We now know that the Senate Banking Committee will vote on Janet Yellen’s nomination as the next Chair of the Federal Reserve Board on Thursday. This will clear the way for a full Senate vote later this year. President Obama’s nomination will need a handful of Republican votes to gain the 60 necessary to avoid a filibuster. There is always the chance that, given the current atmosphere in Washington, that won’t happen, but the conventional wisdom is that she will be confirmed. It would seem sensible, then, to consider a post appointment investment world and begin to plan for that scenario.
Following Yellen’s testimony, it is now clear that QE (the Fed’s bond buying program designed to give monetary stimulus) is likely to continue under her watch, at least in the short term. It is also evident that the policy of ultra-low interest rates will also continue throughout 2014. You can argue all day about whether this is good for the economy in a broad sense or simply another hand out to Wall Street, but one objection raised by critics of the policy is undeniable… those who rely on income from their investments are facing a difficult time.
The Dow at 16k would suggest that investors are doing just fine, but it is of little help to those who are looking for a monthly or quarterly check from their account. Those seeking income have traditionally bought mainly bonds, and for decades have seen a decent income flow and some capital appreciation, but as short term rates have hovered at near zero levels, those days have come to an end.
There are, of course, other ways to generate an income from investments. Dividend paying stocks were all the rage for a while, then Bernanke’s hint at “tapering” QE gave investors there a taste of the risk inherent in that play. Other yield bearing plays, such as REITs and MLPs also suffered as rates began to rise in anticipation of the Fed cutting the $85 Billion of bond purchases per month. The simple fact, though, is that those who need income have to get it from somewhere. Assuming that Yellen will be confirmed, where should they turn?
The answer is nothing new; in a world of low returns from bonds, it makes sense to allocate some of your portfolio to other things that offer regular payments. In September I suggested that some out of favor dividend stocks should be considered, and I still believe that all of them, AT&T (T), HCP Inc (HCP), Con Ed (ED) and Leggett Platt (LEG) offer a reasonable yield for the risk involved.
Back in June, I suggested a less well known source of yield, BDCs. These are companies that invest in start-up businesses and, like REITs and MLPs pass profits through to investors. BDCs are still worth considering, but with one proviso. In that article I suggested Hercules Technical Growth Capital (HTGC). That call has worked out pretty well, as HTGC is up 28% since then; not bad for a stock with an 8% yield at the time. If you did invest then, however, now may be a good time to take a profit and look elsewhere. As I detailed on Friday, there are worrying signs of a bubble in tech and, should that bubble burst, HTCG will get hit hard.
Similarly, MLPs (partnerships that distribute profits from oil and gas exploration) could face a difficult time over the next couple of years. The explosion in US production could be a double edged sword for these entities, especially as the global shift to alternative energy sources continues.
Given these specific risks to some of the more esoteric yield plays, it may pay to be more conservative going forward. A blend of stocks with a decent dividend and REITs may offer investors the best chance of a reasonable yield on their money in the early years of a Yellen led Fed.
REITs (Real Estate Investment Trusts) in particular were hit hard earlier this year as the prospect of rising interest rates impacted their value as a yield bearing instrument and caused concerns about the cost of their borrowing going forward. Prices remain depressed as you can see from this chart for the Vanguard REIT ETF, VNQ.
The worst case scenario of rising interest rates seems to be priced in here, so, given the stated intention of Janet Yellen to continue current policy, some recovery in the price of VNO looks likely. A yield of around 3.25% is not spectacular, but there is some chance of capital appreciation.
So, in summary, if you need an income from your investments, but want to limit risk to your capital, the Yellen years simply offer a continuation of the current problems. To get the return you need you have to take on some risk, but by being a little selective you can control that risk to some extent. Avoid the technology sector and look instead at areas where the possibility of a rising interest rate environment is still priced in. You won’t get rich off the income, but the chances are you won’t go broke either.