Spring Cleaning Your portfolio, Start With Junk Bonds!

 

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Wall Street has a bad habit of putting a bunch of junk into a nice package and changing the label. Junk bonds have been repackaged into “High Yield” ETFs and many retirees looking for income have ignored the default risk. Junk bonds are issued by companies that have low credit ratings, high debt to equity ratios or face  financial difficulty.

One lesson that I learned from the financial crisis is you can’t blindly trust Wall Street. Let me remind you that these are the same people that approved sub-prime mortgages to unqualified borrowers. Packaged these mortgages into investment grade Mortgage Back Securities knowing that there was a high degree of default risk.

Three Sectors with lower revenue growth and higher default rates

  • The oil and gas industry
  • Base metal mining companies
  • Silver & gold miners

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Add the fact that the Fed will start raising rates sometime in 2015, Greece could leave the Euro zone, the possibility of a correction in the U.S. stock markets and you have the making of a perfect storm. (Check your Target Date Mutual Funds to see if they contain any high yield products)

I briefly discussed the danger of investing in Master Limited Partnerships (MLP) geared to mortgages in my last blog post. They are also popular in the oil & gas sector. The tax benefit is hard to resist since the companies pay no income tax on profits and the money is taxed when unit holders receive distributions. The high dividend yields of over 8% should be a red flag that some of these partnerships are just too good to be true.

cautionBe aware that investors living outside the U.S. are subject to  a 40% withholding tax on income received from a MLP plus retirement accounts are not eligible to receive a foreign tax credit.

If you are new to my blog, I am a bond bear and don’t own bonds in any of my portfolios. We may be years away from getting back to more normal interest rate levels but I see no point in buying bonds with negative  yields. Consider reducing your exposure to bonds along with Wall Street’s high yield income products.

The U.S. stock market returns over the past six years have been much higher than the 20 year average.

Stock Investors Should Expect 6%-7% Annual Return, Buffett Says

“The economy, as measured by gross domestic product, can be expected to grow at an annual rate of about 3 percent over the long term, and inflation of 2 percent would push nominal GDP growth to 5 percent, Buffett said. Stocks will probably rise at about that rate and dividend payments will boost total returns to 6 percent to 7 percent”, he said.

“That math isn’t bad, but it is bad for people who expected long-term returns based on looking in the rear-view mirror,” Buffett said at Berkshire Hathaway Inc.’s annual shareholder meeting in Omaha, Nebraska.

U.S.  economic growth is currently under 3% and could turn negative for the first quarter of 2015. Low oil prices combined with a strong U.S. dollar with keep inflation below 2% plus reduced earnings for the stock market.  The job numbers for March came in at 126,000 which was way below estimates of 240,000 plus January & February numbers were revised lower.  The warning signs suggest that we are not out of woods yet, 2015 stock market returns could be negative this year or below average.

I am not a buy & hold forever like Mr. Buffett nor am I a market timer. My spring cleaning includes  taking some profits by selling some winners like Disney and Starbucks. Two excellent companies that I plan to buy again this summer. Cheaper gasoline will hopefully be spent at Disney theme parks this summer and the “Star Wars”movie franchise will be begin again this Christmas.  I am a little worried that the slow down in China and the stronger U.S. dollar could affect Starbucks’ earnings for the next quarter or two. Besides, I am not a fan of drinking hot coffee during the summer months.

I have also reduced my holdings in some under preforming Canadian Reits that are exposed to Alberta’s oil patch and Reits that own a lot of retail space. Target leaving Canada and last week’s Best Buy’s announcement that it is  closing some Future Shop locations makes me more cautious regarding the Reit sector.

Spring is the season for new beginnings. Get rid of your junk, trim back some of your winners and get ready to plant some new investment seeds.

Do you have a suggestion for a blog post? Leave a comment or email me ricodilello@rogers.com

 

 

 

 

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