Things are finally turning around for income investors. Years of ultra-low interest rates forced income investors to crowd into just a few risky, relatively high-yielding investments. But in 2016, a trifecta of economic occurrences began to improve the income investing landscape for everyone.
The first reason is that the FOMC has started to raise interest rates. The December 2015 decision was the first time in a decade that this rate had been changed.
The committee made a unanimous vote to increase the Fed’s main interest rate by a quarter-point, to the 0.25% to 0.50% range from the previous 0.00% to 0.25%. This rate has since been increased again, this past December, to the range of 0.50% to 0.75%.
The increase signals the FOMC’s confidence in the strengthening U.S. economy and what officials see as nascent signs of climbing inflation.
Second, the election of Donald Trump resulted in a sharp increase in bond yields. This selloff augmented a trend that started before the presidential election. Yields on the benchmark U.S. bond, the 10-year Treasury note, have surged to 2.31% from a 52-week low of 1.32%.
The new administration is expected to put policies in place that will increase inflation, which in turn pushes bond yields higher. Inflation is the adversary of long-term bonds because it lowers the value of interest payments.
“Today’s yield level is 50 basis points versus pre-election levels, matching the behavior seen during the 2015 down trade,” wrote HSBC analysts led by chief U.S. economist Kevin Logan in a November 10 note. “The risk of higher yields should be limited from this point, given the FOMC’s rate guidance, in our view.”
Finally, the 2016 global sell-off of rate-sensitive equities has forced higher yields and more-reasonable prices in many sectors.
Electric utilities, real estate investment trusts (REITs), and master limited partnerships (MLPs) have all suffered recently, creating a better environment for investors seeking income-producing assets.
Within this environment, I’ve identified asset categories that will outperform the greater market.
European Dividend Stocks
In 2016, European stocks fell behind their American counterparts, with a negative 1% return on the benchmark STOXX 600 index. The performance was significantly less than the S&P500’s 9.5% return and U.S. small- and mid-cap indexes’ returns near 20%. Even the majority of U.S. traded euro ADRs ended the year in negative territory.
This is all good news for 2017. European equities have become fairly valued compared to the red-hot U.S. stock market. In addition, dividend yields have become significant in comparison to euro government bond yields.
I like Sanofi SA (ADR) (SNY) with a yield of 4.1% and the ETF First Trust STOXX European Select Dividend Income (FDD), which represents 30 high-paying European dividend stocks and is currently yielding 4.9%. I also suggest looking at Vanguard FTSE Europe ETF (VGK), which is currently yielding 3.5% annually.
In your quest for 2017 income, don’t forget the old standbys: income-producing electric utilities. Electric companies were hit with an 8% pullback in the Utilities Select Sector SPDR (XLU) since the July high, setting up an ideal buy opportunity in the sector.
Electric utilities throw off an average yield of 3.6%. That is substantial when you consider that is almost double the yield of the S&P 500. Utilities are also regulated, stable, and a well known safe investment.
Readers are urged to take a close look at Reaves Utility Income Fund (UTG), currently yielding 6.2%, and Sempra Energy (SRE), with a yield just under 3.0% but an aggressive growth target of 12% annual gains for the next three years.
Master Limited Partnerships
MLPs soared at the end of 2016 to recover from a sharp sell-off at the start of the year. Known best as an energy infrastructure company design, MLPs finished higher by an average of 15% in 2016.
The yields remain substantial, with the Alerian MLP ETF (AMLP) producing over 7%, easily beating payouts of electric utilities and REITs. However, caution is advised since distribution growth is slowing, leverage continues at a high level, and valuations are relatively expensive. Although I firmly think we will see continued out-performance in this sector, caution is advised.
Risks To Consider: Risk is part and parcel of the financial markets. Always use stop losses to protect your positions, even in your long-term, income-producing portfolio.
Action To Take: Keep a close eye on the sectors and names above for your income portfolio. The next few years may prove to be the glory days of income investing.
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