K. Le Du
Today's high preferred stock prices and corresponding lower
yields are likely to be a temporary spike more so than a "new
normal" going forward.
The average market price for high quality preferred stocks
started this year at $25.32 per share and closed July at $26.00 - a
full dollar above their $25 par value. While there is no way to
determine in advance what future prices will do, there is a case to
be made that today's high prices will probably come to an end
sooner rather than later (months not years).
In fact, as discussed here, it is the short-term behavior of
European investors, much more so than our Federal Reserve's
monetary policy or any other factor, that will likely lead to lower
preferred stock prices in the U.S.
No New Normal
It is tempting to think that today's high preferred stock prices
are a direct result of the Federal Reserve's "Operation Twist"
monetary policy, phase 1 of which ran from last October through
June of this year (followed immediately by phase 2, now
The objective of Operation Twist is to push down long-term
interest rates by reducing the yield provided by long-term (six
year to 30 year maturity) treasuries.
Under Operation Twist, the Fed has been selling shorter-term
treasuries (with maturities of three years or less) and using the
proceeds to purchase longer-term issues. By purchasing longer-term
treasuries, the Fed is effectively reducing the supply available to
other global investors, hence raising prices. Increasing prices, in
turn, lowers yield thereby achieving the desired policy objective
of lowering the longer-term cost of money in the economy.
The result is a flatting of the "yield curve" as illustrated
here for September 2011 (before the launch of Operation Twist) and
June 2012 (the last month of phase 1).
click to enlarge images
The notion that Operation Twist would pull down the yield of
preferred stocks has a certain amount of intuitive appeal, the tide
affecting all boats the same way. Let's take a look. Here is the
average monthly yield of high quality preferred stocks over the
Notice that while the overall result is a decrease, in five of
the nine months since Operation Twist was launched last October,
the yield provided by high quality preferred stocks was either flat
or went up, not down.
The implication here is that while the Fed's Operation Twist
probably does put upward pressure on preferred stock market prices
(lowering yields), it is not clear from these data that today's
extremely high prices are being caused by this policy.
The marketplace for preferred stocks is subject to the same laws
of supply and demand as any other item that finds itself in a
competitive market of buyers and sellers. As supply increases,
giving buyers more choices, prices tend to drop.
We last saw this in dramatic fashion during 2008 when banks were
continually introducing massive new preferred stock issues into the
market. During the crisis all of our Big Banks - Citigroup (
), Bank of America (
), Wells Fargo (
), JP Morgan (
), Morgan Stanley (
) - introduced multiple issues. Not to be outdone, our regional
institutions got into the act as well with new issues from PNC
Financial (PNC), BB&T (BBT), Fifth Third (FITB) and others.
While there were a multitude of risk-related issues for
investors to deal with at the time, the market was flooded with new
shares and prices dropped accordingly (all the way to an average of
$16.14 per share at the end of October 2008).
Now consider this about today's preferred stock market: at this
point last year the companies that issue preferred stocks had
treated us to $5.7 billion in new issues to consider. So far this
year, the supply of new preferred stocks available for preferred
stock investors to pick from is at a whopping $17.1 billion.
But despite this tripling of supply, prices have not fallen;
rather, they have climbed to an all-time high.
It appears that excess demand is causing today's high prices,
much more so than the Fed's Operation Twist.
Four Key Events
So how long will these high preferred stock prices last? As
mentioned earlier, it is impossible to know for sure. But once we
understand what is causing the current spike in demand, that
question becomes easier to answer.
While there are always of multitude of forces exerting pressure
on market prices at all times, four key events, occurring nearly
simultaneously, are significant contributors to the current spike
in preferred stock market prices.
- Several months ago investors were very worried that the Fed
was going to have to start increasing rates in order to hold off
inflation. Such a rate increase could put downward pressure on
preferred stock market prices (see the Seeking Alpha article
Preferred Stock Investors: How Afraid Should You Be Of
Increasing Interest Rates?
" for actual data on this mechanism) so the more nervous among us
were staying away from fixed-income securities. That fear has
subsided substantially, bringing such investors back in as
- The yields on the alternatives that many fixed-income
investors favor (bank Certificates of Deposit and investment
grade corporate bonds) are paying 1.1% and 3.6%, respectively.
Since these earnings are completely wiped out by taxes and
inflation, many have turned to the next step up the risk ladder -
high quality exchange traded debt securities and high quality
- The June 7 announcement by the Fed regarding Basel III
compliance opened the 90-day premature call window, triggering
redemption announcements for bank-issued trust preferred stocks
(TRUPS - see the Seeking Alpha article titled "
Preferred Stock Investors About To Be Cash-Rich Thanks To
New Fed Action
" for details). Tens of billions of cash started flowing into the
cash accounts of preferred stock investors starting with
shareholders of STI-Z from SunTrust on Wednesday, July 11,
- Eurozone investors are fleeing European assets and moving
their funds to US fixed-income assets, especially investment
grade preferreds and corporate bonds. In March, for example, net
buying of U.S. financial assets including long-term equities,
notes and bonds totaled $36.2 billion, up from $10.1 billion the
If we can accept that today's high prices have been caused
primarily by a spike in demand due mostly to these key events (more
so than by the Fed's Operation Twist policy), then it follows that
the upward pressure will ease as these events run their course.
In fact, some might even argue that preferred stock prices have
already peaked. After having risen from $25.32 to start the year,
the average high quality preferred stock market price at the end of
July was $26.00 per share, down $0.01 from June.
Further, three of the four key events identified above have
probably already played out.
Investors who fled fixed-income securities for fear of
inflation's eroding effects have already returned. Whatever upward
pressure this returning group's demand exerted on preferred stock
market prices has likely already happened.
Bank CD rates and investment grade corporate bond rates leveled
off at 1.1% and 3.6%, respectively, earlier in the year. Like those
who had fled preferreds due to inflation fears but have since
returned, most savers and bond investors who were considering
jumping to high quality preferreds have likely already done so.
Redemptions of bank-issued TRUPS are just about to run their
course as well. The call window opened by the Fed's June 7
announcement will close on September 7, 2012. Prior to the July
2010 signature of the Wall Street Reform Act there were over 30
high quality TRUPS trading on US stock exchanges; today there are
only nine left, six of which have already exceeded their
respective call dates and can be redeemed at any time. With the
exception of a few holdouts, the majority of bank-issued TRUPS
redemptions in response to new domestic and international
regulations have already happened. While the Fed's June 7
announcement has pushed many of the remaining TRUPS shareholders
into the market as buyers looking to replace their called TRUPS
shares, that wave is just about spent.
That leaves us with Europe.
Europe Holds The Trigger For Lower Prices
European officials do not have to solve the eurozone problems
before investors will return to European assets; they simply have
to appear as if they are intent on doing so and are starting to
take credible steps accordingly.
We have seen this on many occasions over the last couple of
years, triggered by a single positive headline. With eurozone asset
yields sky high, investors will jump back to those assets, seeking
to beat the returning crowd, given the slightest indication that it
may be time to do so. If European leaders continue to work through
these issues and show progress, investors will return as quickly as
they fled which could happen at any time.
The increase in demand from those getting over their inflation
fears and those fleeing bank CDs and corporate bonds is likely to
have already happened. And the newly cash-rich buyers who are
seeking to replace their called TRUPS shares will wash through the
For today's excess demand for U.S. preferred stocks to subside,
former European asset investors who have currently parked their
cash in U.S. preferred stocks have to see sufficient reason to
return to eurozone investing. Probably more so than any other
single factor, this is the event that will relieve the excess
demand and high prices that we are currently seeing in the
marketplace for high quality preferred stocks.
For preferred stock investors looking for ways to take advantage
of today's high prices, the Seeking Alpha article titled "
Preferred Stock Investors: Is It Time To Sell?
" describes a technique that can allow you to do so while the
 Source for all preferred stock data in this article:
CDx3 Notification Service
database, Preferred Stock Investing, Fourth Edition, see
PreferredStockInvesting.com. Disclaimer: The CDx3 Notification
Service is my preferred stock email alert and research newsletter
service including data for all preferred stocks and Exchange
Traded Debt Securities traded on U.S. stock exchanges.
 "High quality" preferred stocks are those that meet the
ten risk-lowering selection criteria from chapter 7 of my book,
Preferred Stock Investing. For example, high quality preferred
stocks have investment grade ratings and the cumulative dividend
 Source: 4-Traders.com (a Dow Jones Company), July 24,
2012, "GE Capital, BB&T Issue Preferreds as Yield Hunt Lowers
Capital Costs" by Katy Burne.
 Source: Bloomberg research.
 There are actually thirteen high quality TRUPS still
trading on U.S. stock exchanges but four have calls pending and
have been excluded here.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
Ceragon Networks Management Discusses Q2 2012
Results - Earnings Call Transcript