Taking the longer road to economic recovery
There are two maps leading out of the financial crisis, says this U.S. analyst, and wise investors will avoid risk by following the longer route.
Are we there yet?
The eternal cry of kids on a trip could very readily be applied to the economy today. Is the crisis over?
The answer, says one U.S. analyst, depends on which map you are using. There are two of them, says Mr. Bob Carlson.
There is one map for a short trip and another map for a longer one, he writes in Bob Carlson’s Retirement Watch. As a careful investor, he believes the trip will be a little longer than some passengers would like.
Of course his report was written before today’s encouraging news on job creation in the U.S. But we know enough by now not to get carried away by each bit of good news. Don’t we?
There is still some ground to be made up in this analyst’s opinion, and it has to be made up by disposing of debt.
At the same time, Mr. Carlson sees investors chasing high dividend yields, and he believes they are taking too much risk in the process.
Ignoring risk
“Investors are reaching for yield again,” says this analyst. “Whenever the Fed keeps Treasury yields low, investors seek income from other sources. Unfortunately, investors often ignore or overlook the risk of these alternative income sources.”
They have been piling into high-yield bonds and state and local bonds. Yields on high-yield bonds have declined over the last year, adds Mr. Carlson. Delinquencies are not rising, but that is only because the lenders are refinancing and extending loans.
This allows them to take advantage of investors who are desperate for yield. The terms are attractive for the lenders, but not for investors.
This is a good time to trim investments in high-yield bonds, tax-exempt bonds and international government bonds, says the analyst.
A lonely stock
In his Retirement Paycheck Portfolio (one of many this advisory maintains), Mr. Carlson seeks opportunities for higher yield “without taking high risks.”
There is one surprising entry in the portfolio. This analyst has avoided individual stocks for many months, but Verizon Communications (NYSE-VZ) is the lonely stock in this portfolio.
Verizon certainly fits the yield requirement, with a robust 6 per cent on its $1.90 dividend. But the stock had been lagging the rest of the portfolio.
Still, it has risen considerably from its February low and is benefiting from the general excitement swirling around the wireless phone business. It has reached $31.18, which is Mr. Carlson’s “maximum buy price” and its long-term prospects are solid, he adds.
The highest yield in the portfolio, by the way, is the 8.2 per cent yielded on a $1.00 distribution by Cohen & Steers Closed-End Opportunity Fund (NYSE-FOF). It trades at $12.67.
Short road vs. long route
Now it’s time to pull the maps out of the glove compartment and see where we’re headed.
If you believe this is a traditional short-term economic cycle, says Mr. Carlson, you would think we were on the short road to recovery. Government stimulus leads to low interest rates, which allows consumers and businesses to borrow and spend.
And most economic indicators had good growth rates in the second half of 2009. Not to mention the strength of the stock market rally.
But what if we’re taking the long route. What if the staggering amount of debt accumulated in the past two decades — and especially since 2000 — won’t go away that quickly.
In a short-term cycle, it takes about a year for consumers and businesses to begin borrowing again. But in a long-term cycle, it takes much longer. Mr. Carlson is convinced that we are in a long cycle.
There is still a steady stream of mortgage foreclosures around the U.S., he points out. And employment figures will have to improve, he adds. As we know, things now look a little brighter on that front.
Not fully recovered
Mr. Carlson quotes one study from authors Carmen Reinhert and Kenneth Rogoff, This Time It’s Different: Eight Centuries of Financial Folly. Their research shows that when a nation’s debt exceeds 90 per cent of its GDP, economic growth declines by 2 per cent a year.
In the U.S., it’ s getting close, at 84 per cent. Slower economic growth makes it harder to pay off the enormous debt.
This leads to deflation in the short term. But further down the road the consequence of stimulus spending will almost certainly be inflation.
Improving numbers are not fully recovered numbers, this analyst insists. Stock indexes are still below their 2007 highs. “Household income, spending and net worth also are quite a distance from their peaks,” says Mr. Carlson. Corporate revenues and spending are still down by 10 per cent and retail figures are at the same place they were four years ago.
In Canada things were not as chaotic as in the U.S. and the economy began its recovery sooner. But it is scarcely time to throw caution to the winds.
As for the U.S., this analyst is emphatic. Each piece of good news brings the nation closer to recovery — but we’re not there yet!
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