Why the Eurozone Debt Contagion is Telling Us That It's Time to Buy Dividend Stocks, REITS and MLPs

[Editor's Note: In this latest installment of Money Morning's new "Defensive Investing" series, contributing writer Jon D. Markman demonstrates how the shock waves of the European debt contagion bode well for such income-oriented investments as high-yielding dividend stocks, real estate investment trusts and master limited partnerships.]
 

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With the escalating Eurozone-debt-contagion fears of recent weeks, a significant shift is taking place in the global stock-and-bond markets.

The powerful bull cycle that grew out of the early March 2009 market lows – the quickest and strongest stock-market rebound of the past 50 years – has been losing some of its youthful verve as it matures. That means we can expect the pace of gains to moderate as asset classes (stocks, bonds, currencies, commodities) begin to differentiate themselves.

But that doesn't mean the profit opportunities are gone. As that differentiation plays out, such income-oriented plays as high-yielding dividend stocks, real estate investment trusts (REITS) and master-limited partnerships (MLPs) will prove to be major beneficiaries, experiencing a handsome run-up in price. Shrewd investors will move into those investments before their prices increase.


What Junk Bond Yields Are Telling Us

Investors considering these moves shouldn't dawdle: The global debt contagion emanating out of Europe could accelerate the afore-mentioned differentiation. Investors were reminded of these fears again yesterday (Monday), after the rescue of a regional bank in Spain added to concerns about the health of Europe's economy.

Over in the credit market, we can already see that junk bonds have decoupled from higher-quality investment grade issues. Byron Douglass of Credit Derivatives Research told clients last week that concerns over Greece and the demise of the euro have "shocked" investors who had piled into junk bonds without realizing the risks that they were taking. Now these latecomers to the junk-bond rally are fleeing the high-yield debt securities, which is causing their spreads over U.S. Treasury bonds to widen.

Defensive Investing Here's why this is important.

A bond spread is a quantification of risk. Historically, U.S. Treasuries have been perceived to have little or no default risk. In periods of uncertainty, fears of default risk escalate, inducing investors to jettison higher-risk debt securities. That, in turn, raises bond spreads.

But there's an interesting twist to consider here.

As debt-contagion fears have risen in the past few weeks, high-yield bonds have taken the biggest hit. But Douglass, the Credit Derivatives senior analyst, reports that the pace of the spread widening is outpacing the pressure being placed on junk bonds from the credit-derivatives market.

This is significant because the credit bears at predatory hedge funds prefer to assault bond derivatives rather than cash bonds because that's where they can get more leverage, and because derivatives are less-regulated. This means that the increased yield (decline in price) of junk bonds is happening because "real" investors – pension funds and private citizens – are stepping back, not because opportunistic traders are attacking.

The message: Quality is once again starting to matter. And that means that the initial enthusiastic rally that saw the junkiest bonds (and stocks) move the most is likely coming to an end.

Fund flow data corroborates what the cash bond market is telling us. According to EPFR Global, a Cambridge, Mass.-based credit-research firm, the 54-week net inflow streak for global bond funds ended last week. Most of the money formerly flowing into those international bond flows now appears to be heading into ultra-safe money-market mutual funds.

Once the euro crisis settles down, my expectation is that a lot of this money will start seeking out high-quality, high-dividend stocks in the utility and industrial sectors – as well as the bond-like real estate investment trusts (REITs) and master limited partnerships. We're positioned for this in our Strategic Advantage advisory service.

It's worth making sure that you are correctly positioned, too.

So what does this all mean for the stock market? According to the folks at Lowry Research Corp. it means that the market might be moving from what they call the "primary buying phase" – a low-risk/high-return environment – to a more stable "holding-and-upgrading zone." This change is represented by the intermediate-term trend breaks in their proprietary measures of the supply and demand for stocks, and usually begins with a stronger-than-normal correction.

The best way to interpret all this information is to imagine that, as investors, we're all in a train on a long journey. The action in the credit-and-equity markets over the past two weeks suggests we're about to pass an important milestone as the economy transitions from recovery to expansion and the bull market matures. Veteran analysts like Barry Knapp at Barclays Capital (NYSE ADR: BCS) believe that means that the strategies that have worked well over the last 14 months – focusing on high-beta, early cyclical stocks – will start underperforming. The train is still moving forward, but at a slower pace.

Knapp is telling clients to focus next on higher-quality cyclicals that have attractive valuations, particularly industrial and tech manufacturers. Knapp also likes attractively priced defensives such as telecom, utilities, and healthcare.

I think his point of focusing on high-quality, dividend-paying cyclicals and economically sensitive defensive stocks is the way to go over the next few months. Some choices are aerospace, energy master limited partnerships (MLPs) and foodmakers – and not the large-cap bank or energy stocks that make up a large portion of the major market indexes.

[Editor's Note: As the preceding market analysis demonstrates, Money Morning Contributing Writer Jon D. Markman has never been afraid to make a prediction.

What's more, Markman is usually right. With uncertainty the watchword and volatility the norm in today's markets, defensive investing is the way to go. However, given the competition, low-risk/high-profit investments will be tougher than ever to find.

It will take a seasoned guide to uncover those opportunities. And Jon Markman is that guide.

In the face of what's been the toughest market for investors since the Great Depression, it's time to sweep away the uncertainty and eradicate the worry. That's why investors subscribe to Markman's weekly newsletter, The Strategic Advantage: Time and again Markman has proven himself capable of seeing opportunity when other investors are blinded by worry.

Subscribe to Strategic Advantage and hire Markman to be your guide. For more information, please click here.]


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  1. L. Morin | May 26, 2010

    I am glad to see this article about buying dividend stocks and REITS. Because with the volatility, that's what I have been doing. I switched from banks and energy to dividend and REITs. At this time, I don't want individual stocks so I went with the Ishares ETFs on the Toronto stock market: Ishares Dow Canada Select Dividend Fund (XDV) and Ishares S&P TSX Capped REIT index Fund (XRE). I buy more on dips and I hope my strategy is good. Your article gives me some confidence.

    • William Patalon III | May 26, 2010

      Thanks for the comment — AND for the vote of confidence. Going forward, if there's an area of investing you'd like to see covered, or if you want to share your comments with the editors directly, feel free to drop us a note at mailbag@moneymappress.com. We're always happy to receive feedback — both positive AND constructive. And we want to hear what investors are thinking about, and are concerned about. We often shape our story assignments accordingly.

      Hope to hear from you again very soon!

      Respectfully yours;

      William (Bill) Patalon III
      Executive Editor
      Money Morning

  2. Chris Moran | May 30, 2010

    Enjoyed seeing and reading about dividend stocks, REIT's and MLP's. During the last many quarters I've taken a "bit of ribbing" for being in these stocks. Though I'm having the dividends swept back into shares the cash that is being paid is "king". A tough market we are navigating in there are ways to safe.

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