These High-Yield Sectors Should Flourish in 2014
BDCs, MLPs are among some targets to fixate on if you're trying to generate significant income
It’s hard to find anybody who’s really negative on the economy for 2014.
Estimates are out there for 2014 earnings of $120 per share for the S&P 500. If that’s the case and it comes anywhere close to hitting that target, then we’re talking 1900-1925 on the S&P, which from current levels is about a 4% to 5% advance on the year. With that, you have a lot of companies that are doing more with less and generating better profitability.
The ability for a company to generate very good earnings per share on nominal top-line sales growth is widespread throughout a number of U.S. industries. After all, technology continues to advance the productivity level of every employee by a multiple factor — and the cost to refinance current debt has never been better. If you’re an investment-grade company, you can borrow money for less than 2.5%, 3% tops, then go out and execute a major stock repurchase, a la IBM (IBM). That’s how the company rescued its share price in this current market.
But it’s not just U.S. blue chips that I expect to heat up this year. I think the global recovery glass is half-full, and I’ve outlined my argument for strength around the globe before. If the global economy picks up the pace, then you have another argument for a higher market in that 1900 range on the S&P 500.
Against the backdrop of improving domestic and global economies, these are the specific sectors of high yield I’m most excited about for 2014:
Demand for business development companies (BDCs)
Although these tax-friendly specialty financials are just now becoming more widely known, the federal law that created BDCs was actually a product of the dismal economic climate of 1980. With all the inflation, oil shocks and general malaise that was going on at the time, private equity and venture capital firms simply couldn’t provide financing to small, growing businesses. Because of tight regulations, that left small business with really only one option: getting funding from banks.
Just like today, though, traditional banks were playing defense and were extremely hesitant to make these kinds of loans. In response, Congress passed the Small Business Investment Incentive Act of 1980 that essentially created business development companies — a new kind of publicly-traded corporation that could sell stock on the major exchanges. The law still is in effect today, and allows for the following rules for these new BDCs:
By virtue of their status as specialized investment vehicles, and because the companies they’re invested in aren’t public, “insider” rules are irrelevant.
It gives business development companies the freedom to offer their full expertise on operations, financing, expansion, or any number of areas that a small but growing business might not have experience in on their own.
The other feature of BDCs that makes them so appealing in terms of my strategy for high yield — and that’s causing the sector to go gangbusters in the larger market — is that they can charge huge interest (10% and more) on their small-business loans. After all, the banks just aren’t lending; both megabanks and regional banks have sorely lagged as the Fed has made riskless re-inflation of balance sheets the main focus.
As traditional lending has taken a backseat, it’s prime time for BDCs. When the banks are loath to take risk-on trades — as they have been recently — then this is where small- to medium-sized businesses turn for loans.
As interest rates start to tick up, those lenders who are underwriting floating-rate loans are in the sweet spot; unlike their fixed-rate peers, they will be able to adjust their rates higher along with the uptick in bond yields.
So, I’m focused on those BDCs, asset managers and mortgage REITs that issue floating-rate debt — particularly if they’re also senior secured loans and notes, which are highly favored because they are “senior” to all other claims and first to be repaid should the borrower declare bankruptcy.
Equity income funds
Even after 2013’s big run-up, the market is poised for another 4% to 5% of upside in coming months, as I mentioned before, and there’s plenty of volatility on a day-to-day basis. This is just the type of environment that’s perfect for selling options premium against a rising market — and for owning convertible bonds redeemable for the very blue-chip names that are driving this rally, like Amazon (AMZN), Google (GOOG) and Costco (COST).
I recommend that those of you seeking high yield maintain a solid weighting in those funds whose managers are doing the work for you in generating considerable income from options and convertible-bond strategies.
Liquefied natural gas (LNG) and onshore oil and natural gas exploration
Names like Cheniere Energy Partners (CQP) who are out in front of this up and coming megatrend have proven to be real winners. As the demand for LNG and the push for onshore exploration keeps heating up, I’m on the lookout for more names in this space that will really take off in the coming months.
“Fight the tax man” with tax-advantaged investments
As the politicians continue to battle the federal deficit, taxes probably will trend higher in the long term, which makes master limited partnerships (MLPs) a great investment choice.
When you buy stock in an MLP, you’re part of the business as a limited partner rather than as a shareholder. So you share not only in the income, but also in all the developmental costs — all of which are write-offs that go against the income. Therein lies the answer to why these are so popular, especially among wealthy people: MLPs basically bring in tax-free income.
High-yield assets — like the ones I recommend to my subscribers — have been absolutely thriving in this environment, and 2014 promises more of the same.
The aforementioned securities may be held in the portfolio of Bryan Perry’s Cash Machine.