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Holdups on Wall Street and fixed income on Main Street

Don’t let the confidence tricks on Wall Street steer you off course, says this U.S. advisory, and don’t count on a portfolio of stocks alone.

Wall Street has been the scene of daylight robbery this year. Some critics might say that’s exactly what the bigwigs on the Street have been doing to Shareholder Nation for decades. But we’re not here to argue that point.

The thievery in question is technically legal, but scarcely ethical according to Richard C. Young’s Intelligence Report. Referring to the now-notorious bailout of failing investment bank Bear Stearns, Mr. Young says flatly: “The initial $2-per-share offer was theft. And to top it off, the Fed opened up a $200 billion line of credit to the investment banks just after forcing Bear into the hands of JP Morgan.”

But this is not simply a regurgitation of the Bear Stearns saga. It is the first car in a train of thought that leads Mr. Young to preferred shares, the problem of receding retirement portfolios, the un-cheapness of stocks and the importance of fixed income investments in today’s conditions.

It will also lead us to visit the editor’s choice of the top stocks for American investors in today’s changing conditions.

The senior shareholders

Not all shareholders are created equal — and not all shareholders are treated equally well. Even though JP Morgan Chase raised its initial $2-per-share buyout to $10-per-share, Bear Stearns shareholders, many of them Bear Stearns employees “were absolutely clobbered,” says Mr. Young.

The stock had been at $160 a year before and $30 before the takeover was announced. It’s now lingering at just over $10.

But the preferred shareholders did all right. After the initial shock, the preferred shares quickly recovered and shot back up above $20 a share. Preferred shares pull rank on common stock, of course. Preferred prices can jump around when the common stock is under pressure, says the editor, “but when all is said and done, preferred shareholders are usually made whole.”

This leads Mr. Young to advise his readers to upgrade the quality of their preferred portfolios. He is speaking of the U.S. preferred market, but his advice applies just as well to buyers of Bay Street preferreds.

Some preferreds are better than others, he says. “You want to own preferreds from businesses that are not easily replicated. These are the firms that are most likely to find a buyer in the event of a fire sale,” he explains with an eye on the shaky financial markets. If the equity has value, the preferred holders will make out just fine, as they have at Bear Stearns. Merrill Lynch, for instance, has spent years becoming the largest retail broker in the country. That’s not easily replicated.

And diversify your preferreds, he adds firmly. In fact, diversify your entire portfolio. Don’t let the markets put you off course.

Not at the mercy of the markets

“I’m reading accounts in the financial press about investors who are postponing retirement due to weak equity and real estate markets,” says Mr. Young. “You never want to be in the position where your life plans are at the mercy of financial markets.”

People who make such decisions simply are not diversifying enough, he insists. “As you approach retirement, diversification is your most important ally.” A balanced portfolio of domestic and international stocks and bonds will prevent the unhappy declines that decimate your portfolio.

The highlight of this diversified portfolio is investment-grade fixed income, explains the editor. When he charts stocks and bonds, he finds them going in opposite directions. “When stocks decline,” he says, “you can most often count on rising bond prices.”

Add to that the fact that stocks are not as cheap as they once were. Twenty years ago, stocks traded at 10 times earnings and had dividend yields of 5 per cent. “Today they’re expensive and pay measly dividends.”

Buy bonds!

Mr. Young’s charts show that even the recent correction in equity markets hasn’t made stocks cheap. When stock valuations are low, he adds, subsequent returns are high, but when valuations are high, returns are low.

The stock valuations on his charts point to a 4.5 per cent compound annual return over the next 10 years. Add in today’s dividend yield of 2.2 per cent and a total return of more than 7 per cent should not be expected.

“The additional return that you are likely to earn in equities over bonds today simply does not justify a 100%-stock portfolio,” concludes Mr. Young. Like the World War II posters, he says: Buy bonds!

The editor recommends corporate bonds over government Treasuries for his U.S. readers. The sources we consult here have the same advice on Canadian bonds — the spreads currently favour corporate issues (especially five to seven year terms) over government bonds.

Mr. Young’s prescription for a balanced portfolio also means stocks should be chosen carefully for their size, strength and dividend yields.

Big consumer names

Here are top five stocks for American investors today, in the opinion of Mr. Young. No less than four of them are big consumer names.

1) Unilever (NYSE-UL). While its most venerable product, Pears Soap, is over 200 years old, this British firm now makes more packaged consumer goods than anyone else in the world.

2) Newmont Mining (NYSE-NEM;TSX-NMC) provides a solid position in gold to help keep a diversified portfolio afloat. A recent correction offers a buying opportunity.

3) Tiffany & Co. (NYSE-TIF). New wealth in Brazil, China and Russia is pouring into high-end retailers. Tiffany’s international sales are booming.

4) Sysco (NYSE-SYY) may not be a household name, but this food services firm is eating up its competitors with a streamlined distribution network.

5) Diageo (NYSE-DEO). This British firm owns “a stunning portfolio of the world’s most widely recognized spirits,” including the two best-selling Scotches in the world. Sales are soaring in China and Russia.

Whatever holdups they may be pulling on Wall Street, don’t let them hold up your portfolio. And above all, says this advisory, don’t pick your own pocket by putting all your eggs in one basket.