But today I want to tell you about another class of stock that some income investors gravitate toward: “Preferred” shares.

As the name suggests, preferred stock gives its owner a leg up on common shareholders, especially when it comes to dividends.

Preferred shareholders may receive larger payments, and companies are required to pay these dividends before distributions are made to common shareholders.

This DOES NOT mean the dividend is guaranteed. It simply means that when it comes down to the wire, preferred dividends are going in the mail before common dividends.

Should things get really bad, preferred stockholders also get to “pick the carcass” before common shareholders. Of course, Uncle Sam, secured creditors, and bondholders are even further up the line.

The dividend payments on preferreds can be fixed, adjustable,
or determined by periodic auctions. Some are “cumulative,” which means a company must add any missed dividends to future payments during the time the stock is held.

One other crucial thing about preferred dividends: Only some qualify for the 15 percent dividend tax rate. These are known as “traditional preferred” stocks.

In contrast, any income from “trust preferred” shares will be taxed at your ordinary income rate. That is because they are technically considered debt securities.

If it’s starting to sound like preferred shares are a hybrid of common stocks and corporate bonds, that’s because they are!

Guys Like Buffett Have Made a Killing With Preferreds Lately.
But Does That Make Them Attractive for Regular Investors?

Some critics argue that preferreds give investors the worst of both worlds — limited participation in earnings growth yet fewer rights than bondholders.

However, savvy people were snapping up high-yielding preferred shares as markets around the world crashed. So clearly some important market participants believe they can be good deals.

Warren Buffett is probably the most prominent proponent of preferreds, and two of his bets made a year ago were well publicized:

First, on September 29, 2008, he bought $5 billion in preferred shares from Goldman Sachs. In the bargain, he secured a 10 percent yield. (Goldman’s common shares were yielding about 1 percent at the time!)

Then, just one week later, he plunked another $3 billion on preferred shares from General Electric. Again, he locked in a 10 percent yield.

Plus, in both cases he received warrants that gave him the right to buy shares of common stock in each company. Both agreements provide five-year windows for purchases. The prices were $22.25 for GE and $115 a share for GS.

With GS shares currently trading at $171, you could say Buffett’s Goldman bet has worked out quite nicely. (And I expect the GE position to work out over the long-term, too).

Guys like Buffett can get real preferential treatment when it comes to preferred shares!

However, there is some truth to the notion that Buffett and other prominent preferred investors get access to deals that regular investors will never see. Not just during major crises but all the time!

More to the point: Investing in individual preferreds takes serious research and effort.

There can be multiple classes of what appear to be the same shares …

Yields are not always written in stone …

Ticker symbols and naming conventions get confusing …

The vast majority of the issuing companies are financial firms …

And the list of pitfalls goes on and on.

I would also note that preferred shares have been extremely volatile as investors try to get a handle on the issuing companies’ credit strength.

So …

In Most Cases, I Still “Prefer” Common Dividend Stocks.
However, If You Want a Stake in Preferreds, Try a Fund …

In my book, common shares of dividend-paying stocks are a better choice for most income investors, and should still comprise the bulk of your portfolio.

They are more readily available from a wide range of companies in different sectors and industries … are easier to buy and sell … and many still offer very healthy yields.

Meanwhile, you can get “front of the line” creditor standing with corporate bonds. And many riskier issuers are still offering high yields right now.

However, if you still want to dabble in preferreds, I think your best way to go is using an exchange-traded fund (ETF) or a mutual fund that specializes in preferred shares.

You will avoid most of the hassles I mentioned a moment ago and get solid diversification in one shot. Just remember that financials are still likely to remain a huge component of the overall fund no matter what its label says.

As you’d expect, the ETFs tend to carry lower expense ratios and are generally easier to buy and sell … so those would be my first choices.

There are now at least three to choose from — the iShares S&P U.S. Preferred Stock Index (PFF), the PowerShares Preferred (PGX), and the PowerShares Financial Preferred (PGF). Yields are currently between 8 percent and 9 percent on these funds.

On the mutual fund side, note that you will not find choices from the big-name, low-cost providers like T. Rowe Price, Fidelity, and Vanguard. That’s because it’s hard for large funds to effectively participate in the market for preferred shares. In fact, Vanguard used to offer a preferred fund, but ended up shuttering it in 2001 for that very reason.

And no matter what preferred vehicle you choose, I would absolutely keep your overall investment limited to a relatively small portion of your broad portfolio.

Never forget that with a higher yield almost always comes a higher risk of loss.

Best wishes,

Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

You might respond that bonds are too boring, or too tame, or too risky. Yet the fact is, you can’t really make these sorts of blanket statements about bonds — because not all bonds are alike. Some are very safe … some are very risky … and some can be downright exciting!

Today I’m going to give you a quick overview of the major bond ETF categories. Whatever your goals may be, I bet you’ll find something in this story to help you.

Before we go any further, though, let’s think about why you would even need a bond ETF. The answer is that buying individual bonds can be expensive and bothersome. Brokers are not always familiar with them, while small orders (and “small” in this context means “less than millions of dollars”) usually have higher transaction costs.

With bond ETFs, your money is part of a big pool that tracks an index of individual bonds. This keeps costs down. It also makes bond ETFs as easy to trade as stocks or stock-based ETFs — and they come in many flavors.

Let’s take a look …

Treasury Bond ETFs:
As Safe as Uncle Sam

When you buy bonds, you’re lending your money to the issuer. If the issuer defaults, you lose. This is called “credit risk.” And the best way to minimize credit risk is to lend your money only to issuers that are the least likely to go under.

Treasury bonds are fully backed by the U.S. government.

The U.S. Treasury is about as rock-solid as they come. If you buy Treasury bonds and hold them to maturity, the U.S. government guarantees that you’ll get back all of your principal plus interest.

How long this takes depends on which bonds you buy. You can get Treasury securities that mature in as few as four weeks or as long as 30 years. Normally the longer maturities pay a higher interest rate to compensate you for keeping your money tied up.

However, with bond funds (whether ETFs or traditional mutual funds), most of the bonds in the portfolio are not held to maturity. Instead, they’re constantly “rolled-over” to maintain the desired maturity of the fund. That way, when you buy a 10-year Treasury fund for example, you know that the average maturity of the portfolio will always be 10 years.

Here are a few of the most popular ETFs that cover the various Treasury maturities …

• SPDR Barclays 1-3 Month T-Bill ETF (BIL)

• iShares 3-7 Year Treasury Bond (IEI)

• SPDR Long Term Treasury ETF (TLO)

• PowerShares 1-30 Laddered Treasury Portfolio (PLW)

Corporate Bond ETFs:
Free Enterprise at Work

You can also get easy access to the corporate bond market with ETFs. However, in contrast to Treasury issues, corporates carry a greater degree of credit risk. They also tend to have higher yields.

How risky are corporate bonds? It depends on the ratings assigned by analysts at firms like Moody’s and S&P. Investment grade bonds are thought to be safer than others — but the analysts don’t always get it right.

This is another advantage of owning bonds through ETFs: You’re buying a diversified portfolio instead of just a single issue. So if one of the companies whose bonds are in the ETF goes out of business, you won’t face a big loss.

Here are some examples of corporate bond ETFs …

• iShares iBoxx $ Investment Grade Corporate Bond (LQD)

• iShares Barclays Credit Bond (CFT)

• iShares Barclays Intermediate Credit Bond (CIU)

A special category of corporate bonds is called “high-yield” or “junk” bonds. These are from companies that are small or financially questionable. The interest rates can be very attractive but risks are higher. You can get them in ETF form, too, with funds like …

• PowerShares High Yield Corporate Bond (PHB)

• iShares iBoxx $ High Yield Corporate Bond (HYG)

• SPDR High Yield Bond ETF (JNK)

Municipal Bond ETFs:
Tax-Free Income

If you’re like me, you hate to pay any more taxes than necessary. So municipal bonds might be for you. These are bonds issued by state and local governments, and the interest you get from them isn’t subject to federal income tax.

Typically, municipal bonds are issued to pay for capital projects like roads, schools, sewers, and parks. They’re considered to be riskier than U.S. Treasury bonds, but the tax-free income can be very attractive for those in higher tax brackets.

Muni bonds are an investment in local projects.

If you want to hold municipal bonds through an ETF, here are some of your choices …

• iShares S&P National Municipal Bond (MUB)

• Market Vectors — Intermediate Municipal Index ETF (ITM)

• SPDR Barclays Short-Term Municipal Bond ETF (SHM)

International Bond ETFs:
Income from Around the World

Smart investors know they need to diversify outside the U.S. That’s just as true for your bond portfolio as it is for stocks. Once again, ETFs are a great tool.

When you buy an international bond ETF, you get both the interest payment and a currency adjustment back to the U.S. dollar. These currency adjustments can work either for you or against you. If the other currency rises against the dollar, your bonds will be worth more. If it loses ground, you might take a loss.

International bond ETFs offer a great way to diversify your portfolio.

Not all international bond ETFs are the same. Some focus on the more stable developed markets, while others specialize in emerging markets that haven’t yet proven themselves. If you see a really high yield, you can usually bet that the risk level is high, too.

Some of the top international bond ETFs are …

• PowerShares Emerging Markets Sovereign Debt Portfolio (PCY)

• SPDR International Treasury Bond ETF (BWX)

• iShares JPMorgan USD Emerging Markets Bond Fund (EMB)

One Last Thing …

Bonds are usually thought of as income investments, and with good reason. Individuals and institutions buy them so they can get predictable interest payments.

Remember, though, that bonds and bond ETFs also have the potential for capital gains and losses. If interest rates shoot higher, the value of your bonds can take a hit. Likewise, you can get a nice bonus if interest rates fall.

Especially now, with the economy uncertain and stocks on dangerous ground, every investor needs to be aware of bond ETFs. Take a look at the ideas I’ve given you today. You may find at least one of them is a good fit for your portfolio.

Best wishes,

Ron Rowland
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

But I also keep a watchful eye on other asset classes, including the various flavors of bonds.

That’s because bonds both compete with dividend stocks for investment dollars and can also afford an income portfolio with healthy diversification.

If you’re a Dividend Superstars subscriber, you know that I often talk about bonds in your monthly issues. But the last time I mentioned them here in Money and Markets, was back in May.

My conclusion then: I said it looked like a good time to start nibbling on various categories of corporate bonds.

The basic premise was that yields looked relatively good, and the idea of above-average defaults was already baked into the cake.

I also felt that corporates were certainly a better way to go than Treasuries at the time.

Since Then, Nearly All Classes of Corporate Bonds
Have Produced Good Returns for Investors …

As you’d expect, the returns have run the gamut from “decent” to “pretty darn good for bonds!”

For example, you might recall that I said Vanguard mutual funds were an easy and cheap way to play individual bond classes.

Here’s how some of the funds I mentioned have performed since that column on May 5:

Vanguard’s Intermediate-Term Corporate fund (VFICX) has gained about 10 percent …

And the Vanguard High-Yield Corporate fund (VWEHX) is up about 8 percent.

Remember, these are bond funds. You don’t normally expect 5 percent or 10 percent returns in just a few short months.

What’s more, I am not even counting the yields. That’s why most people buy bond funds in the first place!

So What Do I Think Now That This Rally Has Happened?

After the runup in these funds, yields have come down substantially.

For example, the VFICX now has a yield of 4.63 percent and the VWEHX yields 8.5 percent. The first time I mentioned the VWEHX in Dividend Superstars — in March — it was yielding more than 11 percent!

In short, I can no longer say it’s a great time to be committing a lot of new money to these funds.

That doesn’t mean I think they’re overpriced, just more fairly valued. You could certainly continue dollar-cost averaging into them, or at least reinvesting your current payments as a way of building a bigger position.

After all, if the economy does continue to stabilize, I would expect additional upside, particularly from corporate and junk. But my point is that these categories are no longer screaming bargains.

As far as inflation-protected bonds like TIPs … I remain positive on them as a great way to hedge against a future inflation shock.

I’ve been saying it often, but the Fed is really walking a major tightrope at the moment. They need to keep pumping in money to stabilize the economy … but they’re risking serious inflation down the line.

One minor slip-up in their exit strategy and things could get out of hand quickly.

For all these same reasons, I am still negative on longer-dated U.S. Treasuries. Like Mike Larson, I remain concerned that we have only seen the beginning of a bursting bubble in government bonds.

A crack in that market would send rates up sharply. And only then would I recommend starting to build a substantial position in longer-duration Treasuries.

Best wishes,

Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

There are a lot of uncertainties permeating the market right now, not the least of which is healthcare reform. Will that reform entail a public option that could add $1 trillion to the deficit?  How is reform going to be financed?  And is it going to mean higher costs for employers across the board, or just the healthcare insurers? 

Investing is made infinitely more difficult when 18% of U.S. gross domestic product (GDP) is hanging in the balance.

And you still have to consider: 

• That unemployment is likely to keep rising, perhaps over 10%.
• That the U.S. Federal Reserve’s policy of quantitative easing is slowing down.
• That there is almost certainly a second wave of home foreclosures on top of the current commercial real estate epidemic.
• And that retail sales are still a long way from recovery.

There is also reason to believe that the U.S. dollar will continue to be weak, though it probably won’t sell off precipitously.

The U.S. dollar has weekend against the Euro lately, having fallen 0.8% Friday.  Technically speaking the chart shows a traditional “cup and handle” formation that could lead to an acceleration of the dollar’s downward trend.  Gold prices, up about 13% Friday, confirm this trend and could soon break through the $1000/oz resistance.

Fundamentally, if the economy – encumbered by high unemployment and a relapse of the housing market – does not pick up the dollar could be further imperiled.

Weakness in the dollar will also be affected by the Fed’s withdrawal of liquidity, which is likely to proceed at a gradual pace.

Finally, diversification away from the dollar among the world’s central banks is taking place, albeit at a slower pace than many analysts have suggested, and that too, is weakening the dollar.

Let’s concede that there is no currency that could supplant the dollar as the world’s major reserve currency. So, it’s unlikely that the world’s central banks will simply abandon the dollar anytime soon. However, we must also acknowledge that a reduction in the weightings of the U.S. dollar within central bank reserves is already underway.

An Aug. 14 article by BNP Paribas currency strategist Ian Stannard in Euromoney recently described this gradual shift in currency reserves.  The article noted that only 62.5% of global currency reserves are in U.S. dollars, down from about 66% in 2005.

So I do not anticipate a sudden shift in central bank reserves, but rather a continuation of the measured restructuring we’ve seen so far. Thus, the slow weakening trend in the U.S. dollar is likely to continue.

So, in this very uncertain investment scenario, I prefer to go for more secure returns in bonds.  And we can achieve great diversification at a cheap cost with the iShares iBoxx $ Investment Grade Corporate Bond Fund(NYSE: LQD).

For starters, its weighted average coupon of 6.26% offers a current yield slightly north of 6% at today’s prices.  Investors are assuming interest rate risk, which means that if interest rates climb, the value of the bond has to come down.  But in the short term, there is no immediate threat of inflation.

Looking at the major holdings of the fund – which has no single position that accounts for more than 1.26% of its total holdings – I see some names that have demonstrated continued stability and others that have shown recent signs of improvement, such as American Express Co. (NYSE: AXP).  So I do not expect any major credit spread hiccup here.  I certainly do not see any hiccup that a 6.26% coupon would not compensate for.

For an additional hedge against dollar weakness, I suggest you revisit my June 8 recommendation of the iShares SPDR Gold Trust ETF (NYSE: GLD). You may also consider buying a bit of the PowerShares DB US Dollar Index Bearish (NYSE: UDN) fund.  Do not go overboard. Err on being light, rather than heavy on hedging, since timing currency moves is very difficult.

Recommendation: buy iShares iBoxx $ Investment Grade Corporate Bond Fund(NYSE: LQD) at market.  Consider hedging part of the US dollar risk by buying the iShares SPDR Gold Trust ETF (NYSE: GLD) and PowerShares DB US Dollar Index Bearish (NYSE: UDN). Both funds should account for a fraction of your position.  Have a 5% stop loss on UDN (**).

 (**) – Special Note of Disclosure: Horacio Marquez holds no interest in the the iShares iBoxx $ Investment Grade Corporate Bond Fund, the iShares SPDR Gold Trust ETF, or the PowerShares DB US Dollar Index Bearish fund.

By Horacio Marquez
Money Morning

P.S. The 2 tools that reveal the market’s future – and no one else has them

Jutia Note:Bond investing basics are just as important when considering a fund investment as they are in the purchase of an individual bond.

I’ve minced no words, and cut no corners …

Instead, I have given you specific, consistent guidance on those fronts: Namely stay the heck away from long-term Treasuries and hedge yourself against the government’s unofficial policy of trashing the greenback.

It started last year in my December 5 Money and Markets column, when I issued the most strident warning I’ve EVER released on bond prices. I labeled long-term Treasuries “the biggest bubble of all” and warned you that …

“No government, or central bank, is bigger than the bond and currency markets. Foreign bondholders aren’t going to sit idly by while any government … even the government of the U.S. … openly decides to trash its currency by printing it with reckless abandon. And they aren’t going to sit by while the government manipulates prices higher.

“They’re going to say ‘Sold to you!’ and take their money elsewhere.”

Then on March 27, I compared the finances of the U.K. and the U.S., noting that we’re both in the same boat. I pointed out that policymakers were “transforming a Wall Street debt crisis into a potential debt crisis in Washington.” And I said that …

“Foreign investors have already started unloading ‘agency’ debt — bonds sold by Fannie Mae and Freddie Mac. In addition, China has warned that it’s getting nervous about its massive U.S. Treasury holdings.

“So is it too much to imagine that U.S. bonds will soon have their day of reckoning? I sure don’t think so.”

Now’s the time to hedge yourself against the government’s unofficial policy of trashing the greenback.

Finally, a few weeks ago, on August 7, I said that the never-ending wave of debt washing over the market would have dire long-term consequences. My warning:

“In the case of the U.S. government, our ever-increasing debt load means one of two things is going to have to happen. Either …

1. Economic growth is going to surge, sending tax revenue through the roof and allowing us to pay off all these bills, notes, and bonds.

OR …

2. Taxes are going to have to rise sharply to make good on our debts.”

But Don’t Just Take My Word For It …
Take Buffett’s! Take PIMCO’s!

Now, in a devastating broadside from the editorial page of The New York Times, the greatest American investor of all time is warning of the very same things. Warren Buffett, in a piece entitled “The Greenback Effect,” wrote on Wednesday [emphasis mine]:

“Enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible … Still, their threat may be as ominous as that posed by the financial crisis itself.”

And …

“Our immediate problem is to get our country back on its feet and flourishing — ‘whatever it takes’ still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

“Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt.”

Buffett’s warnings speak volumes about the seriousness of this problem.

That’s not all …

Buffett also noted that our government is spending $1.85 for every $1 it takes in from taxes … that ever-increasing purchases of Treasuries by foreign investors are “no sure thing” … and that our deficit is on track to hit 13 percent of GDP, more than double the previous non-wartime record of 6 percent.

Sound familiar?

It should. Because that’s exactly what we at Weiss Research have been warning you about for several months! But the fact that Buffett is weighing in speaks volumes about the seriousness of this problem.

Officials at PIMCO, the world’s largest bond fund manager, are also warning about the consequences of our government’s actions.

PIMCO Managing Director Curtis Mewbourne just wrote a lengthy piece about how emerging markets are supplanting developed markets as the focus of economic power. He added that this has serious implications for the dollar, saying [emphasis mine] …

“While we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative. In combination with other factors, that likely means a continuing devaluing of the U.S. dollars versus other currencies, especially the [emerging markets] currencies.”

Again, the issue isn’t so much WHAT is being said but WHO is saying it. The warnings you first got from us at Weiss Research months ago are now being echoed in the halls of power! And that could have serious implications for the financial markets.

Bottom line: You simply must take steps to protect yourself from falling bond prices, rising interest rates, and a weak dollar.

Until next time,

Mike Larson
Money and Market

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Usually, the two don’t go hand-in-hand – especially not in the small-cap sector.

But that doesn’t mean to say that it’s impossible to grab the best of both worlds.

If you’ve read my columns here or in our monthly Xcelerated Profits Report newsletter, you know that I focus on the small-cap space – both in my specialist areas of healthcare and biotech and other sectors, too.

Typically, these small-cap stocks are ripe for big gains more so than income through dividends. But I’m actually a big fan of dividends, too.

So what if there were a way to load your portfolio with outstanding profit potential and generate income, too? There is – and I’ve got three stocks below that can do the job…

Digging For Dividends

I’m not a market timer so I’m not going to tell you that now is the time to get out of equities before the market turns lower.

But what I will say is that with the Nasdaq and Russell 2000 (small-cap) indexes having blasted off their lows by 58% and 67% respectively, it makes sense to get a bit more defensive.

The reason is two-fold – and very simple: Owning dividend-paying stocks generates income and improves a portfolio’s return over the long-term.

However, it’s hard to find good small-cap companies that pay dividends. Smaller companies usually pour any excess cash back into the business to help it grow, rather than distributing it back to shareholders.

In fact, of more than 7,400 stocks with market caps under $1 billion, only 1,356 pay dividends. And if you want a meaningful dividend yield – let’s say 3% – the number decreases to less than 800.

I further whittled down the list to companies with high current ratios, low debt, and profit expectations to help ensure that dividends would continue to get paid.

I also stayed away from companies that paid a very high dividend. Companies with yields approaching 10% or higher may find those payouts unsustainable if business continues to be difficult.

Yes, if you want a higher potential reward, you do need to take on more risk. But buying stocks with sky-high dividends is riskier than those with solid but more sensible yields.

Here are three of the best from my small-cap dividend stock screen…

A Trio Of Small-Cap Dividend Stocks

• WD-40 Company (Nasdaq: WDFC): The company makes everyone’s favorite industrial lubricant – WD-40 – plus household cleaners and other products. Through the first nine months of its fiscal year, it generated $18 million in profits and boasts $36 million in cash versus $21 million in debt. Earnings per share are expected to grow 13% in fiscal 2010.Current dividend yield: 3.4%

• American Ecology Corporation (Nasdaq: ECOL): The firm handles America’s hazardous waste. Not a great business if you’re the guy with the rubber gloves moving barrels of the stuff. But not bad if you’re an investor – particularly a new one, given that the shares have endured a beating over the past year.ECOL is profitable, has $24 million in cash and no debt. Over the first six months of 2009, it generated $17 million in cash from operations. So far it has paid out over $6 million in the form of dividends.

  Current dividend yield: 4%

• CDI Corporation (NYSE: CDI): The company provides engineering and information technology staffing services. With so many businesses cutting jobs, it’s had a tough time over the past year. But it’s still profitable, with earnings per share expected to nearly double next year. It has $77 million in cash, no debt and generated $10 million in cash from operations.Current dividend yield 3.6%.

If you have any small-caps paying dividends in your portfolio, use the “Comments” link below to let me know which ones are your favorites and I’ll run a follow-up column, featuring stocks sent in by readers. Be sure to tell me why you like the stocks, too.

Hoping your longs go up and your shorts go down.

Marc Lichtenfeld
Smart Profits Report

Dividends still matter. But you have to know where to look.

A record setting 367 companies reduced their dividends during the second quarter, no doubt leading many shell-shocked investors to conclude that income is dead.

But there’s more to this story. A total of 283 companies actually said that they boosted their payouts, and an even-larger group of companies maintained their current dividend payouts, Standard & Poor’s Inc. reported.

Not surprisingly, each of the two groups of companies featured some defining characteristics. The companies that had cut their dividends were largely domestic in nature, or at least had a decidedly domestic emphasis. By and large, the firms that were able to maintain or even boost their quarterly payouts were internationally focused, with the potential for some explosive business growth in the world’s key emerging economies.

A Tale of Two Markets

To understand the divergent fortunes of the two groups of companies, just look at the divergent performance of the two world economies that are most talked about today: The United States and China.

At the time of this dividend report’s recent release, the U.S. stock-market benchmark – the Standard & Poor’s 500 Index – was up a respectable 7.26% so far this year.

By comparison, China’s Shenzhen 100 Index had quietly risen 110.10% during that same period.

Such a steep run-up in stock prices often spooks investors. That’s understandable. We always evaluate such situations with caution, too.

But while most investors are worried China’s stock market could take a tumble, we would look at it as a minor near-term setback – and a major long-term profit opportunity.

Even with the double-digit – or triple-digit – run-ups the stocks of many China-based companies have already experienced, many Chinese companies remain stunningly compelling buys, especially when they feature solid dividend payouts, as well.

And China’s not the world’s only upbeat investing opportunity. The story is much the same in other parts of the world, too. Right now, there are more than 100 international income funds that feature yields of 6% or better.

So how do you tell which companies have a promising payout future? Or which ones figure to be dividend duds?

There are three key areas to examine.

International Sales: It goes without saying that fast-developing economies such as China and India will almost certainly leave their U.S., European and Japanese counterparts in the dust.  Therefore, it makes sense to begin the hunt for the world’s best dividend players by looking at companies with a significant business exposure to these and other emerging markets.

If this causes you to step out of your investing “comfort zone," well, let’s just say that’s great.

Some 74% of the world’s economic activity currently takes place beyond U.S. borders, so it makes no more sense to confine yourself to U.S.-only investments than it does to make the same mistake twice.

My favorites include companies that derive 40% or more of their sales from the Pacific Rim, as well as from China. The fact that China’s been growing at a double-digit clip for years means that other countries in that region are experiencing spin-off growth. Taiwan, for instance, has solid manufacturing ties with Mainland China – and the relationship between those two one-time political sparring partners is closer than ever, thanks to several trade agreements signed in recent months.

Granted, one can make all sorts of arguments about the sustainability of China’s growth, but history shows that you are better off hitching your wagon to strong horses than weak ones. Because most people still tend to view China as a Third-World, Communist-led, economically backward country, they’re often stunned to discover that China has had the world’s largest gross domestic product (GDP) for 18 of the last 20 centuries.

And it soon will again – and probably a lot sooner than most investors are prepared to accept.

In fact, I’m predicting that China’s stock markets could have a larger market capitalization than their U.S. counterparts within the next five years, but that’s a story for another time.

Payout Ratios: This is one measure that allows you to gauge the relative security of your investment in any given company. In case you’re not familiar with the term, a payout ratio is the percentage of a company’s profit that it pays out to shareholders in the form of dividends.

While there are exceptions, if the payout ratio approaches 100%, and the choice I’m considering is not a Canadian Trust or Limited Partnership created expressly for dividend-payout purposes that, to me, constitutes a waving red flag. If business conditions plummet, or management doesn’t have as good a handle on cash flow as it thinks it does, any decrease in earnings will obviously affect future dividend payout plans.

On the other hand, if the payout is around 50%, history suggests that this is a sustainable level and that management is unlikely to severely decrease the company’s dividend payment. That’s barring a catastrophic earnings reversal, of course.

Distribution Source: Thanks to all manner of accounting tricks – politely called “adjustments" in corporate accounting-speak – it’s harder than ever to determine where a company’s income is coming from. For example, some investments – especially Canadian Income Trusts and shipping partnerships – prefer to pay dividends from available cash flow, as opposed to bottom-line profits, like most other public companies.  That can increase the aforementioned payout ratio, and can also mislead investors as to the sustainability of future dividend payments.

But you should look anyway.

Generally speaking, dividends come from earnings, making them reasonably predictable. The stuff that isn’t predictable is often the result of special distributions based on short-term or long-term capital gains. Because this type of income often results from one-time sales of assets, or from accounting transactions, they are usually paid semi-annually or annually (as opposed to being paid quarterly, which is the common practice among most U.S. public companies). And while these “special dividends" can provide a nice bump in payments, don’t confuse this type of payout with the cash you received from ongoing operations.

The other type of payout that can throw a monkey wrench in things is called a “return-of-capital" event. While it can result in big cash payments that investors enjoy tremendously, it’s not a regular payout, either. Like the short-term and long-term distributions we just discussed, return-of-capital transactions are not part of regular earnings. They’re typically the result of tax savings, depreciation or other changes in the assets a firm owns. Write-downs and write-ups are good examples of what I’m talking about here.

Either way, return-of-capital transactions are a danger sign in my book because the firm may be trying to return your original investment – which is a strategy often pursued when a dividend cut is imminent and not yet announced.

And that’s the last thing you should want right now.

By Keith Fitz-Gerald
Money Morning

If you’re looking for a dividend paying stock to bolster your income – one ideally suited to weather the current economic mess – look no further than Philip Morris International, Inc. (NYSE: PM).

10 Reasons This Dividend Won’t Go Up in Smoke

When it comes to evaluating the safety of a dividend paying stock, the first thing we need to verify – given the current economic slowdown – is demand for a company’s products. After all, a company needs a steady stream of cash coming in to afford to pay it out to shareholders. So, the first three reasons, understandably, pertain to Philip Morris’ rock-solid demand…

1. Recessions don’t matter. As you might suspect, addictive products tend to enjoy the steadiest demand. In fact, based on empirical evidence out of Citi Investment Research, the last two recessions “had no material effect on [cigarette] demand.” This go round should be no different.

2. Higher taxes are offset by population growth. As world governments contend with sagging economies, they continue to turn to tax increases on cigarettes to meet budget obligations. And obviously demand is not inelastic – consumers are sensitive to price changes. The World Health Organization estimates for every 10% increase in price, demand slips 4% in mature markets and 8% in developing markets. However, when you factor in population growth, the impact is almost cut in half. More importantly for Philip Morris, its highest margin markets (accounting for 60% of revenues) come from the less impacted mature markets. In other words, the company’s profits are extremely durable.

3. Emerging markets. The WHO estimates that 80% of the world’s 1.3 billion smokers live in developing countries. Sales in emerging markets are increasing modestly compared to declining volumes in developed markets. Philip Morris is uniquely positioned to capture the lion’s share of this growth. It owns seven of the leading 15 international brands, including the hands down leader, Marlboro. It operates in 160 countries and already derives over 60% of sales from emerging markets. So it’s no surprise that total volumes increased a steady 2.5% in 2008. And total sales, net of excise taxes, increased by 12.7% to $25.7 billion. As management acknowledges, there’s no mistaking that, “This strong performance was driven by emerging markets.”

Show Me the Money… to Pay the Dividend

Beyond steady demand, we also need to verify that cash isn’t being misspent and jeopardizing the stock dividend payment. The next three reasons pertain to Philip Morris’ ability to pay its dividend indefinitely…

4. Ample free cash flow. In 2008, the company generated $6.8 billion in free cash flow, a year-over-year increase of 52.7% thanks to solid sales growth, supply-chain optimization and other cost-cutting initiatives. Best of all, this figure should keep climbing, as the company is only about halfway through its three-year, $1.5 billion cost-reduction program.

5. Solid cash buffer. With $2.4 billion in the bank, Philip Morris is sitting on enough cash to cover two quarters worth of dividends.

6. Minimal litigation and regulation risk. The 2008 spin-off from Altria eliminated the legal and regulatory risks facing the domestic operations. In other words, we don’t have to worry about the possibility of any adverse judgments requiring the company to pay enormous settlements, thereby hindering its ability to pay the dividend in the short to intermediate term. Same goes for the newly passed legislation granting the FDA regulatory control over the industry.

7. Credit is no concern. The bulk of the company’s debt was issued before the credit markets soured. And it’s well laddered at “attractive interest rates,” so there’s no concern about interest costs skyrocketing and cutting into dividend payments due to untimely refinancing. Should any emergencies arise, the company can tap into its $6 billion in unused bank credit lines.

8. The payout ratio is conservative. Even after increasing the dividend by 17.4% in August, to $0.54 per quarter, the company’s still only paying out 61% of profits. So profits would need to drop dramatically to pose an immediate threat to the current payout. The low ratio also leaves plenty of room to increase the dividend.

A Good Measure of Subjective Value, Too

The final two reasons the company’s dividend is safe pertain to subjective factors, like management and market predictions. As a result, they’re not significant on a standalone basis. But they do contribute positively to the overall outlook for the stock…

9. Management pedigree and commitment. Remember, Philip Morris spun-off from Altria, which increased its dividend in 39 out of the last 41 years. That history and “commitment to reward our shareholders generously” is ingrained in Philip Morris’ management. And as the CFO reveals, if maintaining that commitment “means that the payout ratio overshoots 65% [occasionally], so be it.”

10. Currency tailwinds. A strong dollar hurts results because the company is based in the United States, yet records almost all of its sales in foreign markets. However, many experts (and yours truly) believe the dollar is doomed, which will only magnify the company’s profitability.

In the end, the fundamentals above prove the most important thing as an income investor – the dividend’s safe.

They also point to the prospects for steady share appreciation. After all, the stock’s trading cheaply, at just 12 times earnings and management expects to increase earnings by 14% next year.

As CFO Hermann Waldemer explains, “We have excellent momentum going into 2009. Our market shares are growing overall… And our share growth is accelerating [too].”

We’ll get proof when the company reports earnings July 23. But if we wait for the results, I’m afraid shares will get away from us and diminish the yield.

At current prices, the stock pays a reliable 5% with strong prospects for prospects for appreciation. So don’t miss out.

Good investing,

Louis Basenese
Investment U

In May, Mohammed El-Erian issued a fairly gloomy forecast for the world economy.

The CEO and Co-CIO of PIMCO, a firm which manages $700 billion in assets, said the world economy has entered a “new normal” state.

He predicted, “For the next 3–5 years, we expect a world of muted growth, in the context of a continuing shift away from the [United States, Japan, and Germany] and toward the systemically important emerging economies, led by China.

That’s pretty much in line with what we’ve been expecting. We’re looking at GDP growth of 1% to 2% and single-digit stock market returns in the years ahead. It’s also in line with expectations of a W-shaped recovery or an L-shaped recession.

This is nothing new though. We’ve known the bubble era has been over for a while. That doesn’t mean there’s nothing we can do though. There is plenty. We’ve just got to move with the markets. As we’ve been looking at recently, an investor willing to learn new strategies will always be able to find something that works.

One strategy working now (and should continue to work in the years ahead) is in an asset which has outperformed stocks andbonds during the last period of economic malaise. An asset that has handily beaten stocks so far this year. An asset which we have another chance to buy thanks to the current correction.

But let’s start back at the beginning.

Let History Be Your Guide

In the early 1970’s the U.S. economy was just starting out on a decade of doldrums. The combination of rampant inflation, international conflicts, too many government “fixes,” and a whole host of other problems stifled the economy for a decade.

No one thinks of the years between 1973 and 1982 to be good times. Unemployment steadily grew throughout the decade. There were three official recessions. GDP contracted for 38 out of 120 months. Nearly one-third of the decade was spent in recession.

When the economy was actually growing, it wasn’t growing fast. Real GDP, which takes out the effects of price inflation, grew an average of 1.8% per year during that time.

From an investor’s perspective, there were very few hiding places. Stocks went nowhere. The S&P 500 rose from 103 to 140. This doesn’t seem too bad – until you account for inflation. Once rising prices are factored in, the return is much closer to zero for the decade. Bonds were just as bad. Long-term corporate bonds returned an average of 6% per year. Again, that return turns negative once inflation is factored in.

There was one investment class which performed exceptionally well throughout the decade though - convertible securities – a.k.a. “convertibles.”

Convertibles are an investment which combines the upside potential of stocks with the safety of bonds. They are bonds and preferred stocks which are convertible into common stock at a predetermined price. Hence, they pay regular income like a bond and have the potential return of the stock they could be converted into.

Long-time Prosperity Dispatch readers should be familiar with convertibles. We looked into them last fall as a safe way to wade back into the markets. We also had a chance to for an exclusive one-on-one with  John Calamos, the world’s foremost convertible securities expert.

That was months ago though. Now, with sub-par economic growth practically imminent, we can get prepared. As it turns out, convertibles are practically tailor made for the “new normal” economy.

From a historical perspective, convertible securities perform best during periods of slow economic growth. 

Just look at how they did during the last extended period of economic malaise. The table below compares stocks, corporate bonds, and convertibles between 1973 and 1982.

It’s not hard to see that convertibles were one of the best investments of the 70’s. When bonds did well, convertible bonds did just as well. When stocks did well, convertible bonds did just as well. Convertibles really are the best of both worlds. But they get even better.

High Returns Without High Volatility

As Mark Twain noted, history doesn’t repeat itself, but it certainly can rhyme.

Right now, it looks like history is rhyming when it comes to convertibles.

In the first five months of 2009 the S&P 500 went basically nowhere. The index of the largest 500 large-cap stocks took a very windy road to a 1.2% increase.

Convertibles, on the other hand, performed exceptionally well. The Merrill Lynch All U.S. Convertibles Index climbed more than 15% over the same time period.

The chart below shows convertibles not only outperformed stocks, they did with much less volatility.

This is the other value in convertibles. Since they are part bond or preferred stock, they pay regular interest or dividends. As with most other income-focused assets, they’re much less volatile than common stocks.

In the past few months, convertibles have shown their tendency to fall less when markets are falling and rise just as fast when markets are rising. In January and February the S&P 500 fell nearly20%. Convertibles fell about 5% over the same time period. And when stocks did eventually rally, convertibles went up right along with them.

Convertibles really are truly valuable assets as we enter the “new normal.” As with all investments though, the final concern is when to pull the trigger and buy.

When it comes to convertibles, we can consider ourselves lucky we’re still in a period of deleveraging and uncertainty.

Still on Sale

Right now the markets are correcting. Frankly, we expect to see a volatile, yet generally flat market in the months ahead. There are just very few drivers for a sustained rally in the short-term.

It looks like investors are getting used to “new normal” levels of economic growth and valuing stocks accordingly.

That’s why we consider the general market as neither significantly overvalued nor significantly undervalued. Convertibles, however, still remain at historically low levels.

Convertibles have recovered a bit since the credit crisis. So convertibles aren’t the cheapest they’ve been in 30 years. When we exclude the credit crunch though, convertibles are still heavily discounted and sitting at multi-decade lows. Convertibles are about 6% below the fair market value according to Calamos’ research.

Two things are important here. Discounts don’t last long in convertibles. Since convertibles offer the upside of stocks and the safety of bonds, they get snapped up quickly when they are this cheap. It’s only a matter of time until the market starts rewarding convertibles for their ability to post solid returns with low volatility. Also, at their currently discounted level, buying convertibles is like getting a 6% head start on the market.

I’ve long considered convertibles to be the closest thing to the perfect investor most folks will ever come across. And now they’re looking better than ever.

Success in the “New Normal” Economy

The value in dynamic investments like convertibles just goes to show there are decent opportunities in the current market.

We may be in the midst of a correction. It may turn out to be the final head fake rally before the next leg of the bear market. We still haven’t reached an ultimate bottom yet. Or it may turn out to be a buying opportunity for the next liquidity-fueled rally.

At this time, no one knows for sure. As investors though, our hands aren’t tied. And investments like convertibles which perform any way the markets go and during sub-par economic growth will be in high demand in the months and years ahead.

The fundamentals of investing successfully haven’t changed. We still have to find low-risk, high-reward investment opportunities. Ones which will perform well in the current and future market environments. It’s all part of the “take what the market gives you” strategy resourceful and successful investors adhere to. And that type of mentality focus will work in any type of economy.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Why?

Forget that it’s always entertaining, informative and often loaded with unconventional investment perspectives. Read it because the man controls a boatload of money.

At last check, his PIMCO Total Return Fund – the largest mutual fund in the world – boasted $159 billion under management.

With so much at stake, he can’t make investment recommendations flippantly. They require deep thought… and a track record of accuracy. Otherwise, investors wouldn’t keep entrusting him with their money.

So what’s he recommending now?

Bonds, of course.

After all, he is the Bond King, or “the nation’s most prominent bond investor” as The New York Times likes to say. Not doing so would be sacrilegious… and detrimental to his business.

But, he also likes “stable dividend-paying equities.”

Here’s my rub. He’s ambiguous. A “stable” dividend-paying stock is not self-evident. And investing in unstable dividend-paying stocks can lead to disastrous results (i.e. – a stock that cuts or cancels its dividend AND drops in price).

So let me provide you with a six-step screen to easily identify stable dividend-paying stocks.

How to Avoid the Dividend Trap… and Find Stable, High-Yield Investments

Countless studies demonstrate that dividend-paying stocks outperform non-payers by a wide margin.

From 1972 to 2006 dividend-paying stocks returned an average of 10% annually versus 4% for non-dividend payers, according to Ned Davis Research. Going back to 1926, other studies confirm almost half of the S&P 500’s return was due to the dividends paid by the companies in the index.

So, I’ll take Bill Gross’ recommendation one step further. Forget now. Dividend-paying stocks ALWAYS deserve a place in your portfolio.

Yet, in this market, it’s increasingly difficult to find reliable dividend stocks.

“This is going to be the worst [dividend-cutting year] in 50 years,” Howard Silverblatt, Senior Index Analyst at Standard & Poor’s, predicted in January. So far he’s right with industry titans like General Electric and Dow Chemical announcing cuts.

Keep in mind, Dow Chemical maintained or increased its dividend every year since 1912. That means conditions this year are worse for the company – at least on a cash flow basis – than during the Great Depression.

Against this backdrop, it’s understandable why many investors consider no dividend safe. But that’s a mistake. Fact is, countless companies will weather this storm with their dividend intact.

To find such companies I focus on the following six criteria and I recommend you do the same:

1. Simple business. The fewer the moving parts the fewer things that can go wrong and sap cash intended for dividend payments. Focus on companies doing one or two things that you can understand, as opposed to massive corporations with dozens of operating segments.
2. Steady demand. Given the Great Recession, the first thing we need to verify is demand for a company’s products. After all, a company needs a steady stream of cash coming in to afford to pay it out to shareholders. Stick to industries or sectors with recession-proof or recession-resistant demand (food, alcohol, tobacco, health care, etc.).
3. High cash balance. Cash IS king, especially when it comes to maintaining a dividend. Consider it insurance against any unexpected slowdowns. At a minimum, insist on enough cash to cover one quarter’s worth of dividends.
4. Minimal need for credit. Securing credit in this market is extremely difficult. Accordingly, I focus on companies that do not need to raise significant amounts of capital. Remember, too, when interest rates rise, so do interest payments for companies that rely on a significant amount of debt. So it’s also important to focus on companies with reasonable or low debt balances. This insures interest payments won’t sap money intended for us.
5. Cash flow positive. If a company’s not generating cash each quarter, the only way to pay a dividend is by borrowing or tapping into cash reserves. Such practices are not sustainable over the long term. Eventually, the dividend will be cut.
6. Earnings buffer. Insist on a dividend payout ratio (annual dividends/annual net income) of 80% or less. A company paying out 100% of earnings has no wiggle room in the event of a slowdown. If business suffers, so will the dividend.

Obviously not every stable dividend-paying stock will meet all these criteria. But the more criteria a stock fits, the more stable you can consider its dividend.

I followed these six criteria to unearth all the dividend stocks I’ve previously mentioned here – TEPPCO Partners (NYSE: TPP), Lorillard (NYSE: LO) and Windstream Corp. (NYSE: WIN).

Lorillard and Windstream remain attractive at current prices.

Next week, I’ll reveal another dividend-paying stock worth your consideration. But please note, in the days ahead my dividend-sleuthing prowess will change venues.

Louis Basenese
Investment U

As you know, I am a big believer in longer-term investing strategies, and a huge fan of stocks that reward shareholders with steady (preferably rising) dividend payments.

Unfortunately, the latter are getting harder and harder to find …

Dire Dividend News Continues Hitting the Tape

According to the latest data from Standard & Poor’s, the second quarter of 2009 saw just 233 dividend increases.

How does that stack up historically?

Well, it’s the worst second quarter on record since 1958!

In terms of decreases, it was the second-highest number, with 1958 taking the honors.

Even worse, S&P says the first half of 2009 along with the 12 months ending in June both hold the most dividend decreases and fewest increases since records began back in 1956.

This trend marks a sharp departure from the kind of dividend activity that we saw over the previous couple of years. Consider that in the second quarter of 2008 there were 455 positive dividend actions vs. 97 negative ones. And in 2007, the numbers were 542 hikes vs. just 18 decreases.

Yikes!

Does that mean income investors should give up all hope of getting solid payments from dividend stocks?

Of course not.

In fact, my Dividend Superstars subscribers have seen a number of their portfolio companies increase payments in the last year. And I expect many more dividend hikes this coming year, too.

However, the new reality is that you have to be very selective about what companies you buy … what market metrics you watch … and what sectors you overweight.

In the latest issue of Dividend Superstars, I gave my subscribers an in-depth look at precisely what groups of stocks have been outperforming during the 2009 rally, and also how each sector has been stacking up in terms of dividend payments.

While I don’t have nearly enough space to go into it all here, I’d certainly like to make a few important points.

First, as you’d expect, financial dividends have been evaporating at a rapid clip. And I don’t think the sector will be quick to regain its crown, either … especially not with all the new proposed legislation out there. So right now, I’m only recommending the purchase of one very niche dividend-paying financial company.

Second, many of the so-called “defensive” sectors that I favor have remained solid places for income investors to hide — both for steady dividends and for insulation from the overall market meltdown.

Third, the recent rally has been largely fueled by more aggressive stocks in more cyclical sectors. That tells me that investor expectations are very high right now, and any second-quarter earnings disappointments could send the broad indexes down in a hurry.

For All These Reasons, I Continue to Suggest
Approaching the Stock Market Conservatively

A few weeks ago, I warned you to consider selling off recently-purchased aggressive stocks that were sitting on substantial capital gains. And I want to reiterate that view today.

Sure, second-quarter earnings could blow off the roof and the stock market party could resume. But at this juncture, I would rather stay cautious and take some money off the table.

This is precisely what I have told my Dividend Superstars subscribers to do in the last few issues, and I have also recommended they position their portfolios for possible downside with a hedge.

And as I mentioned, I continue to overweight the portfolio with plenty of solid dividend-paying defensive names in sectors less likely to take severe hits should we see a “double-dip” recession. I consider that scenario a distinct possibility, especially given the fragile nature of the consumer … the tenuous “recovery” in housing … and the fiscal policies coming out of Washington.

Here are three of the specific characteristics I suggest looking for in this market:

#1. Sound fundamentals. Stick with the tried and true companies that have plenty of cash on their balance sheets, relatively low debt, good sales, profitable operations, etc.

#2. Businesses that are less sensitive to economic cycles. I’m amazed at how many investors have been piling into retail stocks, real estate shares, and other economically sensitive parts of the market.

Sure, these companies have been beaten down … and yes, they’ll represent good values someday. But I have yet to see real progress made in their underlying businesses right now. And I don’t believe we will see them make great strides in next quarter or two, either.

#3. Strong brands. I don’t care if the economy heads north, south, east or west next … companies with highly regarded products do well.

Again, at this point in the business cycle, I’m talking only about companies that sell brand name necessities though. Sure, Starbucks has terrific name recognition. But its business doesn’t pass point #2 above.

So make no mistake: I do think a sound portfolio should continue to have a stake in equities (as well as certain bonds). I just think you need to be selective, and remain relatively conservative.

After all, what are the alternatives?

Getting nearly nothing from CDs or money market funds? Or taking on substantial risk with long-term Treasury bonds?

Heck, most of my favorite dividend stocks are paying double, triple, even quadruple what you’d get from those investments … and that’s not even counting the added potential for capital gains.

Bottom line: Let’s keep our expectations in check … remain conservative and selective … and prepare our portfolios for maximum income with minimum risk.

Best wishes,

by Nilus Mattive
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Many balked at the idea. But the results don’t lie…

Year-to-date, General Electric is the worst-performing stock in the Dow, down 22.3%. Meanwhile, TEPPCO is up 69%, including dividends.

(If any of you took me up on my income investment recommendation, e-mail us and let us know how you did at comments@investmentu.com.)

Of course, part of the move higher for TEPPCO can be attributed to news that Enterprise Products Partners (NYSE: EPD) is buying the company, as I predicted.

For those of you that purchased the stock, I recommend you take profits now. And whatever you do, don’t reinvest them in GE.

GE: Reasons Why It’s Not a Safe Income Investment

My reasons for disliking GE as a safe income investment remain the same.

The company defies the golden rule of income investing – go with simple businesses, because simple businesses make money and can pay dividends, consistently.

Remember, GE’s business is all over the place with sales in water, security, railroads, oil and gas, media and entertainment, lighting, health care, consumer lending, commercial lending, energy, electrical distribution, consumer electronics, aviation and finally (drum roll) appliances.

And it’s only getting more complicated. This week, the company announced it’s getting involved with embryonic stem cell research.

Another problem? GE will always be fighting the law of large numbers. At a market cap of $125 billion, it takes an awful lot of growth to move the earnings needle and in turn, share prices.

Right now, that’s not happening.

Income Investing: The Smart Way to Pick Dividend Stocks

Again, it’s not fair of me to bash GE without offering up an alternative. So here it is: Windstream Corp. (NYSE: WIN).

The company is the country’s largest rural wireline telecommunications company. It was formed in mid-2006 through the combination of ALLTEL’s wireline business with VALOR Communications Group.

It operates in 16 states… in the sticks! Off-the-beaten-path markets, where big carriers like AT&T and Verizon don’t focus because the upfront costs are too high. Just to give you an idea, in most suburban and urban markets the number of access lines per square mile are over 110. In most of Windstream’s markets it’s below 20.

Obviously, this lack of competition confers notable advantages on Windstream. Namely, high and steady profit margins. Even in this declining market, Windstream’s been able to maintain its operating margin of 35%.

Even better, at current prices, the stock yields 12%. (In comparison, GE currently yields 3.4%).

Here are the four main reasons I believe this dividend is safe:

• Wide Economic Moat. Many carriers are losing traditional phone customers to cable phone services. However, Windstream is partially insulated from this trend. About 30% of its customers don’t even have the option to get cable modem services. The cable companies just don’t serve those markets. At the same time, the severities of this recession are forcing many larger carriers to cutback or suspend expansion efforts into Windstream’s territories. The delay only allows the company to solidify its competitive position and minimize the impact of new entrants over the long term.

• It’s Growing for Free. The big old honking stimulus bill included $7.2 billion in funds for Internet expansion. Windstream qualifies for the grants and can use the “free” money to expand its footprint in rural markets.

• Solid Cash Flow. In the last year, cash flow improved 14% to $763 million thanks to lower capital expenditures and cost cutting efforts. In 2009 we can expect the same, as management doesn’t anticipate the need to increase capital expenditures.

• Credit is No Concern. Windstream’s got a sizable $5.4 billion debt balance, but it’s reasonable relative to cash flows (interest expense should consume less than 28% of cash flow), lower than the industry average leverage and there’s no immediate need for refinancing. The earliest debt maturity is in 2011 for $457 million. If necessary, the company could pay off the balance from current cash flows and the money in the bank. After that, the next significant debt maturity doesn’t come until 2013.

Like TEPPCO, Windstream comes with a kicker – it’s also a takeover target.

In the last five years we’ve seen larger carriers, eager to juice growth, acquire rural carriers with high margins for a hefty premium. Windstream possesses the same qualities of past takeover targets, so a deal is certainly possible in the next six to nine months. A cheap valuation, at just 9.5 times forward earnings, increases the odds.

Bottom line, Windstream provides reliable income and the potential for significant capital appreciation like we witnessed with TEPPCO. Sadly, we can’t say the same about GE. So dump it if you own it! And Buy Windstream instead.

Good investing,

Louis Basenese
Investment U

The Treasury debt placement was well received by the markets.   We saw these issues amply oversubscribed and trading well after their placement.  This was very encouraging.  End of the half adjustments also saw a bid coming back into the U.S. dollar.  And, with the Federal Reserve issuing a statement in which they are not expanding quantitative easing further, the ghost of hyperinflation is delayed for the time being. 

With all the slack in the U.S. economy there is no room for manufacturers to pass cost increases on to consumers.  As the fiscal and monetary stimuli become ingrained, this will change.  But for the moment, the great fears of a runaway monetary base have been moderated.

This view is also supported by the commentaries of both Warren Buffet and General Electric Co. (NYSE: GE) Chief Executive Officer Jeffery Immelt.  The oracle of Omaha saw no recovery yet in his numbers.  And Buffett’s group holdings are diversified enough, and he and his management team are as well connected enough, to be ahead of any recovery. 

Similarly, Immelt commented that the underpinnings for a recovery were in place.  And he also observed that China, and some government-driven emerging markets are strong and could be driving U.S. exports.  He did mention that the thrust of aircraft engine orders come from abroad rather than the United States.

In this column, we took early and aggressive advantage, starting last October and December, of low market valuations.  The market did not price then the strong monetary and fiscal stimuli that were devised to bolster the economy. 

Without the Fed’s strong measures and quick actions, we would have fallen into a deflationary spiral and much deeper downturn.  But the Fed’s actions normalized markets one by one; starting at the epicenter, the interbank and money markets, and moving outward in concentric circles through mortgages, and student and car loans.  These actions helped bring the corporate bond markets and the equity markets back to life.

Stocks appreciated the Fed’s effort, as the market shifted its valuation from an “end-of-the world” scenario to a deep recession scenario or better.  But that trade is over. 

As Warren Buffet says and Jeff Immelt implicitly recognize, the recovery will take a long time to materialize.  There are still huge numbers of homes facing foreclosures, and the slack in the U.S. economy is very pronounced.  We need to see some more good news in order to justify higher valuations. 

Ahead of this realization by the market, we have been in profit-taking mode for the most volatile stocks and moved to hold for longer-term recommendations. 

The Standard & Poor’s 500 Index has recognized this and had started moving sideways with a very slight downward bias as of late.  Do not construe this to be bad news.  In fact, the cup-and-handle formation in the S&P 500 usually precedes a sharp move up. 

That is a very distinct possibility that we will eventually be playing with many of our existing ‘Buy’ recommendations, as well as with new ones, should the scenario materialize.  But we need to get over the cap-and-trade and healthcare reform humps. 

If the cap and trade legislation passes, the overall cost of energy will go up, taxing the whole economy, and there will be a shift to renewables, creating many jobs in this industry and ample profits.  We need to see these issues defined before pulling the trigger in most hugely actionable trades. 

So, I started screening different income-generating strategies and I discovered a great way to have both upside with high-yielding, yet low-default bonds, and at the same time enjoy dividends from mammoth companies that are likely to keep paying them: The TS&W/Claymore Tax-Advantaged Balanced Fund (NYSE: TYW).

I normally shun from recommending funds.  Why pay management fees when I can come up with a similar strategy on my own and recommend it to you? 

But there are two circumstances that make this case different:

• When there is such a level of expertise behind the strategy that it would be almost impossible for a non-expert to replicate with a decent chance to obtain similar results.
• And when the value of diversification is huge, and such diversification is unavailable or almost impossible for the individual investor to obtain.

Both of these reasons are huge factors here.  Let me explain.

Let’s start by explaining what this fund has in its belly.  It can invest from 50% to 60% of the fund in tax-free municipal securities and between 40% and 50% in equities and other income securities.  So we are not only playing the rally in bonds that stand to benefit from the markets’ realization that we are in for a longer recession than expected, that inflation is very subdued, and that the debt placements by the U.S. Treasury were well received. 

It helps the bond market a lot to have seen that the Fed did not continue expanding its quantitative easing.  So why not benefit from this by buying high-yielding, tax–free bonds? 

We are going to get both capital appreciation and a high yield.

The fund is positioned right now some 54% in munis and 10% in other income. And it is well diversified in 59 strong large caps with an average market capitalization of about $55 billion that pay an average dividend yield of 4.85%!

The key to the strategy is executing precisely in the muni world, given the fund’s higher weight in it.  Also, this very specialized asset class requires detailed credit analysis of municipal and project finances.  The beauty of most munis is that these jurisdictions have taxing power and they are careful to keep their credit ratings. 

In fact, fund’sholdings are 42% in AAA-rated bonds, making it 88% of the bond holdings rated single A or better.  In addition, it has a duration of 15 years, which will be beneficial to returns with a bond rally. 

But as many in the market learned painfully last year, “not all AAA bonds are made equal,” and many went straight to default.  I have known this for a long time and have always done my own research on credit quality, never relying on rating agencies.  Because of this discipline, I was able to get out of Enron, Worldcomm, the toxic-waste-laden structured investment vehicles, and innumerable securities well before they were downgraded to junk.  

So why am I sending you to a muni-heavy fund, at a time that the US municipal and state finances are under such pressure?  Because I know the manager of the fund very, very well.  He is not just your typical fund manager.  He is someone that has been at the top of his class for decades.  He is extremely well known by his clients, issuers, and Wall Street, which grants him top-level access.

I used to work a few offices down the corridor from Vincent Giordano at Merrill Lynch Asset Management and cannot even begin to tell you how much I have learned from him over the years.  He was responsible for bringing the municipal bond management of the firm up to above $60 Billion from $2 Billion by the time he left to start this fund.  He did that on the basis of exemplary and disciplined performance, leveraging the superb distribution network that Merrill Lynch has.  “Vinnie,” as all his friends call him, is the poster-child of discipline, never becoming complacent and always questioning his own assumptions.  This requires inordinate amounts of reading, research and consulting the best sources in the market.  He is a master of risk-reward analysis, which is the key in any investment.

But get this:  The fund is trading at a 12.46% discount to Net Asset Value.  That is, as a closed-end fund you are buying exposure to the securities it holds at such discount to what you would have to pay just to buy them yourself. 

In addition, the fund yield is an amazing 9.50%, most of which is tax free, since it is coming from munis.

Hence, on the back of a very supportive fixed-income environment and to keep a toe in high-dividend, strong large caps, we go for an expertly-managed and well diversified balanced muni-equities fund.

Recommendation: Buy the TS&W/Claymore Tax-Advantaged Balanced Fund (NYSE: TYW) at market (**)

(**) – Special Note of Disclosure: Horacio Marquez holds no interest in the TS&W/Claymore Tax-Advantaged Balanced Fund.

By Horacio Marquez
Money Morning

• Buy them through Vanguard if you are a mutual fund investor. (The average fund company charges expenses six times higher than Vanguard’s.)
• If you are a closed-end investor, try a tax-free fund like Nuveen Insured Municipal Opportunity Fund (NYSE: NIO) trading at a 10% discount to its net asset value and yielding over 6% paid monthly.
• Or, to avoid annual expenses and have the certainty of a final value on a particular date, buy individual tax-free bonds.

But, whatever you do, buy them – now.

Tax-Free Bonds: Why It’s Time To Buy Them

So, why is now the time to buy tax-free bonds? Let me count the ways:

• Ten-year municipal bonds, while down from the historic premium they reached a few months ago, are yielding as much as 10-year Treasuries. Treasuries are taxable. Munis are not.
• Most municipal bonds are safe. Yes, a few areas – particularly in California and Alabama – are troubled. But the historical default rate on municipal bonds is just 0.3%.
• Taxes will soon be going higher. A lot higher.

Yes, I know that President Obama, when he was candidate Obama, promised a tax cut for 95% of Americans. But that was then and this is now…

In the meantime, we’ve seen the federal government:

• Ride to the rescue of General Motors and Chrysler…
• Pass a massive $787 billion economic stimulus…
• Spend hundreds of billions more to recapitalize banks…
• Bail out insurance companies…
• And “fix” the mortgage market.

Now the Obama administration is:

• Proposing the biggest changes to the health care system since the advent of Medicare in 1966.
• Planning to spend billions more to lighten our dependence on foreign oil and reduce carbon emissions.
• Now urging policy makers to rewrite the rules governing the entire U.S. financial system, spending who knows how many billions more.

As for candidate Obama’s promised tax cut, I’m reminded of the remark former Clinton aide George Stephanopolous once made to Larry King, “The President kept all the promises he intended to keep.”

The Consequences of Federal Spending & Encroachment

The consequences of all this new federal spending and encroachment into the private sector won’t be fully apparent for years to come.

But the wild fiscal imbalance is already crystal clear. Washington politicians will soon demand that you sacrifice even more of your paycheck so that they won’t have to sacrifice the near erotic charge – and high incumbency rate – they get from spending it.

This is ironic when you consider that to a large extent it was government that landed us where we are today.

Sure, the mortgage boom and housing market bust was due in part to shameless lenders, greedy borrowers, and unscrupulous Wall Street types. But who set the stage for them?

• Who took short-term rates to the cellar, creating a massive incentive for consumers and investors to borrow?
• Who gave real estate investors a $500,000 tax exemption on their profits from flipping houses every two years?
• Who passed laws criminalizing banks’ failure to lend to subprime borrowers?
• Who set up quasi-government institutions Fannie and Freddie – or, as I prefer, Phoney and Fraudy – to warehouse those bad mortgages, leaving taxpayers to pick up the tab?

The answer? The federal government.

As The Free Market System “Fails”…

And what will we get as a result of this supposed “failure” of the free market system? More federal government.

I’m not sure whether to laugh or cry. But I am sure our Founding Fathers must be spinning in their graves.

• Thomas Jefferson said, “That government is best which governs least.”
• George Washington said, “Government is not reason, it is not eloquence, it is force.”

No wonder polls show that more than 60% of Americans are skeptical of increased government intervention in the economy.

They suddenly recognize that we’re in for a lot more government, a lot more “market failure”… and a lot more taxes.

Sadly, there isn’t much you can do about it… except buy munis now.

Good investing

Alexander Green
Investment U

But don’t be fooled. The recessionary forces weighing on it will likely prove too much to bear and stocks could merely be saving themselves for the next leg down this summer. Aside from that, a bear market rally of this magnitude simply isn’t sustainable over the long-term without another pullback along the way.

Over the past few weeks, we’ve prepared you for this by highlighting investment strategies that can not only protect you from this scenario, but also put money in your pocket, and allow you to invest with less money and risk upfront. If you missed them, check out our columns on covered call selling, put option selling and LEAPS options.

But here’s another great income-producing strategy that can help offset any downside – dividend stock investing…

Want To Buy A Dividend Stock? Look At These Four Areas First…

Investing in companies that give you money back for holding the shares can literally pay dividends.

It’s a strategy that works well in any market – but it’s particularly reassuring to have a stable source of passive income during a tough climate like this one. In addition, each dividend payment will reduce the original price you paid for the shares.

However, you must make sure you invest the right way. Keep in mind that dividend yields rise when stock prices fall, so in a market like this, it’s crucial that you don’t just chase after big numbers.

You need to dig a little bit deeper to make sure you don’t get stuck with a company that is all style, but no substance. While a fat dividend may be good PR and helps entice more investors to the stock, you need to make sure it’s solid. That means looking at its…

• Existing Cash & Cash Flow: How much cash does the company have on its books? Can it even afford to pay a dividend? While management can cut costs, the cash flow statement is harder to tweak. Take a look at this, plus its ability to generate cash flow from current operations, which it can dish to shareholders and reinvest back into the business. While short-term profits can fall, if a company has sufficient cash to protect the dividend, you’re in better shape than investing in one that doesn’t.

• Earnings Growth: While all companies endure short-term profit fluctuations, make sure a company has long-term earnings growth potential. Sometimes, if its potential is limited, it will sweeten the deal by paying more in dividends, which is not a particularly good long-term strategy – for them or you.

• Debt Level: While it’s not terrible for a company to have debt, the question is: Can the firm handle it? If the burden is too heavy, yet it’s still paying a cash dividend, it may not be sustainable for long.

• Dividend History: Does the firm have a good track record of raising its dividend – or at least holding it steady – through good times and bad?

Two Sectors To Consider For The Best Dividend-Yielders

When selecting dividend stocks in a bear market, it’s imperative to diversify away from volatile, vulnerable stocks.

For example, take the iShares Dow Jones Select Dividend Index ETF (NYSE: DVY). From trading in the mid $60s in early 2008, it got crunched when the financial crisis hit, as half its holdings were in financial shares.

And two WisdomTree ETFs recently combated the volatility in financials by removing the sector from two of its funds and renaming them – the WisdomTree Dividend Top 100 Ex-Financials (NYSE: DTN) and WisdomTree International Dividends Ex-Financials (NYSE: DOO).

Instead, look at sectors like Utilities and Consumer Staples, which traditionally churn out healthy dividends, as the companies within them generate critical repeat business, regardless of the economy. After all, everyone needs food, drink, electricity, and gas. As such, the balance sheet keeps ticking over and they’re able to withstand shocks better than others.

There are many utility-based ETFs, but take a look at the largest one – the Utilities Select SPDR (NYSE: XLU), which tracks S&P 500 utility stocks, or the Vanguard Utilites ETF (NYSE: VPU). The funds pay a dividend of 4.8% and 4.3% respectively. In addition, ETF Guide says the income received from the dividends is taxed at 15% rate, lower than regular income tax rates.

In the Consumer Staples area, consider the Consumer Staples Select Sector SPDR (NYSE: XLP), with a dividend yield just under 3%, or the iShares Dow Jones U.S. Consumer Goods ETF (NYSE: IYK)

For a broader exposure to dividend-yielding companies, check out the PowerShares High-Yield Dividend Achievers ETF (NYSE: PEY), which includes companies that have increased their annual dividends over the past 10 straight years. It also has a 12% and 14% weighing in the Utilities and Consumer Goods sectors respectively.

The bottom line with dividend-yielding companies is to look for solid, stable businesses (preferably in sectors more resistant to the recession that can generate repeat business regardless) that can grow both now and in future, handing you some healthy passive income in an economy where it’s tough to get it.

Martin Denholm
Smart Profits Report

Standard and Poor’s Inc. (NYSE: MHP) last week put Britain’s credit rating under review for a possible downgrade, a precursor to a potential reduction in the country’s AAA credit rating. Since that indignity was avoided even in 1976, when Britain had to be bailed out by the International Monetary Fund (IMF), this raises questions about the safety of an investment in Britain’s government debt.

Needless to say, Britain and the United States have pursued similar policies in response to the ongoing global financial crisis, and are currently running similar budget deficits: Britain’s budget deficit this year will be 12.3% of gross domestic product (GDP), compared with 13.2% for the United States, according to The Economist.

Given those parallels, Britain’s credit review has to raise questions about whether a similar fate might await U.S. Treasuries. Indeed, the 10-year U.S. Treasury yield has already risen to 3.45% from its low of 2.07% in December, and it appears likely to rise even more.

That brings us back to my opening question: Should individual investors who are subject to inflation even consider U.S. Treasury bonds as a safe and secure investment?

Let me give you an extreme example – one that has jaundiced my entire view of government bonds since childhood. My Great Aunt Nan, a favorite relative in my childhood who had operated a small business, retired at 65 in 1947, having been born in 1882, one year too early for a self-employed person to qualify for a government pension in Britain. That was no problem, however – she had pretty substantial savings, which if invested prudently would give her enough income for a comfortable retirement. So she invested those savings prudently – and, indeed, patriotically – in a British government “War Loan” then yielding 2.5%, a “consol” paying income perpetually, with no maturity date. It gave her a retirement income of about 400 pounds a year, equivalent to about $30,000 today.

Actuarially, she was lucky – she lived in quite good physical and mental health to 91, which meant many happy visits to her during my childhood in the 1950s and 1960s.

Financially, she was rather less lucky, and suffered from an investment one-two punch:

• First, the War Loan in 1973 – the year of her death – yielded 10.8%, so the nominal value of her savings had declined by 77% (since the market value of a bond moves opposite the direction of interest rates).
• Second, consumer prices increased by 227% between 1947 and 1973, so the real value of her income had declined by 69%, and the real value of her savings had declined by 93%.

Government bonds – a safe investment. Yeah, right …

Obviously, there are examples that make the opposite case. For instance, if you had invested in long-term U.S. Treasuries in 1981, when they yielded around 15% (the U.S. prime rate actually reached 21.5% during that period), you would have done very well, indeed: The U.S. Federal Reserve, having finally vanquished inflation, embarked upon a rate-reduction campaign that brought American interest rates down at a steady rate for much of the rest of that decade.

But since governments control both monetary and fiscal policy – and since politicians are politicians – they combine to engineer things so that there are far more bad years than good years to be an investor in government bonds. Central banks and insurance companies buy government debt because they have to, but there’s no reason for you and I to get involved in these unattractive one-way bets. Even at 3.5%, 10-year U.S. Treasuries are a positively bad investment, since the U.S. budget deficit is so large that supply of them will never be limited, while inflation looks likely to reappear in force, draining the value of these bonds as inflation did to the savings of my great-aunt.

As daunting as all this all sounds, it’s not the worst that could happen: We still haven’t considered the possibility that the government could actually default on its debt.

Economists will tell you that governments can’t default on bonds in their own currency, because they can always print more money. In extreme cases, printing more money will lead to high inflation or even hyperinflation, leading to an effective repudiation like that perpetrated on my great aunt, or even like that carried out by the German Weimar Republic in 1923, when German prices were measured in the trillions of marks.

Economically, to avoid Weimar 1923, it would be better for a government to default outright, because at least non-government bonds and shares would still be worth something, and values would not be altogether destroyed.

After all, think about it – which would you expect to provide better investments: private companies, which create value, or the government, which merely spends money?

There are no sure things in life, but there are better investments and worse ones. Today, Brazilian government bonds, currently yielding 11.86% in Brazilian reals for an eight-year maturity, are a sounder investment than U.S. Treasuries; Brazilian inflation is expected to run 4.4% in 2009, so that’s a real yield of 7.46%, and the Brazilian budget deficit is only 2% of GDP.

Gold is always attractive while you think inflation is imminent – even at its current price, which is close to $1,000 an ounce. The gold market at $100 billion a year of production is far too small for the potential demand from central banks and speculators, so if inflation gets a real grip, the price of gold could easily go to $5,000.

Then there are stocks. Not cyclical stocks, which will suffer badly if the government finance chaos causes an even deeper recession than we already have. But shares in modestly leveraged companies producing low-priced consumer staples, which will continue to be purchased in even the deepest recession. In this area, think about such companies as The Procter & Gamble Co. (NYSE: PG), The Coca-Cola Co. (NYSE: KO), The Hershey Co. (NYSE: HSY) or, for lowish-priced entertainment, why not Nintendo Co. Ltd. (OTC ADR: NTDOY)?

In one way or another, Procter & Gamble, Coca-Cola, Hershey and Nintendo add value to our lives.

And to my way of thinking, that makes each of these a much better investment than a debt-ridden government. Don’t you agree?

By Martin Hutchinson
Money Morning

And if it is, how should you play it?

For the past few months, optimistic analysts and investors have been scouring the global economy for so-called "green shoots" – a new financial buzzword that refers to any early indicators of a financial recovery.

Investors believe they’ve seen enough evidence that the U.S. economy may be bottoming out to ignite one of the strongest stock-market rallies in years. After closing at a 12-year low on March 9, the Standard & Poor’s 500 Index has soared 32%. The  Dow Jones Industrial Average has zoomed more than 27%, and the tech-laden Nasdaq Composite Index has rocketed 34%.

In a March 15 interview on the CBS show, "60 Minutes," U.S. Federal Reserve Chairman Ben S. Bernanke said the United States escaped a repeat of the 1930s Great Depression. The economic downturn would hit bottom this year, with an actual recovery starting in 2010.

"And I think as those green shoots begin to appear in different markets, and as some confidence begins to come back, that will begin the positive dynamic that brings our economy back," Bernanke told viewers.

But now those "different markets" appear to be sending some troubling signals.

Green Shoots Yield to Red Ink

Last week, Mexico reported that its economy contracted at an annualized rate of 21.5% in the first quarter. The report followed equally dismal reports from Japan, Germany and the United States. Japan – the world’s second largest economy – said its gross domestic product (GDP) contracted at a 15.2% clip, its worst performance since 1955. Germany’s economy shrank at a 14.4% annualized pace, its worst showing since 1970.

In fact, Europe as a whole stumbled in the first quarter, as economic activity in the 16-nation Eurozone fell the most in 13 years. The Eurozone’s economy contracted by 2.5% in the three months that ended March 31.

At home, the U.S. economy contracted by a 6.3% annual rate, with the U.S. Federal Reserve predicting "a gradual recovery" that starts in the second half of this year.

If uncertainty continues to be the watchword, how should investors position themselves?

Staying on the sideline may appear safe, but it’s actually been proven through research to be a risky strategy. For instance, after looking at S&P 500 returns between 1993 and 2007, Davis Advisors Funds found that investors who remained invested and didn’t try and "time" the market ended up being much better off than investors who moved in and out of the market – often missing strong days in the market, as a result, says Wellcap Partners Managing Partner Alan Schram.

Investors who remained invested received an average annualized return of 10.5%. But investors who missed just the best 30 trading days over this stretch saw that return drop all the way down to 2.2%. And the more strong days an investor missed, the worse the returns got, Schram says.

Here’s a summary of the results of that study, looking at the investor’s action and the average annual returns that resulted:

• Stayed the course: 10.5%.
• Missed the 10 best days: 7.1%.
• Missed the 30 best days: 2.2%.
• Missed the best 60 days: (-3.2%).
• Missed the best 90 days: (-7.4%).

Nevertheless, there’s still about $8 trillion sitting on the sidelines – enough to create a sustainable market really should the "green shoots" grow into a full-fledged recovery.

Are Income Stocks the Antidote in a Sick Economy?

OK, so it pays to stay invested – but invested in what? And what if the hoped-for recovery ends up getting blunted? After all, those "green shoots" could easily wither on the vine.
According to Money Morning Contributing Editor Martin Hutchinson, seeking out stocks with high – but sustainable – dividend yields is the perfect strategy for an imperfect market.

Stocks with high-dividend yields are one part of a two-element investing strategy that Hutchinson says can create "permanent wealth" for investors who are willing to follow it through. Gold is the other key part.

Income From Dividends: One Pathway to Permanent Wealth

Dividend payouts are a way that a company’s leadership can signal its confidence in the future, Hutchinson says. A company has to have profits and – just as important – cash flow to finance the quarterly payouts, so a company that is maintaining a high yield is basically letting its investors know that it’s upbeat about its future.

Management is "basically saying to you that we’ll be able to keep paying this going forward," which is a bullish sign, Hutchinson says.

Income is a key component of any investment strategy.

"Dividends create wealth in two ways. First, they provide cash flow that you can either use for living expenses or to reinvest: That means there’s no more having to sell shares, often at a depressed price, to meet your monthly bills, or to finance a vacation or home remodeling," Hutchinson says. "Second, if you buy shares with high dividend yields, there’s a good chance that the market will eventually notice the superior [dividend] payouts, and revalue the shares so that their dividend yield is back down around the market’s average. For a dividend yield to go down in this manner, the stock price has to go up. Once that happens, you have received dividends and capital gains."

While dividends provide income stability, gold provides a hedge against the inflationary pressures that are virtually certain to emanate from the massive amounts of money that the federal bailout and stimulus plans are injecting into the U.S. economy.

The recent surge in the prices of both gold and oil are proof that the markets expect inflation to escalate.

"Gold and gold-based investment – such as gold-mining companies – are an important part of a permanent-wealth-investment strategy because of gold’s historic function as a store of value that is impervious to inflation. At the moment, when inflation is low but there is a big danger of it rising, gold investments are an essential protection for permanent wealth investors," Hutchinson says.

By Jason Simpkins and William Patalon III
Money Morning

P.S. The secret to protecting your wealth in this financial crisis Click Here

But those same investors are starting to unleash a landslide of cash into the markets. According to the April, 2009 Merrill Lynch Survey of Fund Managers, optimism about global economic growth has reached its highest level since 2004, prompting investors to lower their aversion to risk.

The percentage of investors who are overweight in cash in their accounts fell to 28% in April from 41% in March. That’s a significant drop, and it represents a lot of cash being put to work elsewhere.

Those numbers make sense, according to AMG Data. The $3.7 trillion money market fund sector experienced cash outflows of $35.5 billion in February, $51.15 billion in March, $18.7 billion in April and $15.2 billion so far in May.

Why? Investors’ aversion to risk is waning, and they are beginning to feel comfortable again putting money into riskier investments. So where’s all this cash going? That depends somewhat on whom you ask, but the short answer is just about every place it came out of last fall, including municipal bonds.

Gary Baker, co-head of international investment strategy at Banc of America Securities-Merrill Lynch Research, recently remarked, “Improving sentiment on financials has decisively removed the log jam on sector rotation, prompting a march out of defensives into cyclicals.”

And it’s just getting started, according to Michael Hartnett – Gary Baker’s partner at BOA: “It’s important to note that asset-allocators are still underweight equities, indicating they have yet to fully embrace the idea of a new bull market.”

One place they are embracing the bull market idea, however, is China, where investor bullishness is at a six-year high: “Investors looking to play the global recovery are using China and other emerging markets, rather than Europe or Japan, to do so,” Harnett said.

Opening the Financing Floodgates Into Municipal Bonds

Perhaps the most interesting place money appears to be flooding into is one area that sorely needs it: the municipal bond market.

In the midst of the financial crisis in the fourth quarter of last year, money was drained from the muni -bond market – and the 1,728 mutual fund share classes that invest in them. Investors pulled out $9.42 billion and market losses slashed another $$42.3 billion from the sector.

That was a tough time for many state and local governments, who rely heavily on municipal bonds to finance many large capital-intensive projects like schools, water and sewer plants, and hospitals.

Jed McCarthy, managing member of 1861 Capital Management, said, “People forgot ‘munis’ were safe credits.”

Well their memories have apparently returned: Investors are shoveling money back into municipal bonds at record rates – to the tune of $1.73 billion per week – according to AMG Data.

As a result, the muni market is appreciating once again, regaining $23.4 billion so far in 2009. Great news for investors and governments alike.

Newfound Interest In Municipal Bonds Has Staying Power

This newfound interest in municipal bonds will likely have staying power. The reason? Investors – many of whom were burned big time in the stock market last year – are looking to reinvest, but want a safer alternative than stocks.

They’re not ready for a full-on charge into equities just yet…

They are finding it in municipal bonds. Right now, 30-year munis (according to the Municipal Market Date-Line yield curve) offer a tax-exempt yield of 5.19%. This translates into an equivalent taxable yield of 8.5% (assuming Obama’s proposed top tax bracket of 39%).

As far as municipal bond funds go, there are literally hundreds of them. You can buy funds that contain bonds from nearly every state in the union, and most brokerages offer general, closed-end municipal bond funds as well.

iShares S&P National Municipal Bond Fund ETF (NYSE: MUB) and the SPDR Barclays Capital Municipal Bond ETF (NYSE: TFI) are two good ways to cover the entire space.

Check out www.municipalbonds.com for everything you need to know to get started investing in municipal bonds. But don’t wait for a market correction. We’re already in it.

Good investing,

David Fessler
Investment U

"We’ve got the cash flow to pay the dividend," GE Chief Executive Officer Jeffery Immelt said in a Feb. 5 interview with The Wall Street Journal.

But by the end of the month, Immelt’s resolve had collapsed under the weight of the global financial crisis and his company announced its first dividend cut since the Great Depression. GE slashed its payout by more than two-thirds, from 31 cents to 10 cents per share.

GE is not alone. Companies typically abhor dividend cuts, as they are widely viewed as a sign of desperation. But lean times – like those we’ve experienced in the past year and a half – have left even the proudest U.S. firms with little recourse.

By cutting its dividend, GE will save about $9 billion a year.

The 117-year old American icon was joined by a record number of companies that issued dividend cuts in the first quarter of 2009. Companies slashed a total $77 billion from investor payouts in the three months ended March 31. For the first time since 1955, dividend cutbacks actually outweighed dividend increases. 

“While the number of dividend decreases is at a record high, the number of increases has set a new record low,” said Standard & Poor’s Chief Index Analyst Howard Silverblatt.  “The average has been for every 15 increases there is one decrease.  Now it is three increases for every four decreases.”

The long list of businesses that have cut their dividends reads like a “Who’s Who” of Corporate America.  Bank of America Corp. (NYSE: BAC), Citigroup (NYSE: C), Motorola Inc. (NYSE: MOT), CBS Corp. (NYSE: CBS), and Pfizer Inc. (NYSE: PFE) were among the victims.

Now that even America’s proudest, most-reliable labels have reduced their payouts, it’s hard to tell exactly which companies will be the next to cut their dividends. But here are some simple rules to follow when looking for a safe place to invest your money for long-term dividend growth.

Three Rules for Dividend Investing

Dividends remain a critical element of investing success, Money Morning Investment Director Keith Fitz-Gerald has repeatedly said. That’s especially true in the uncertain, whipsaw market conditions that have dominated since last fall.

According to Fitz-Gerald, one study by Ned Davis Research is particularly telling, noting that dividend-paying stocks provided returns of more than 10% a year from 1972 to 2005. Non-dividend paying stocks, in contrast, posted gains of just 4.1%.

Other experts say there are three rules to follow in order to identify companies whose dividend payouts are likely to remain in place – or even grow.

1. History Repeats Itself: Look for companies that have a history of raising their dividend.  For some organizations, dividend growth is a top priority and their track record will show that.  Although GE is clearly an exception, if a company has consistently raised its dividend for decades at a time, it will likely continue to do so.
2. Earnings vs. Payout: Research is key when investing in any stock. When looking at companies that offer a dividend, a good question to ask is: “What does the company pay per share versus its assets and earnings?”  Dividend payouts cannot grow if a company’s earnings do not grow, so check a company’s earnings history.

3. Black-and-Blue Stocks: Avoid stocks whose earnings have been hammered. While in today’s market most stocks are beaten down, stocks valued below $10 a share are generally there for a reason. 

Three Companies That Are Unlikely to Cut Their Dividend

NYSE Euronext (NYSE: NYX): NYSE Euronext is a diverse exchange group that offers a 4.69% dividend yield, making it an extremely attractive investment opportunity. While the company was hit hard during the beginning of the recession (trading at over $100 a share to a meager $25.59 as of yesterday’s close), it still shows strength for long-term investment.

“The dividend is intact for 2009 and we have no plans to change it,” NYSE Euronext Chief Executive Officer Duncan Niedereaur said during a recent appearance on the 1,000th episode of CNBC’s “Mad Money.”

NYSE Euronext completed its takeover of the American Stock Exchange (AMEX) in October.  And the company has seen a tremendous improvement in its overall trading activity over the past month. Its cash equity business is up 11% on a month-over-month basis, and its U.S. consolidated equity volumes were close to record levels at 12.3 billion shares.  That’s a 48% increase from last year, and a 12% jump from February.

Additionally, the U.S. Securities and Exchange Commission (SEC) recently had a hearing and ruled unanimously in favor of reinstating five rules against short selling following the guidelines of the former “Uptick Rule.”  This ruling is important to the Big Board’s growth because short sellers helped drive down share prices. 

The recession that’s plagued the markets over the past year and a half has severely diminished trading volumes, and therefore the profits of the New York Stock Exchange. The newly established rules on short selling can only make the company stronger. 

“We are a three-year-old public company,” CEO Niedereaur said. “Long-term prosperity for this company is based on fairly run markets and the reinstatement of the uptick rule is a major plus for this company.”

Johnson & Johnson  (NYSE: JNJ): Johnson & Johnson is a strong company with a solid dividend that yields 3.51%. Its stock remains undervalued, down 23% from its 52-week high of $72.76 a share.

Johnson and Johnson is the quintessential dividend growth stock. Its dividend has grown 14.10% on average every year since 1999.  A growth rate that high means the company’s dividend is doubling about every five years.  This has been the pattern since 1974.

Last year, JNJ’s revenue was $63.7 billion, producing a net profit of $13 billion – an increase of 22% from 2007. 

JNJ’s most recent acquisition of Mentor Corp. (NYSE: MNT), a global supplier of medical products for the cosmetic-surgery market, gives JNJ the opportunity to compensate for a decline in its pharmaceutical sector (the unit has cut more than 900 sales jobs and is dealing with drug-approval  issues).

“Mentor will become the cornerstone of a broader Johnson & Johnson strategy for aesthetic medicine – serving both consumers and medical professionals,” Johnson & Johnson Chairman Gary Pruden said in a statement. “We will use our combined strengths and experience to build a market-leading aesthetic business that capitalizes on Johnson & Johnson’s broad-based commercial capabilities, worldwide surgical care footprint, and clinical scientific capabilities.”

The Proctor & Gamble Co. (NYSE: PG): Proctor & Gamble offers a healthy dividend of $1.60 a share, yielding 3.26%. At $54.02, its stock down 26.5% from its 52-week high of $73.57 share. 

P&G is another example of a classic dividend growth stock:  It has been raising its dividend for the past 55 years. For 10 consecutive years, P&G has delivered its shareholders an annual average return of 3.10%.  Since 1973, dividend payments have doubled every seven years.

Proctor & Gamble offers branded consumer goods that branch off into three global markets: Beauty, household care, and health and wellness. Many common household items come from this company, such as Gillette Co. shaving products, Tide laundry detergent, Pampers baby diapers and Bounty paper towels, to name a few. During troubled times, a stock such as this is often a nice defensive play, since families are unable to do without these items. 

“Today we reach a little more than half of the world’s 6.7 billion consumers,” Proctor & Gamble CEO Alan G. Lafley recently told BusinessWeek. “We want to reach another billion in the next several years, and much of that growth is going to be in the emerging markets, where most babies are being born and where most families are being formed. We see growth across our entire portfolio.”

Since 61% of P&G’s sales come from outside the United States, a weaker dollar is going to be a large factor in this company’s success.  A weaker dollar makes U.S. made exports cheaper for foreign consumers to buy. While the company is timid about its earnings and fears that business conditions may have slowed from last year, the Cincinnati-based company raised its dividend in March.  From an investment-research standpoint, increasing dividends despite expectations of a decreased consumer market is typically a good sign.

By Martin Biancuzzo
Money Morning

Early this morning, that’s what Fed Chairman Ben Bernanke told a Congressional committee charged with overseeing (?) the economy.

Is he right and inflation is not a concern now? Or is he wrong and Inflation is a much bigger risk than he’s letting on?

These are the questions weighing on many folks’ minds right. And rightfully so too. After all, the difference between getting it right and wrong will be big.

If you bet correctly, the window of opportunity is wide open.

If inflation wins out, now is one of the best opportunities in years to invest in farmland, toll roads, and other “real assets” which perform exceptionally well during inflationary times.

If deflation wins out, now is the time get out of everything. Cash and long-term government bonds will be top performers.

That’s why now, with opinion still sharply divided, is time to get positioned. First though, we’ve got to determine which way to go.

Let History be Your Guide

Over the past few months we’ve looked at all sides of the inflation/deflation argument. We’ve discovered that all bubble-booms throughout history eventually end in deflationary busts. We’ve also watched the Federal Reserve go to unprecedented lengths to increase the money supply in an effort to battle deflationary forces.

Our current situation, however, is not like every other bubble-boom-bust. So many comparisons have been made to the Great Depression. But most of them fail to account for one key difference, massive government spending around the world.

The current levels of U.S. government deficit spending are well documented. After a year of nearly $1 trillion “stimulus” packages and aggressive loosening of monetary policy, Congress is now set to debate spending another $4.1 trillion. While they haggle over whose friends will be taken care of the most, the administration tries to close every tax loophole in exchange for a short-term cash infusion, and everyone pats themselves on the back for finding $100 million in savings, there are much bigger consequences to be dealt with.

The deficit resulting from the record budget spending is expected to be between $1.7 trillion (best estimate) and $2.8 trillion (highest estimate I’ve seen – probably much more reasonable as well) after the new spending plan budget is passed.

Of course, every administration for the past 50 years has proven “deficits don’t matter” so that’s not much of an issue for too many people (enough to matter right now anyway).

That’s small compared to the real issue at hand anyway. The big problem is the outlays the government is about to make – whether they’re funded by increased taxes, printing money, or debt (or all of the above).

Desperate Times and Desperate Measures

Under the guise of saving the economy, the U.S. government has committed itself to spending so much money that GDP growth is inevitable.

This is not a new strategy. It has been a few times before in U.S. history. Just take a look over the past 150 years. The last few times U.S. government spending reached these levels (as a percentage of GDP), the consequences, which were always the same, followed close behind.

In 1861, the Union printed more money, borrowed everything it could, and spent it all to fight back the “rebels.” Inflation between 1861 and 1865 ended up at 117% for the period. That’s 16.7% on an annualized basis. 

In 1917, President Woodrow Wilson aggressively emptied the government coffers in World War I. Prices increased 126% between 1917 and 1918. That’s 50.3% annual rate.

In the 1940’s we went through it again. The U.S. involvement in World War II forced another surge in government spending. This time the prices rose 108% between 1941 and 1945. That works out to a 15.7% annual rate of inflation.

Then in the 1960’s, during the quest for the “Great Society” amidst the Vietnam War, the U.S. government stepped up spending in a big way. The end result was the “lost decade” of the 70’s and stagflation which followed.

See a pattern here?

You’re not the only one. That’s why I’m so perplexed the markets, once again, expect it really is different this time.

It’s no secret the government is spending big. History shows the results are always the same. Still though the market doesn’t seem to be too concerned about the inflationary effects of what will surely follow.

The market’s refusal to accept reality, however, could be starting to come to an end.

A Changing Tide: Bonds Don’t Lie

Although the stock market gets all the headlines, the bond market is actually far better at predicting an economic recovery, expected inflation, etc. It’s just so much bigger and more efficient.

That’s why I always pay close attention to it. And a funny thing happened this week. Something which showed the tide could be turning when it comes to the deflation/inflation debate (well, at least where people are placing their bets – I’m always weary of people who don’t “eat their own cooking”).

This week the yield on the 10-year Treasury bond climbed to 3.18%. That’s just shy of a five-month high of 3.21% and could be forecasting inflation on the horizon. Remember, bond yields move inversely to bond prices. So the yield increase means the selling pressure is increasing and/or the buying demand is declining.

In the chart below, you can really see the decline in the value of the long bond as tracked by the Barclays 20-Year Treasury Bond ETF (NYSE:TLT):

Long-term government bonds have experienced a pretty strong sell-off since the credit crisis sent bond prices soaring.

Why would bonds be selling off, you ask?

Well, there are two reasons.

The first is the economy is showing signs of improvement. As the economy shows some “green shoots,” investors are likely willing to take on a bit more risk. As a result, they sell out of government bonds and move into riskier assets like stocks and corporate bonds. Both of which have been doing exceptionally well lately.

The other reason is inflation. A bond’s yield must be equal to or higher than inflation expectations. If it wasn’t the bondholder would be getting a negative return. Although this has happened in rare instances in the past, most bondholders are not willing to accept a guaranteed loss. So when inflation starts to become a concern, bond prices fall and yields rise.

Whether this is the big one when inflation really starts have impact or it’s is a few months or years down the road doesn’t really matter here. Inflation is coming and it’s never too late to get prepared.

Winning Either Way

In the past few of years we’ve seen a lot of changes. Politics has moved into a greater role in our personal and business lives. As it has, the divide between the capitalists and socialists has grown even wider.

We could even be witnessing Alexander Tyler’s prediction play out right before our eyes. The Scottish philosopher warned of democratic governments:

A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy.

Slowly but surely, it looks like the “majority” has figured it out. And the inevitable result will be sharp increases in government spending to appease the majority. There are only a few ways to fund that spending. As we looked at a few months ago, there will be three ways:

1. Increase taxes
2. Borrow more money
3. Print more money and inflate the debt away

At this point, it’s likely we’ll get some increase in taxes (remember, it’s the “patriotic” thing to do), a lot more government borrowing, and a lot of money printing and inflation. They’re the politically easiest choices to make.

Its times like these which I can get exceptionally frustrated. When I first started investing, I enjoyed looking for great ideas, great business models, and great products.

There was nothing like uncovering a successful business which was meeting its customers’ needs and the customers were happy purchases and on its way to creating vast amounts of shareholder value.

But when all the forces are pointing towards a huge wave of inflation coming – an annual rate of 10% to 20% given the historical ranges – you’ve got to take what the market gives you. And right now, while the inflation/deflation debate rages on, it’s giving us a chance to protect ourselves from the coming inflationary wave inexpensively and maybe actually profit as well.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

As I wrote in my last essay, long-bond prices are plummeting right now. They have just broken down to new five-month lows… and the selling pressure is so strong, not even the Fed’s printing press can hold prices up.

When the long bond falls in price, its interest rate rises… The long bond’s yield was as low as 2.5% in December. It has now risen past 4%. This could be a huge problem for income investors

The long bond competes with other income investments for investor capital. So a rise in the long bond’s interest rate can crush certain income investments. Let me explain…

If the long bond’s yield rises from 4% to 8%, the yield on all other income investments must also rise by 4%. A 12% junk bond would become a 16% junk bond. A 14% dividend payer would have to become an 18% dividend payer.

Here’s the problem: For yields to rise that much, prices must fall – a lot.

So right now, as long-bond rates rise, buying income investments is a treacherous proposition. Here’s the advice I gave to readers of my 12% Letter on how to safely earn income in a bond bear market…

First, keep compounding. When you reinvest your dividends, your dividends start paying dividends, too. Compounding is a powerful force that builds fortunes. A bear market in the long bond will NOT hurt the power of compounding.

Second, the "junkiest" bonds and high-yield stocks will suffer the most from a long-bond bear market. Avoid risky income investments that use debt and financial engineering to pay large dividends. Stick with only the best-quality, high-cash-flow businesses that relentlessly raise their dividends.

Finally, make sure you understand how to trade a covered call. Covered calls are the perfect strategy for collecting income in a bond bear market. Unlike bond coupons or stock dividends, the yield you earn from selling covered calls has nothing to do with market interest rates or credit quality. You can generate double-digit dividend yields without taking big interest-rate risks.

Take these precautions, and you should have no problem earning high income yields in a long-bond bear market.

Good investing,

Tom Dyson
Daily Wealth

There are two ways these BABs work… 

A state or agency can elect to pay a higher rate to bondholders, while 35% of the interest it pays will be rebated back to the issuer by the Federal government. Or the issuer can pay a lower rate in which 35% of the interest received by investors will be tax-free. While issuers have so far mostly gone with choice number one, either way, the bonds are taxable, an important difference from traditional municipal bonds. 

Since BABs are taxable, try comparing them to corporates instead of munis altogether. 

This Broke State Could Reward You Handsomely

California recently issued $5.23 billion of 25 and 30-year BABs that pay an annualized rate of 7.4%. But with the Fed reimbursing it for 35% of the interest, the state will only be responsible for 4.8% in the end. 

To get a similar yield in the in the corporate bond market, an investor could buy bonds of Amgen (Nasdaq: AMGN), Norfolk Southern (NYSE: NSC), or Verizon (NYSE: VZ), three solid companies that shouldn’t be going under any time soon.

Then again, these days, you can never be too careful, which is yet another reason why a BAB is interesting. Because for the same yield, investors who take the patriotic route through a Build America Bond, can have their cake and eat it too… backed by the full faith and credit of the state of California. 

While I can understand if that particular state’s finances don’t dazzle you these days, even now with all of its economic woes, the chances of default are significantly low. And quite frankly, if California starts defaulting on bonds, we’ll have much bigger problems to deal with than whether or not we receive our interest payments. 

If even after all of that, trusting the first state to officially go running for help from the Fed still sounds like the financial equivalent of sticking your head into a fire ant hill, than don’t worry. Other BABs do exist. 

The New Jersey Turnpike Authority also issued 30-year BABs at approximately the same rate as California. While that deal was supposed to raise $250 million, due to overwhelming demand, it has since grown to $1.32 billion. 

BABs vs. Treasuries and Munis

One note of caution though: Don’t make the mistake of assuming that just because the Federal government is subsidizing the interest payments, it’s guaranteeing the bonds in the same way it would a Treasury. 

But while the Fed won’t, the state or agency issuing the bond will… With a yield that’s around 3.6 percentage points higher than a U.S. Treasury. 

Comparatively, a 30-year, tax-free muni from the state of California yields about 5.0%. Even in the highest 35% tax bracket, you’d need to earn 6.75% to make up the difference between paying taxes on the bond and earning tax-free income. 

Or you could take the much more simplistic road by choosing a BAB, which in this example yields 7.4%. 

Investors interested in taxable income at attractive yields with high credit quality may want to take a closer look at BABs.  Keep in mind these may not be suitable for trading at this point as they are not be as liquid as other bonds.  As of right now, they’re likely better used as a long term investment. 

For more information about this new type of bond, be sure to talk to your broker. Or if you prefer, call GunnAllen Financial’s Bill Nonte at 1-800-329-1924.  He’ll be able to answer your questions and help you determine if this is a suitable investment for you.

Marc Lichtenfeld,
Smart Profits Report

"This is the best thing that could ever have happened to us," I tell them.

It’s as if someone just flicked on the "turbo" switch for income investors. Every dollar you invest is now bringing in two, three, even four times as much income as it did a year ago. As I covered last week, yields on the MLP sector are high. You can earn safe double-digit income in assets like Annaly. Best of all, options premiums are high, so you can turn world-class blue-chip stocks into 15% income yielders right now.

I write an advisory called The 12% Letter. It’s dedicated to finding the best income opportunities in the stock market. Right now, our portfolio of income-producing assets is just amazing.

Take Procter & Gamble as an example of the kind of blue chip we’re holding. Procter & Gamble has the highest dividend yield its had since 1988.

The dividend is 4%… and it grows every year. P&G now has 53 consecutive years of dividend growth… and over the last 10 years, the dividend has increased an average 11% a year.

To supplement Procter & Gamble’s 4% dividend yield, we’ve sold covered calls against our position… turning the 4% yield into a 15% yield. The quality of P&G’s business lets me know it’s a safe 15% yield as well.

Procter & Gamble generates obscene amounts of cash. In the last 12 months, P&G’s operations spun off so much cash, it was able to invest $3 billion in growing its business, buy back $10 billion in stock, pay off $2.8 billion in debt, and pay out $4.9 billion in dividends.

And as Dan Ferris highlighted last week, you can pick up names like Procter & Gamble and ExxonMobil at cheap prices right now.

Combine the cheap valuations, the dominant competitive advantages, and rich option premiums, and you have yourself a very safe stable of income stocks. (I encourage you to learn about companies like Annaly and pipeline stocks to round out your income portfolio. These ideas are also safe double-digit yielders.)

Right now, the yield in my newsletter’s portfolio is 13%, including the income from our option selling. In other words, $100,000 spread evenly across the stocks in the portfolio will spin off $13,000 per year in income.

To get safe 13% annual income from the world’s strongest stocks is unbelievably attractive… especially when you consider 30-year mortgage rates are 4.75% and national CD rates are 2%.

This opportunity is available right now. And it’s paying off for those who have the guts to stand up and buy when no one else will.

Good investing,

By Tom Dyson
Daily Wealth

The wild market swings have most investors just as wary as when the market was setting new lows. After six weeks of steady upswings, there still aren’t too many believers in this rally. The mainstream media echoes investor sentiment.

BusinessWeek questions “Is the rally on strong footing?”

Canada’s Globe and Mail advises, “Don’t get your hopes; it’s a dead cat bounce.”

The Financial Times reports Duncan Neiderauer, CEO of NYSE Euronext, said, “The real money investors are still waiting. I think they’re waiting, they’re watching. They want to make sure that what we saw in March is real.”

On top of that, the mixed signals from economic data shows we’re not completely out of the woods yet. Retail sales fell more than expected this week. Meanwhile, consumer confidence readings rose.

With so much bullish and bearish data and comments thrown at us every day, it’s tough to make a choice. But that doesn’t mean there’s no opportunity. There is. And it’s not necessarily in stocks.

You can find an opportunity in a security which, at currently depressed levels, offers just as much upside potential as stocks and carries significantly less risk than as well. And for investors who move in now, they will be able to ride the current upswing without risking too big of a risk.

I’m talking about bonds.

Follow the Money

Since stock prices fell off a cliff, bonds have become fashionable again. The combination of high yields, low volatility, and a perceived sense of safety has brought investors back into “boring old bonds” in a big way.

Bond returns have been just as good (even better in many cases) than stocks since the markets set new lows last fall and again in March. For instance, the iBoxx Investment Grade Corporate Bond ETF (NYSE:LQD) has rebounded more than 20% from its October lows. It yields about 6%.

The return on more speculative high yield bonds has been even better. The iBoxx High Yield Corporate Bond ETF (NYSE:HYG) has climbed 25% in since early March. It yields almost 12%. As you can see in the chart below, high yield bonds consistently outpaced stocks:

The rally in bonds has been a strong one. And the force driving it is a bit more apparent. The bond rally has been driven by the big money. The big money, like mutual funds and institutional investors, has been buying bonds steadily throughout this downturn and shows no signs of slowing down. That’s because retail investors are continuing to fuel the big money’s buying spree.

A few weeks ago in when we looked into “When Will This Rally End?” we identified where retail investors are putting their money. In the chart below, you’ll see they’ve been pulling money out of stock funds and putting new money into bond funds during periods of relative calm:

This is good news for bonds. Recent data from the Investment Company Institute reveals demand for bonds hasn’t slowed.

Last week, more than $11 billion of new money flowed into mutual funds. Of that money, about $3.8 billion flowed into stock funds, $6.6 billion went to bond funds, and the rest went into hybrid funds which invest in both bonds and stocks.

Clearly bonds are attracting attention once again. Once you take into account the lack of faith in the rally and how cheap bonds have been, it’s not much of a surprise. They offer a lot of potential at current levels.

Double the Return, Half the Risk

For years bonds were written off. A long bull market in stocks attracted a lot of investors to stocks.  The rallying cry of Wall Street was, “Bonds are safe and safety is for losers.” When the credit crunch hit though, safety was cool again.

Back in December we looked at the emerging opportunity in bonds. In “Bonds Haven’t been this Cheap since 1932” we looked at why bonds were bonds offering safety, a high yield, and plenty of upside potential:

When the economy is rolling along, credit is flowing freely, and anyone can get a loan at a pretty good rate. In this case the risks might be lower, but the rewards are much, much lower. The risk/reward situation is against you.

During rough times, the risk/reward situation gets flipped around. When no one else is willing to lend (which is basically what buying bonds is like), you can get paid a much higher interest rate. There are a lot of borrowers, not many lenders, and you can get a very high reward (much higher interest rates) for your risk.

That’s what is going on with the bond market right now. The risks are a good bit higher, but the rewards are much, much higher than usual…

From here, either high-grade corporate bonds are absurdly cheap or the world economy, as we know it, is coming to an end.

The financial world as we know it has changed but it didn’t come to an end. And now, despite many well-documented economic problems, they’re still on the rise. And when bonds are rising they offer two ways to make money from them.

The first way is from the interest payments. The vast majority of corporate bonds offer interest payments of anywhere between 5% and 15% depending on credit quality of the issuer.

The second way is from capital appreciation. This return only comes from when bond prices fall.

Take a bond which is issued at $1,000 two years ago which yielded 10%, or $100 a year. The price of it may have fallen to $800 when the credit crunch hit. It still pays $100 a year in interest which works to a yield of 12.5%.

The higher yield will attract some new investors because of the greater return. But you get more than just the $100 interest payment from the bond. The price of the bond also goes up with the bond market. So the total potential gains on a bond like this $100 a year in interest as well as $200, or 25%, in capital appreciation.

That’s a pretty good return for a stock. But it’s a great return for a bond. Once you add that most bonds are safer and, as a while, are less volatile, you’ve got a very attractive opportunity. That’s why investors have been moving back into bonds in a big way. But it’s not like bonds are without risk, but there’s any easy way to unload that.

Taking What the Market Gives You

The big risk with bonds comes in their liquidity. Most are not easy to buy and sell for individual investors. As a result, if the market for bonds turns down, other buyers for the bonds could disappear in short notice. This is what happened during the credit crunch when bond prices plummeted to 70 or 80 cents on the dollar for investment grade bonds.

That’s why, when it comes to bonds, you’ve got to be liquid. The easiest way to do that is with an ETF or closed-end fund. This way you get instantaneously diversified as well.

So with another week of volatility ahead (bank “stress test” results come out next week – in order to be credible at least one bank will have to perform poorly) bonds could be a safe haven which offers income and some decent upside potential as well.

The rally in bonds also shows us there are other worthy investments aside from common stocks. And successful investors will always find the opportunities which offer the best returns relative to risk. At the Prosperity Dispatch, we’re true believers in taking what the market gives you. Right now, it’s giving us an opportunity in bonds.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Most people will never recognize this opportunity because they don’t know what a truly great income investment is. Most income seekers like to buy things like commercial real estate stocks (REITs) to collect rents.

REITs have a big problem: They’re required by law to pay out 90% of their distributable earnings. So if they want to grow, they have no choice but to take on debt or dilute your interest by selling more shares. That’s why so many REIT dividends have been cut over the past two years. Banks are in horrible shape and getting worse all the time, so it’s only going to get worse for businesses like REITs that depend on a lot of debt financing.

Take another traditional income investment: risky commodity stocks with high current yields. Investors love royalty trusts because most of them are in the energy business. These stocks paid double-digit dividends when oil was over $100 a barrel. It was great earning those big yields… until the sector fell more than 70%.

I’m not interested in those traditional income investments because right now we can buy mature, World Dominator businesses that have large competitive advantages at huge discounts. These are – and always will be – the Holy Grail of income investing.

A "World Dominator" is a company with an absolutely dominant position in its industry… like Procter & Gamble, ExxonMobil, or Wal-Mart. World Dominators can raise prices to keep ahead of inflation, get financing (or not need it) when other companies are finance-starved (like right now), and are large and well-managed enough that you can count on fewer (if any) bad surprises happening to them.

You should be looking for companies like these if you’re interested in collecting large amounts of investment income for decades. Here’s why…

Most World Dominators are past their capital-intensive, high-growth cycle… so they can funnel surplus cash to shareholders in the form of dividends and share buybacks. Instead of funding growth, cash goes to you.

World Dominators are also usually the lowest-cost provider of their product or service. They tend to crush the competition and have exceptional brand names. That means they often generate enormous amounts of cash. And that cash can support dividends through good times and bad.

Here’s where most investors don’t "get it." World Dominators aren’t yielding in the eye-popping double digits. They yield 3%-5%. But that yield grows like an oak in your portfolio. ExxonMobil, for example, has raised its dividend every year for 26 years. Procter & Gamble has increased its dividend every year for 53 years.

Now is a great time to buy these stocks. Without times of great financial turmoil, it’s hard to make a lot of money in stocks. We need bad times to buy stocks cheaply enough to make us rich over the long term. As I’m sure you’re aware, we’re in "bad times
Now is a great time to buy these stocks. Without times of great financial turmoil, it’s hard to make a lot of money in stocks. We need bad times to buy stocks cheaply enough to make us rich over the long term. As I’m sure you’re aware, we’re in "bad times" right now. The Dow Industrials just turned in the third worst year in its history… and the worst ever since the Great Depression. This has set off a fire sale in these companies. Most World Dominators go for less than 10 times annual cash flow.

If you have, say, seven or more years until you’re going to need an alternative income source, you should load up on World Dominators now and reinvest the growing dividends until you need to live off them. By the time you actually need the income, the yield over your cost will be much higher, and you won’t make the mistake of chasing high current yields on REITs or energy trusts.

Think about it: Which is more certain, Procter & Gamble’s 53 consecutive years of dividend growth or the price of oil? It’s an easy choice.

Good investing,

By Dan Ferris
Daily Wealth

Sue Moore runs a Super 8 Motel in Bowling Green, Missouri. The recession has been hard on some areas of the Midwest, but in Bowling Green, things have held up well. A nearby construction project is the reason. Nearly 1,000 workers have been holed up in Bowling Green… filling up the motels, booking up the restaurants, and keeping the waitresses busy at the local diners.

The contractors are working on a project to lay a pipeline across America. The pipeline is 42 inches in diameter and – when finished – will run 2,053 miles from Colorado to New Jersey. This month, the workers will complete the Midwest section of the pipeline and move away from Bowling Green.

They call this pipeline “Rex” for Rockies Express. It will be the largest natural gas pipeline in America… And at a cost of over $6 billion, it is one of the most expensive natural gas infrastructure projects ever undertaken.

The western section of the pipeline is already operating. Now the Ohio section is complete, gas will start running across the Midwest, too. Construction on the final leg of the project – the piece from Ohio to New Jersey – will begin soon.

The Rockies Express will carry between 11.5 billion and 2 billion cubic feet of gas per day. According to the owners, there was so much demand for this pipeline, it will run at full capacity, immediately.

Pipeline construction is a major headache, but once you’ve completed the project, there’s no better business… especially if you like earning a steady income stream. Here’s why:

There’s almost no cost to run Rex. It needs almost no maintenance or labor. And it’ll do its job for the next 100 years. Rex doesn’t care about recessions or wars. Buried underground, your investment is completely safe.

And Rex will always be full, so it’ll keep cranking out cash flow. There’s a massive surplus of gas in Wyoming and Colorado. There’s a shortage of gas in the cities of the Northeast and the Midwest. There’s no competition. Rex is fully subscribed under long-term contracts… even though it’s still under construction.

The government will set the tariffs for transporting gas in the Rex pipeline. This is a good thing. The government sets the tariffs high to make businesses undertake these costly construction projects. Price stability is another benefit of the government’s regulation. Cash flows from Rex will be so steady, they’ll resemble bond coupons.

In sum, Rex is a perfect investment for the investor who wants to earn 10% a year on his money without taking big risks. Unfortunately, you can’t invest directly in Rex… it’s owned by a syndicate of the biggest energy companies in the U.S. But it is easy to invest in pipelines with similar investment characteristics to Rex.

The bear market trimmed most pipeline stock prices by over 50%. The Alerian MLP index is an index of the 50 largest pipeline companies. The index yields 10.5% right now, but it’s easy to find individual pipeline companies with yields as high as 15%. Click here for a list of the pipeline companies in the index.

Good investing,

By Tom Dyson
Daily Wealth

At the time, Buffalo had two newspapers. Warren Buffett had just bought the Buffalo Evening News. The Buffalo Courier-Express was worried Buffett was trying to run it out of business to get a monopoly on Buffalo’s advertising revenue.

The judge agreed and ordered an injunction against Buffett’s newspaper.

"There are only two newspapers now," said the judge. "If [Buffett's] plan works as I find it is intended to work, there will be but one left."

Before the Internet and local television broadcasting, a single newspaper in a medium-sized town like Buffalo was a great business. There was no other way for businesses to contact their customers, so the newspaper was like a "toll bridge" connecting businesses and potential customers. It could raise advertising rates – tolls – through the roof, and businesses wouldn’t be able to do a thing about it.

But sharing the market with another newspaper is a lousy business. Buffett had no pricing power and only half the customers. So Buffett bought the Buffalo Evening News and tried to bankrupt his only competitor. The judge’s injunction lasted for two years until the appeals court overturned it. In 1982, the Buffalo Courier-Express went out of business, and Buffett’s newspaper started making huge monopoly profits.

Toll- bridge businesses are Buffett’s favorite businesses… especially when they operate in uncompetitive markets. He invested in ABC television in 1979, when there were only three networks. American Express is another famous Buffett investment. It’s a toll bridge collecting interest from consumers and fees from merchants for using Amex’s payments system.

Notice all these businesses have the same characteristics. They all provide basic services. And after the initial costs of building the toll bridge, these businesses don’t require much money to operate. The fees they collect are all profits. And they’re hard to compete against. The upfront capital costs are huge, half the market is the best a competitor could hope for, and they won’t have any pricing power unless they can afford to bankrupt the competition like Buffett did in Buffalo.

In The 12% Letter, we’ve invested heavily in low-competition toll-bridge businesses. They make excellent income investments. Because they don’t have any major operating costs, management can pay out almost all the fee income to shareholders as dividends. Toll bridges are excellent inflation hedges, too. The upfront costs can be financed and paid back in devalued dollars over time like a mortgage, but the revenues rise with inflation.

My favorite kind of toll bridge is a pipeline company. These businesses move natural gas around the country in steel tubes buried six feet underground… an essential service that costs next to nothing to maintain. There’s never any competition. And there’s no commodity risk. No matter what the price of natural gas, the pipeline operator simply collects tolls. Plus, you’ve got the government on your side, giving large tax breaks to encourage investors.

The bear market has destroyed pipeline stocks. The Alerian MLP index is an index of the 50 largest pipeline companies. The index yields 10.5% right now, but it’s easy to find individual pipeline companies with yields as high as 15%. Click here for a list of the pipeline companies in the index.

Good investing,

Tom Dyson
Daily Wealth

The options market is the most "high-octane" market on the planet. That’s because option contracts are like medical insurance. Most of the time, you’re healthy. The premiums you pay disappear into a black hole and the insurance company wins. Once a decade, you have a major surgery and the insurance company makes you a huge payout.

There’s no middle ground. You either make a small loss or score a huge win. It’s the same with options. Option prices can move up or down hundreds of percent in a day.

Generally, only professional investors write options… like only insurance companies write medical insurance contracts. The gains are so small and the potential losses are so large, it’s just not an appropriate strategy for most amateur investors.

But there is one scenario where it’s safe to write options. The technical name for this strategy is "covered call writing." A covered call trade has two parts. First, you buy the stock – a safe blue chip stock works best. Then, you sell a call option against the stock. The stock "covers" your liability on the call option, and the option premium from selling the call turns into a simple income stream.

The financial crisis has caused option prices to explode in value – everyone wants to buy "insurance" on their stocks. So now, covered call writing is a wonderful way to make huge income streams. The premiums are so large, you can make up to 70% a year in income by selling options on the safest blue-chip stocks. And you’re covered, so you never have to worry about the risk of dealing with options.

Let me show you an example using Google. Using this strategy with Google, you can collect a 54% annual payout…

Google is one of the few stocks that is up in 2009 (it has millions in the bank and a business that continues to grow by about 10% a year, even during this recession).

Google is a $340 stock. Let’s say you buy 100 shares of Google at $340 tomorrow. At the same time, you sell one Google call option contract with a $350 "strike price" and a maturity date three weeks away. What you’re doing is giving someone else the right to buy 100 Google shares at $350 a share in three weeks. (One contract contains options on 100 shares, so you can only sell one contract per 100 shares.)

In return for this privilege, the option buyer will pay you upfront cash. As the markets currently stand, you’ll get $10.50 per share. The 100 shares you bought cover your potential liability to the call option owner, so the cash you receive becomes a simple "one-off payment."

In this case, you made $1,050 in guaranteed income in three weeks ($10.50 per share times 100 shares). That’s a 54% annualized yield. Plus, if Google’s stock is above $350, you make a small gain in the stock when the option buyer pays you $350 per share. As long as Google is above $329.50 (that’s $340 minus the $10.50 in income), you make money.

(Please keep in mind… I’m using Google as an example… not recommending you go out and buy the stock.)

I’ve named this strategy the "Dividend Capture" because it’s like collecting special dividends. You get in… you get your payout… you get out… and then you move on to the next opportunity. It’s a little more advanced than what most investors are used to. But for those who don’t mind a little extra work, it’s a great strategy right now.

I’ve loaded my newsletter’s portfolio full of opportunities just like this. If you like the sound of 70% income stream from the strongest American stocks, you should, too…

Good investing,

Tom Dyson
Daily Wealth