For the retirees and other income investors, 2013 is shaping up as a pleasant year indeed. Utilities, master limited partnerships, REITs and other dividend-rich stocks are hopping.
There’s just one itty-bitty problem with all this prosperity, though. When a stock climbs dramatically in a short period, a new buyer can expect much lower returns.
So, we investors need to be patient and creative while waiting for our favorite income stocks to drop back into an attractive buying range.
For now, if you’ve got fresh cash to put to work, I advise you to channel it into what I call “stock substitutes”– assets that generate good income, with the prospect of some capital appreciation too.
If we play our cards right, these substitutes will roll up a total return that matches, or perhaps even beats, the popular stock indices over the next few years.
We often hear that interest rates are scraping rock bottom. However, that’s not true of all bonds and money market instruments. In recent weeks, yields have ticked up on closed-end municipal bond funds.
One winner in the space is BlackRock MuniEnhanced Fund (NYSE:MEN), which I recommended to my Profitable Investing subscribers during the panic triggered in late 2010 by Meredith Whitney’s sensational — and, thus far, inaccurate — predictions of widespread bankruptcies among America’s local governments.
Since our initial purchase in December 2010, MEN has notched a total return of 49%. Not too shabby for a fund that invests almost exclusively in high-grade tax-exempt bonds!
Over the same period, an S&P 500 index fund, dividends reinvested, has returned approximately 19 percentage points less. See why I’m keen on “stock substitutes?”
Even more astonishing, MEN has maintained this wide lead over the stock fund despite a recent pullback in MEN’s share price. At last glance, MEN was trading about 7% below its 2012 peak, registered in late November.
In other words, unlike the overheated stock market, municipal funds such as MEN are close to, or already in, a decent buy zone. If we combine MEN’s 5.5% tax-free yield with perhaps a 5% to 6% increase in the share price back to the old high, we arrive at a total return that should equal or surpass that of the stock market for the next year (maybe longer).
Certain foreign currencies also catch my eye as stock substitutes. It’s true, of course, that most central banks in the industrialized world are pursuing the same zero-rate policy as the Fed. Their currencies are literally “of no interest.”
However, a few emerging nations, in an effort to attract foreign capital, are paying solid yields on short-term money market instruments. Short-term paper won’t reward you if interest rates fall, but it also won’t lose value if rates go up.
Instead, the main opportunity — and risk — in foreign T-bills and bank deposits is the currency itself. You want to own currencies that are commercially undervalued against the dollar. These units have the best odds of appreciating against the greenback. Under the right circumstances, currency gains piled on top of your interest income can provide a stock-like total return for several years at a time.
At the moment, my favorite currency, hands down, is the Indian rupee. Granted, India — like every country — has its share of problems, such as a nagging trade deficit, stubbornly high inflation, widespread poverty and a government that takes a stop-and-go approach to economic reform.
Ah, but there are compensations! Indian money market rates are the highest of any major country — 8% versus nothing for the United States, Europe or Japan. What’s more, the rupee is deeply undervalued. According to figures compiled by the International Monetary Fund, a basket of goods and services costs about 40% less in India than in the United States.
I don’t expect that gap to close overnight. Over time, though, the undervalued currency will stimulate exports, putting upward pressure on the exchange rate. Meanwhile, India’s high interest rates will give the currency another lift by drawing foreign investors.
Easily the most convenient way to access the rupee is through the WisdomTree Indian Rupee Fund (NYSE:ICN). This ETF owns a mix of Indian government paper and other short-term rupee-denominated instruments. Net of expenses, ICN is churning out a current yield of 7.7%.
Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk “value” approach has won seven “Best Financial Advisory” awards from the Newsletter and Electronic Publishers Foundation.