Defensive stocks for a phony recovery
The economy recovery is a mirage, says this U.S. advisory, and interest rates will go through the roof, so look for safe, dividend-paying stocks.
Here are three numbers to ponder.
20%, $200 and $2,000.
Those are the figures that could be reached for, respectively, interest rates, oil and gold.
This is not a prediction, we read in Richard C. Young’s Intelligence Report, but “simply a real possibility that must be hedged against.”
There is a recovery in place, says Mr. Young, but it’s a phony. Just wait until adjustable rate mortgages kick in. Real estate, the swamp that sunk the economy in the first place, is still a mess, in his opinion.
The U.S. government and the Federal Reserve Board, not this editor’s favourite teams, will ultimately have to defend the flailing U.S. dollar with higher interest rates.
Mr. Young points to another alarming figure. The yield on the Dow Jones Industrial Average is less than three per cent. Sound, sustainable bull markets do not start with low yields on blue chip stocks, he says.
So this editor, a great believer in dividend paying stocks and compound interest, is adding more defensive stocks to his portfolio.
We’ll look at his stocks first (and toss in several Canadian picks), and then see what is likely to drive interest rates off the charts.
Abundance of water
From his vantage point in the Florida Keys, Mr. Young has a healthy respect for Canadian investments. This month, his listing of the Top 10 stocks for U.S. investors features two Canadian banks.
Bank of Nova Scotia (TSX/NYSE-BNS) is number four on the list and Toronto-Dominion Bank (TSX/NYSE-TD) is number seven.
He also likes Canada’s abundance of water and its reliance on hydroelectricity rather than coal-fired or gas-fired power generation, which still accounts for more than half of America’s electrical needs.
But for his two latest defensive stocks, he stays home in the U.S. and goes straight to water utilities, the companies that keep the water flowing through the taps.
These companies are about as defensive as stocks can get, says Mr. Young. “Water utilities appeal to income seekers, retired investors, and those soon to be retired. When you buy water utilities, you aren’t looking for much in the way of capital appreciation. You want reliable dividends and modest dividend growth.”
Water utilities are simple and predictable. There is no competition and the earnings stream is protected from inflation. When inflation rises, so does the cost of the water system. To offset the higher costs and guard the return on equity, local regulators invariably approve price increases.
“What’s not to like here?” asks the editor.
Flowing along steadily
He is adding two such utilities to his master list of stocks. The first is Middlesex Water (NASDQ-MSEX). This company, which owns water utility and wastewater systems in New Jersey and Delaware, has been around for 112 years.
It sells water wholesale to surrounding towns and cities. The revenue base is stable, with 45 per cent coming from residences and 10 per cent each from industrial, commercial, fire protection and contract operations.
The company has paid a dividend since 1912 and has increased its dividend every year since 1936. Today it stands at $0.72. With a yield over 4 per cent, this stock is a good buy, says the editor. It’s now 4.5 per cent. And the shares flow along steadily at about $16.
A lower yield
Connecticut Water Service (NASDQ-CTWS) is younger than its Jersey counterpart. It’s just 53 years old. This firm serves 54 towns in Connecticut. But it also owns two unregulated businesses, Chester Realty and New England Water Utility Services.
Residential customers generate 62 per cent of revenue, with 17 per cent from fire protection, 12 per cent from commercial sources and the rest spread among industrial, public authorities and other customers.
The company has paid a dividend every year since it was founded, and has increased it 33 years in a row. The dividend stands at $0.91. The yield has fallen below 4 per cent, to 3.89. In Mr. Young’s judgment, this would make Middlesex the better buy of the two at the moment. But like its counterpart, this firm’s shares flow in a steady stream, at $22.
Already seeing inflation
The reason for buying such safe stocks, says this editor, is the coming of higher interest rates — much higher interest rates.
There are two paths to those loftier rates. The less likely of the two, Mr. Young believes, is that Federal Reserve Board chairman Ben Bernanke and his cohorts will move to counter the excessive liquidity they have pumped into the system.
He’s not buying it. “I don’t think Bernanke and the Fed have the will to prevent an inflation spiral, but we shall see.”
The much more likely cause is galloping inflation. And we’re already seeing it, says this editor. “Goods and services inflation isn’t rising yet, but asset price inflation is running rampant.”
We’ve “blown right through” fair value in stocks, he adds, and credit spreads have dropped back to pre-recession levels even though the risk of default is far higher now. Commodities and gold prices are rising. The Fed is printing money with abandon.
All of this liquidity is likely to spill over into goods and services prices as the movement of money and manufacturing capacity heat up.
“Once the turn is made, watch out,” concludes Mr. Young. “The risk of accelerating inflation will be a clear and present danger. Don’t get caught flat-footed. Make adjustments to your portfolio ahead of the herd. Dividend-paying stocks, gold, short bonds and hard currencies are the mandate.”
And apparently a Canadian bank or two wouldn’t be out of place in that mandate.
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