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4 Benefits Offered by Preferred Securities

What Me Worry?

Strong as Steel: Impacts of New Futures

Coupon Type Counts In Regard To Preferred Index Performance

QE and Asset Prices

4 Benefits Offered by Preferred Securities

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Aye Soe

Managing Director, Global Head of Product Management

S&P Dow Jones Indices

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  1. Preferred stocks can offer investors greater assurances than common shares in terms of both knowing that they will receive the dividend payment and knowing what the dividend amount will be.  Since preferred securities are higher in seniority than common equities, dividends must be paid to preferred shareholders before common shareholders.  Also, since most preferreds provide a fixed dividend payment, an investor will know what amount to expect at the next payment date.  In times of poor performance, a company will be more likely to either cut the common dividend amount or cancel the dividend altogether, rather than cut the preferred dividend amount.
  2. Historically, preferred stocks have offered higher yields than other asset classes including money market accounts, common stocks and bonds.  For institutions and individual investors seeking current income, the high yields are seen as attractive investments.
  3. In addition to higher yields, preferred stocks have low correlations with other asset classes such as common stocks and bonds, thus providing potential portfolio-diversification and risk-reduction benefits.  It is important to note that preferred securities exhibit higher correlation with high-yield bonds and equities, which are more sensitive to credit, and lower correlation with investment-grade corporate and municipal bonds, which are more sensitive to interest rate risk.
  4. Preferreds have a tax advantage over bonds, as many preferred dividends are qualified to be taxed as capital gains as opposed to bond interest payments, which are taxed as ordinary income.

Contributors:
Phillip Brzenk, CFA
Associate Director, Index Research & Design

Aye Soe, CFA
Director, Index Research & Design

For more on preferreds, read our recent paper, “Digging Deeper Into the U.S. Preferred Market.”

The posts on this blog are opinions, not advice. Please read our Disclaimers.

What Me Worry?

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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U.S. Stocks are up by about a quarter since the start of the year with 472 of the 500 stocks in the S&P 500 up since December 31st, 2012.  IPOs are getting attention following the successful launch of Twitter.  And more commentators and gurus are arguing for further gains, a coming collapse or both. Should we abandon stocks on worries that the bear markets of 2000 and 2007 will return? Or, is it “Damn the torpedoes and full speed ahead” into the stock market?

Two widely-recognized measures of market over- or under-valuation are Robert Shiller’s cyclically adjusted price-earnings ratio, CAPE and Tobin’s Q.  CAPE is a version of the usual ratio of stock price to earnings which uses the inflation adjusted price of the S&P 500 index and divides it by inflation-adjusted earnings per share averaged over the last ten years.  These adjustments usually yield a higher figure than the simple PE. Currently CAPE is about 24 and the usual calculation of the PE is about 17.   The chart, based on data on Shiller’s web site, shows CAPE from 1980 to now.  The average since 1980 is 21. The current level is above the average but not as high as at recent market peaks.

CAPE

Tobin’s Q is the ratio of the market’s value to the replacement cost of the assets of companies in the stock market.  It is something of analogy to a price-to-book value ratio.   The ratio was developed by James Tobin an economist and Yale professor as part of research on financial markets, monetary policy and the economy.  Its current values, like CAPE, are above the long term average but also below historic peaks.  The web site http://advisorperspectives.com/dshort/ often provides comments and updates on Tobin’s Q.

Neither CAPE nor Q react quickly enough to time the market or give buy or sell signals. They do indicate if stock valuations are rising or falling and are high or low compared to long range norms.  Both indicate that stock valuations are higher today than a year ago and certainly higher than in March 2009 when the market bottomed.

If a portfolio was 60% stocks and 40% bonds at the start of the year, it is now 75%/25% with no trading at all.  If an investor was comfortable at 60/40 in January, is he or she comfortable at 75/25?

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Strong as Steel: Impacts of New Futures

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Jodie Gunzberg

Managing Director, Head of U.S. Equities

S&P Dow Jones Indices

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This morning I was interviewed for CCTV2 on the impact of new futures markets with a focus on iron ore. Although Iron ore is not in the major indices, the DJ-UBS and S&P GSCI, it is an economically significant commodity that is the main input for steel. I thought you might be interested in the questions and answers,

1. What can we take-away from the launch of China’s Dalian Commodity Exchange’s new futures market?

It is exciting when there is a new futures market launch.  Generally, it reflects an evolution of more efficient pricing that reflects the physical market. For example, the new launch of low sulfur gasoil follows the hedging requirements in the distillate market.  It has been shown historically that in commodity markets where futures contracts are available, the physical prices are less volatile, which comes from the ability for commercial producers and consumers to hedge. – or in other words, “buy insurance”, and this in-turn gives them more incentive to store.

2. You said, “when futures get developed they are reflecting some kind of growth in the physical market…” What then does this mean for iron ore?

Iron ore is like other commodities since the aim of the futures market is to manage the risk of price volatility.  Since there are relatively few major producers compared with many smaller consumers, there has been an imbalance of bargaining power. The iron ore market, which is the biggest input for steel production, is going through an evolution in effort to increase transparency of pricing to better reflect aggregate supply and demand.

3. So when a new (local) futures market is launched, how does this usually impact the global market worldwide of that commodity?

The clearer pricing transparency and ease of hedging generally improves the efficiency for that commodity’s market.  Transportation is the key factor for the globalization of the market, and for iron ore, the rail to transport from the mine to a ship  is costly to develop and maintain.  By improving the hedging capability, it is possible infrastructure will develop faster with less risk, which may reduce the volatility of the worldwide price.

4. Key relationships across futures / underlying markets may hold if iron ore acts like other commodities. What are these key relationships and how do you think iron ore may respond?

Futures prices reflect the spot market price plus the costs of transportation and storage. Given iron ore’s infrastructure challenge, the futures market may improve the yield, which may also have positive implications for the steel markets by reducing the price volatility there.

5. Anything else on iron ore futures?

The progress in this market reflects the industry’s advancement to provide transparency, liquidity, and consistency to historically private markets.  This is an exciting chance not only for the physical market growth, but for investors to get direct exposure to iron ore.

The posts on this blog are opinions, not advice. Please read our Disclaimers.

Coupon Type Counts In Regard To Preferred Index Performance

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Kevin Horan

Director, Fixed Income Indices

S&P Dow Jones Indices

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Preferred indices started the year with some very strong returns. First quarter 2013 saw the S&P U.S. Preferred Stock Index (TR) return 3.13%. By the end of April, the overall index was up 4.40% year-to-date while the floating rate component of the index, as measured by the S&P U.S. Floating Rate Preferred Stock Index (TR), was returning 10%. The reason a higher return is not reflected in the overall index is that floating rates only make up 4% of the index.

The summer months took their toll on the preferred indices as May returns for fixed (-0.57%) and variable (-1.69%) coupon preferreds sold off while floaters held on, returning just under 1% for the month. June was the month that delivered the damaging blow, as the markets became very concerned after the FOMC meeting hinted at the tapering of Fed stimulus. The yield-to-worst on the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index rose 33 basis points throughout the month, from 2.12% to 2.47%, with the majority of the increase occurring after the June 19 FOMC announcement. The index was down 2.20% for the month as floaters dropped 5.91%, fixed coupons were down -2.16%, and variable coupons, as measured by the S&P U.S. Variable Rate Preferred Stock Index (TR), were down 1.04%.

Returns for July and August were not any better, and it was not until September that preferred returns began to recover. Though the overall index returned 0.26% for the month, the positive performance resulted from both fixed-rate and variable-rate coupons, while floaters remained in the red returning -1.57% for the month. October was the first month in which fixed-, variable-, and floating-rate coupons all had positive returns. The kicking of the can down the road on the U.S. debt ceiling and a stronger message from the Fed that stimulus will continue for the near future led to renewed confidence, not only in preferreds, but in all fixed income markets.

With November only half over, returns on the preferred indices are down (as seen in the table below). Rates, as measured by the S&P/BGCantor Current 10 Year U.S. Treasury Bond Index, have resumed their upward movement, going from a yield-to-worst of 2.55% at the beginning of the month to its present 2.73%. Markets are somewhat confident that the Fed will continue its stimulus, but other factors such as the pace of economic recovery, as measured by numerous economic indicators, will continue to determine the rest of the month’s performance.

For additional index information, please refer to www.spindices.com

 

Performance up to Nov. 14, 2013

 

 

US Preferred Indices Performance Chart up to Nov. 14, 2013

 

The posts on this blog are opinions, not advice. Please read our Disclaimers.

QE and Asset Prices

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David Blitzer

Managing Director and Chairman of the Index Committee

S&P Dow Jones Indices

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In an earlier post on this blog, Bluford Putnam (of the CME Group) correctly points out that the Fed’s much-discussed three rounds of Quantitative Easing (QE 1-2-3) haven’t created either jobs or inflation.  While job growth has picked up somewhat this year, both payroll employment and the unemployment rate have not recovered to their pre-crisis levels.  Inflation seems to be a thing of the past; few, if any investors worry about rising prices or the falling value of their money.

QE 1-2-3 has, however, made a difference  The principal result of the bond buying and explosive balance sheet growth at the Fed is asset price inflation. Stocks, as measured by the S&P 500,  are up roughly 2.6 times from the bottom in March of 2009.  Home Prices have had far less time to recover but are up about 20% in 18 months. While some might argue that boosting asset prices is the wrong way to support the economy or that Fed policy should be aimed at economic growth with low inflation rather than encouraging higher price assets, QE 1-2-3 has done something.

Higher asset prices suggest that the Fed should look to unwind QE 1-2-3. Both stock prices and house prices are reaching levels where there may be cause for concern.   From the first quarter of 2009, when the market bottomed to the second quarter of this year earnings per share for the S&P 500 are up about 2.6 times, the same pace as the market. However, the rate of growth of earnings is slowing down, suggesting that either valuations will climb or stock prices will not. On the housing front, there are some cities where price gains look like the halcyon days of 2005 and 2006.  The question of bubbles is being asked more often. (for a picture, see here

Continuing asset price inflation is reason enough for the Fed to scale back the QE 1-2-3 program.  Since 2000 the economy has been rocked by two boom-bust cycles in the stock market and the largest boom-bust cycle in housing since the 1920s.  A little insurance against another cycle, even if the cost is somewhat higher interest rates, wouldn’t be a bad choice.

The posts on this blog are opinions, not advice. Please read our Disclaimers.