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Looking for a Winner Without the Taper? Try Preferred Stock

Preferred stocks offer some advantages over bonds


Whew!  It has been a crazy, heartburn-inducing week for Fed watchers.  First, Larry Summers, Obama’s reputed first choice to be the next chairman of the Federal Reserve, dropped out of the running.  Then Wednesday’s bombshell:  No “tapering” of the central bank’s $85 billion a month of bond purchases, even though more than 70% of economists were expecting the Fed to cut back on the program (at least modestly) this month.

Now that we’ve had a few days for the dust to settle, what conclusions can we draw from the Fed’s action (inaction)?  Perhaps the most interesting item is not the “taper” decision itself, but the rationale behind it.

For the third time this year, the Fed downgraded its 2013 outlook for U.S. economic growth.  Bernanke & Co. are expecting real GDP to increase just 2% to 2.3% for the year, down from a June estimate of 2.3% to 2.6%.

Ponder that.  In the first half, the nation’s “real” (inflation-adjusted) output of goods and services grew at a 1.8% annualized rate.  So the Fed is now forecasting only a minimal pickup in the second half, contrary to ever hopeful Wall Street’s view that the economy is rapidly accelerating.

Of course, the Fed may be wrong.  But at least their staffers can lay some claim to objectivity; unlike the brokerage firms, they have no stocks to palm off on the public.

If the Fed is, in fact, correct, we can look forward to a substantial drop in bond yields over the remaining months of the year.  In the October issue of Profitable Investing, due to be published next week, I’ll give you several trading ideas to profit from a bond rally.  But let me share just one with you now.

Preferred stocks behave very much like bonds in that prices rise when yields are falling (and vice versa).  However, they also offer some advantages over bonds.

For one thing, most preferreds yield quite a bit more than even the longest-dated Treasury bonds.  Furthermore, many (not all) preferreds throw off dividends that qualify for that wonderful federal tax break—the 20% maximum rate, plus the 3.8% Obamacare surtax in certain cases.

Among preferreds with the qualified dividend, I like one issued by Jamie Dimon’s way-too-big-to-fail bank, J.P. Morgan Chase (JPM).  The preferred stock carries the NYSE ticker symbol JPM-D.  (Another popular quote symbol for the same issue is JPMPRD.)

JPM-D pays a stated rate of 5.5%.  Quarterly dividends.  However, because the stock is trading at a substantial discount to its $25 par (face) value, your current yield, as of Thursday’s close, stands at 6.4%.  For a taxpayer in the top bracket, that’s the equivalent of a corporate bond yielding 8.7%.

Be aware, this stock, like most preferreds and unlike a bond, has no maturity date.  The resale value of JPM-D will fluctuate with open-market interest rates.  For the next six to 12 months, though, I suspect that most of the price fluctuation will be on the upside.

Buy JPM-D at $22 or less.  Always, always use a limit order when buying or selling preferreds, because their trading volume tends to be much lighter than with common stocks issued by the same company.

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.

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