The hot topic on the pickleball courts over the July 4 weekend was the growing likelihood of an economic recession this year. Which surprised me since most of the players I know are retired.
Typically, a recession is accompanied by a rise in unemployment. If you are retired, this aspect of a declining economy is not a direct threat to your financial security.
But the other characteristic of a recession, falling asset values, may pose a greater threat to retirees than to young people. That’s because many retirees rely on positive investment returns to supplement their Social Security income.
When I started as a stockbroker 40 years ago, you could get high returns on high quality bonds. For this reason, most retirees simply converted their retirement savings into bonds and lived on interest payments.
This strategy will no longer work for most retirees. In 1981, the 30-year Treasury bond yielded more than 14%. By 2011, this return had fallen below 4% and has remained there ever since.
It’s easy to generate meaningful retirement income when government guaranteed bonds pay 14% interest. This equates to $70,000 per year on a $500,000 investment.
But when the return drops to 4%, that same investment only produces $20,000 in annual income. I don’t know many people who can live comfortably on that level of income.
For this reason, many retirees gradually moved more money into the stock market as bond yields fell. And over the past 20 years, that strategy has worked pretty well.
Even after its recent 20% decline, the S&P 500 index is still up 380% over the past two decades. This equates to a compound annual growth rate of approximately 8%.
Cash flow is cool again
Here’s the problem for many retirees. The next 20 years are unlikely to be as rewarding for stock market investors as the past 20 years.
Three months ago, I explained why the stock market will struggle to produce high returns in the future. In sum, we won’t see the kind of cheap labor, cheap energy, and cheap money that inflated corporate profits in the past.
That being the case, my pickleball buddies are right. Most of them can expect to live another 20 years in retirement, maybe more.
In this regard, it is not a recession that scares them. It’s what a recession means for their future retirement income that worries them.
Read this story: Are we facing a great judgment?
What they really want to know is this: where can they put their money now to produce a reliable stream of income for the rest of their lives?
I believe the answer to this question will determine much of the behavior of the stock market in the second half of this year. We already started seeing it in the first half of this year, but no one noticed.
Dividend stocks are back in fashion. They were shunned as high multiple momentum stocks were all the rage last year. But now that rising interest rates have deflated future earnings multiples, current cash flows are quiet again on Wall Street.
I’m just passing by
This is good news for intermediate securities such as master limited partnerships (MLPs), real estate investment trusts (REITs) and business development companies (BDCs). Many of them pay yields above 6%, which is about double what you can get with a 10-year Treasury note.
For example, the Global X MLP ETF (MLPA) currently yields 6.8%. Its three main holdings are intermediate energy operators Enterprise Products Partners LP (NYSE:EPD), LP Energy Transfer (NYSE: ET), and Magellan Midstream Partners LP (NYSE: MMP).
Since energy stocks are the only S&P 500 sector in positive territory this year, their returns are relatively weak. But for every other sector in the index, stock prices are low and dividend yields are high.
Take into account BDC VanEck Income ETF (BIZD), which currently pays a dividend yield of 8.8%. Its stock price is down 15% this year on fears a recession could trigger a wave of small business defaults.
The same thing happened two years ago at the start of the coronavirus pandemic. However, once Wall Street realized the end of the world was not over, its stock price quickly rebounded.
Real estate investment trusts (REITs) have also been affected this year, as many own commercial properties. During a recession, companies reduced office space to reduce overhead.
For this reason, the Invesco KBW Premium Yield Equity REIT ETF (KBWY) is down 10% this year. It pays dividends monthly, currently at a 7.2% 30-day SEC yield.
This fund replicates the performance of the KBW Premium Yield Equity REIT index. It will do this by “investing at least 90% of its total assets in small- and mid-cap stock REIT securities that have competitive dividend yields.”
These aren’t the kinds of companies that get much attention from professional portfolio managers these days. They have bigger things to worry about. But when it becomes clear that the worst is behind us, don’t be surprised if these pass-through stocks find renewed popularity on Wall Street.
Above, I shared my thoughts on a way to weather a looming recession. However, not everyone has the same investment goals or risk tolerance.
I would like to know what steps you have taken or will soon take to protect your portfolio. You can do this by emailing me at [email protected]
I might use some of your answers in the future Stocks to Watch article. We have plenty of savvy investors among our subscribers with decades of investment experience that our readers might find useful.
Editor’s note: It pays to keep investments simple. Peter Lynch said it best in his classic 1994 book beat the street: “Never invest in something that you cannot illustrate with a pencil.”
US-based utilities are easy to understand because companies and their stocks are great indicators of dividend growth. Public services provide essential services, a virtue that tends to make their actions recession-proof. They are also immune to shocks overseas, such as the Russian-Ukrainian war. For our “dividend map” of the best utility stocks to buy, click here now.