OH BABY. Somebody keeps delivering some clever titles. You know it’s all downhill from here.
I recently sold my house, meaning I’m sitting on a significant amount of cash. (Looks in wallet, finds TWO twenties.) I’ve been looking at some value stocks that I think have the ability to move much higher, but pickings are a little slim in this bull market. There’s also a stock I was very close to buying until something happened to change my mind. More on that next week, but suffice to say there are only a few value opportunities out there.
I’m currently earning a tenth of a percent or something with the money in my chequing account, so that obviously has to change. I’m looking at investments that throw off some sort of income, yet staying away from the dividend growth darlings who have gotten so much attention during this low interest rate environment. Primarily this means I’m looking at REITs, high yielding former income trusts, and preferred shares, the latter of which will be the focus of the rest of this post.
The Canadian preferred share market is very heavily favored towards financials. The big 5 Canadian banks are, by far, the largest issuers in the market. When the life insurance companies needed to raise capital during the last few years they also heavily relied on preferred shares. Throw in a few utilities and that’s pretty much the extent of the Canadian preferred share market.
Most of the time this wouldn’t be so bad, but I’m pretty bearish on the Canadian banking sector, even going as far as using options to short some of the biggest ones. (Royal Bank, Bank of Montreal, TD, and National Bank, in the interest of full disclosure) While I don’t think they’re going to blow up or anything, the preferred shares would still go down in value as the price of the common stock goes down. And if things really do hit the fan they’ll stop paying the dividend on the preferred shares, since you always want to do that before you stop paying the interest on the debt, since doing that would trigger a default.
There’s another reason why I’m looking south of the border, and that’s the currency. If you’re bearish on Canada, you’re automatically bearish on the Canadian dollar. If you buy American stocks and the Canadian dollar goes down, this improves your return once you sell these and convert the currency back to Canadian dollars. This is a really easy way to go short the Canadian dollar while taking very little risk, since there’s not much chance of the Canadian dollar going a lot higher from here, at least from this sexy guy’s perspective. Worst case scenario is just a little currency loss, while the best case is adding 3-5% annually to your yield from currency gains.
One note: you’re not getting the dividend tax credit if you hold American preferred shares. I’m satisfied that the increased yield from American financial preferreds and the potential currency advantage will more than offset that, but these would be a good bet to stash in my TFSA or RRSP.
The American preferred share market is huge compared to the Canadian market, but is still primarily financial based. American financials are, in my humble opinion, some of the strongest in the world. The Fed has been pumping money into the U.S. economy for years now, and primarily that money is just sitting on financial institution balance sheets. They’re well capitalized and the woes of the housing crisis are largely behind them.
Recently, as interest rates went up a couple months ago, preferred shares have sold off close to 10%, meaning it’s pretty easy to find a basket of preferred shares that yield 7%. If you buy now and hold for a couple of years I think, if you get a falling Canadian dollar, you can very easily get double digit returns on these preferreds. Sure, there’s always the risk of rates increasing, (negatively affecting the price of your preferred stock) but I think that risk is low at this point.
If you’re looking for income, I think American preferred shares are a good place to be. Stay tuned for actual names in the future, assuming you can stay awake that long.