stocks that will supposedly profit if this, that or the other thing comes true?
Or are you just jaded enough to know that holding and hoping that something happens is a sure thing for nothing but disaster?
The election season, even if it now seems to be never-ending, is prime time for either the stock pitchmen or the market curmudgeons to soapbox on what to do next to either cash in or to sidestep another slide.
Despite all of the millions of dollars of campaigning, complete with all of those incessant advertisements as well as the massive protest marches — when the final tallies are taken — how much will really change?
We’ll still have a U.S. economy with slow, but a bit steadier growth. We’ll still have plenty of government deficits and debt. And we’ll still have plenty of uncertainty as to what Washington will do next.
Those pitching a massive change will more likely be disappointed — but so will those who warn that it’s all just for naught.
The key to investing to make money is not to get sucked into either the story stocks or the malaise of market malcontents, and instead to focus on the more likely of outcomes.
Then look at the more likely of investments that will make the most of the probable and not just the possible.
By just about anyone’s account, expect some changes that hit Capitol Hill as well as statehouses around the nation. That change will come in the form of a reversal of fortune for the incumbent party’s overwhelming control over government.
But that change won’t be overwhelming, and thus neither will the results for investors wishing to place bets on story stocks.
It will most likely end up merely locking down further political action through the next two years until yet another general election.
While historical look-backs are rife with correlation issues, if we do take a look at the midterm elections of 1994 and 2006 when incumbent parties gave up some power in Congress, there is some comfort for those seeking market improvements in 2010-2011.
In November 1994, after an anemic performance of the S&P 500 including a price loss and a meager 2+% total return over the prior 12 months — post the change from Democratic control to Republican in Congress and Democratic control of the White House, the S&P 500 surged some 28%
And for the same period of time, US intermediate Treasurys went from a loss of nearly 7% to gains of more than 20%.
In November of 2006, with the shift from incumbent party control to the opposition, the S&P 500 continued to perform from the prior 12 months with post electoral gains of over 12%. Treasurys fared similarly, going from a positive performance of nearly 5% to nearly 7% in 12 months post the election.
So as the polls suggest, the 12 months after the election might well continue to support generally higher stock and bond markets. And the reasons might upset folks on both sides of the political aisle as it might well be explained not by better policy, but rather just a lockup of government that lends a hand to the markets.
But, should you just hold and hope that history repeats itself? Or — given plenty of other issues remaining in the economy and market — wouldn’t it be a much safer bet to focus on the ongoing developments regardless of the post-electoral marketscape?
Let’s look at a series of continuing developments that shouldn’t be changing regardless of the electoral results.
First, taxes are a certainty of course and more of them continue to be part of the investment gauntlet. While many might be hoping for Federal tax rates for income, qualified dividends and capital gains to remain the same, don’t completely rely on it.
There should be at least some compromise on some of the tax rates given both political parties’ rhetoric over fiscal needs and wants. And even if we do get lucky and sidestep any Federal tax hikes, there’s still plenty of damage coming from the state and local level.
Tax receipts for state and local authorities are strongly on the rise. In fact just in 2010 – 29 states have hiked tax rates amounting to more than $24 billion. And with an estimated budget gap of states nationwide estimated to be running at over $136 billion, increased taxes and fees are almost a bankable certainty.
Add the public pension deficits on the state and local level ( which, according to two recent studies by professors at the University of Rochester and Northwestern University, are running at more than $5.3 trillion) and along with the reality of death, higher taxes are looking like a done deal.
There are some prudent and profitable trades for your portfolio that will not only continue to perform with an expected post-electoral stock and bond boost, but will also counter higher taxes.
Start with muni bonds. Yes, muni bonds — but not just buying them willy-nilly. Rather, focus on three closed-end investment funds that continue to sidestep so-called insured munis for known quality issues.
Buy the AllianceBernstein National Municipal Income (NYSE: AFB[1]), Blackrock Municipal Income Trust II (AMEX: BLE[2]) and the Nuveen Quality Income Municipal (NYSE: NQU[3]) funds. Each is trading around book value or at small discount or premium for their assets and management.
The average tax-free yield is running near 6.5 %, which, grossed up for most investors, equates to a taxable equivalent of nearly 10%. And over the past five years of turmoil – they have managed to deliver an average return of 35%.
Any rising taxes will only strengthen issuers while also goosing demand for quality tax-free bonds.
Then move on to tax-advantaged stocks. Passthrough securities come in various flavors and acronyms including Master Limited Partnerships (MLPs), Limited Partnerships (LPs), General Partnerships (GPs), Limited Liability Companies (LLCs) and other structures.
What they all have in common is that they avoid double taxation of dividends. All profits are paid out and thus passed through to shareholders which then are liable for taxes.
In addition to the profits passed through are many of the writedowns, including depreciation costs, which are referred to as return of capital. This means that for just about all passthroughs, the dividends are sheltered either fully or in part when it comes to the investor’s tax liabilities.
The market for these stocks has continue to pound the general S&P for over the past 5 years. The Alerian MLP Index is up nearly 100%, while the S&P has lost another 1+% in price.
There are a growing collection of ETFs and funds beginning to take notice of various sectors within this group. But they tend to underperform the group, even those supposedly tracking the index.
How about three that not only perform but outgun the index and pay well enough to deliver returns with or without higher taxes?
On the petrol side, consider this producer and a distributor. Linn Energy (NASDAQ:LINE[4]) is a quality liability-adverse passthrough paying over 7.5%. It focuses on established fields in the south-central U.S. as well as in Southern California. Its return since coming to the market in 2006 is more than 130%.
Then on the less price-sensitive distribution market is Enterprise Products (NYSE: EPD[5]). This is a pipe and processing partnership paying a bit less with a dividend yield in the mid-5% range — but performs with a five-year return again in the 130% range.
One newer passthrough to buy is a dry-bulk shipping company focusing on high-contract demand routes in the Pacific. Navios Maritime (NYSE: NMM[6]) pays near 9% and since coming to the market in late 2007 it’s delivered a return in excess of 40% .
Second on the continuing post-election developments concerns pensions. As noted above, public sector pensions on the state and local level are huge now and hugely underfunded. Add in the federal retirement system including the Federal Thrift Savings program and the market for managing retirement pension assets is gargantuan and only getting bigger.
The way to cash in on this is not just to whine about it, but go for the companies running the pension assets.
The key with this market segment is that they don’t have to perform, only continue to hold and gather assets. The more the assets – the more the fee income.
One of the biggest public pension managers is Blackrock (NYSE: BLK[7]) which runs the core of the Federal Thrift program’s funds. Assets under management have continued to soar more than 800% and it should only keep growing as pension funds begin to address lagging contributions.
Then there’s another successful manager, Pimco, which is owned by the German financial giant Allianz. While the company also has a host of insurance business lines, Pimco continues to pull in ever-higher amounts of pension assets. This is primarily due to the tidal shift in public and private pension funds away from stocks and back to bonds as the core of their assets.
Pimco, being one of the largest bond managers, should continue to pump up Allianz in the coming year. And a general positive post-electoral market won’t hurt either. Buy Both Blackrock and Allianz.
A third and last post-electoral development worth buying into is off-shore drilling.
Unless you’re in Florida, most of the rest of the nation regardless of political party is demanding more petrol production and that means resuming offshore drilling. But what will be happening post-election is a new series of Federal regulations focused on at least appearing to try to avoid another disaster.
One of the best drill rig contractors that’s used to working in hostile waters, both political and natural, is SeaDrill (NYSE: SDRL[8]). With management focused on liability management, it has an admirable track record of drilling and budget safety. And not only does it satisfy the politicos, it also more than satisfies shareholders. Its dividends are solid and heavy, climbing strongly to a current rate of over 8% .
And the market is beginning to notice, as shares are performing much like its rigs, with gains over the past year of over 50% . Buy the best for yield and gains.
Neil George is editor of The Pay Me Strategy[9].
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