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.

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

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

"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

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

Why do I say this? Tell the average investor about a company with a cutting-edge technology, an exciting Phase III drug or a new gold strike and they’re all ears.

But tell them about a blue-chip stock with steady sales, a big order backlog and rising stock dividends and they’re more likely to stifle a yawn.

That’s unfortunate. Because, contrary to what most investors believe, innovation is not always a great predictor of business success. As Andrew Carnegie famously said, “Pioneering don’t pay.”

Nor is a young company that’s just feeling its oats – and retaining all its earnings – likely to be the best long-term investment. It’s a well-known fact that four out of five new businesses fail in the first five years.

What really makes money for investors over time – and without the hair-raising volatility of growth stocks – is steady businesses paying stodgy old dividends.

Stock Dividends – Cash In Your Account is a Sure Thing

As my Investment U colleague Mark Skousen writes in his book “EconoPower,” “Earnings may be suspicious due to creative accounting. Revenues can be booked in one year or several years. Capital assets can be sold and the value listed as ordinary income. But cash paid into your account is a sure thing, a litmus test of the company’s true earnings. It’s tangible evidence of the firm’s profitability.”

Regular payouts impose fiscal discipline on a company. And history reveals that dividend-paying stocks are both less risky and more profitable than most stocks.

Dr. Jeremy Siegel, a professor of finance at The Wharton School of the University of Pennsylvania, has done a thorough historical study of various asset classes.

In his book “The Future for Investors” – endorsed by such investment luminaries as Robert Shiller, Peter Bernstein and Barton Biggs – he demonstrates that one of the best keys to success is focusing on tried and true stocks that pay steady, rising dividends.

“The constant pursuit of growth – through buying hot stocks, seeking out the next big thing, or investing in the fastest growing countries – dooms investors to poor returns,” says Siegel. His research shows that high-dividend payers have outperformed the market by a wide margin over the years.

Stock Dividends & The Dogs of the Dow

That’s the reason for the great popularity of the Dogs of the Dow strategy. You simply buy the 10 highest-yielding Dow stocks and then replace them a year later with a new list. It doesn’t produce the best results every year. But this simple strategy has delivered excellent long-term results, beating the broad market handily since 1973.

If you’re going to buy individual stocks, do your homework. See how long the company has been paying its dividend. Gauge how secure it is by looking at the company’s cash position, sales and expenses (especially debt service).

Trust me, a dividend from a highly leveraged company with declining fortunes and low cash levels will not be maintained. (This is especially true today in the banking and brokerage industries.)

Still, there are a number of attractive stock dividend payers out there right now. We’ll be talking about several of them in the weeks ahead.

In the meantime, conservative investors may want to take a diversified approach by buying a dividend-oriented fund like WisdomTree Total Dividend (NYSE: DTD), currently yielding 5.3%.

Good investing,

Alexander Green
Investment U

More companies have been bought, bailed out or bankrupted since this financial crisis began than most of us have seen in our lifetimes. And even as Wall Street’s dominoes keep falling, no one can be sure if the worst is over.

From here on – recession or not – targeting dividend stocks is one of the few strategies that will deliver income safely and efficiently.

In theory, dividends should prop up an investor’s portfolio during uncertain periods, or in market downturns. That’s because even if a company’s stock price falls, executives do all they can to maintain the firm’s dividend payout. That’s part of the reason that, over time, dividends have accounted for a major portion of investors’ total returns.

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"Dividends are a nice anchor in a turbulent market," said Judith Saryan, manager of Eaton Vance Dividend Builder Fund (EVTMX), FoxBusiness last year.

Or anytime. In fact, over the last 100 years, 40% of a stock’s total return is from dividends. That’s not surprising. According to a study by Ned Davis Research Inc.,  dividend-paying Standard & Poor’s 500 stocks rose by an average of 9.4% a year between 1972 and June of last year, well ahead of non-dividend-paying stocks, which rose by only 1.8% annually during the same period.

“Dividends are a sign of quality," said Todd Ahlsten, manager of Parnassus Equity Income (PRBLX), said in an interview last year. “They force management to look at cash flow and how it invests in its business."

But not all dividends are created equal. As losses mount, Standard & Poor’s 500 heavyweights have been putting their dividends on the chopping block, cutting or outright eliminating them for an indefinite time period.

And these aren’t fringe companies and chump change we’re talking about…  

General Motors Corp. (GM), Ford Motor Corp. (F), Sprint Nextel Corp. (S), MBIA Inc. (MBI) – their dividends are gone.

And Citigroup Inc. (C), Bank of America Corp. (BAC), Fifth Third Bancorp (FITB) reduced their dividends to a mere penny. Fannie Mae (FNM) lowered its to 5 cents in August and hasn’t paid one since.

Nor does the list end there.

Just yesterday (Thursday), in fact, motorcycle icon Harley Davidson Inc. (HOG) slashed its dividend 70%, the first such reduction since 1993. The move was aimed at conserving cash, but sent Harley’s shares down 8%. in a move that was aimed at conserving cash. And the Dow Chemical Co. (DOW)– facing credit-market uncertainty, lower product demand and legal problems related to a failed joint venture – yesterday cut its dividend 64%, the first such move in the company’s 112-year history.

But there are still hundreds of companies holding their ground in the global financial crisis.

These firms understand that continued growth and success depends on a large body of investors. And to keep them on board the companies must maintain – and hopefully increase – their dividend payouts.

DRIPS Aren’t Dropping

With the stock market’s wrenching decline, many company’s shares are trading at bargain levels. A company that’s been able to maintain its dividend usually represents a better value to its shareholders.

In the reverse situation, where stock values soar, dividend yields fall, meaning income investors have to settle for lower returns.

So, with stocks down and yields high, income investors should consider starting or stepping up dividend reinvestment plans (DRIPS).

In DRIPS, the dividends investors would normally receive as cash are reinvested back into the stock under their name. To start, investors often don’t even need as much as the price of a full company share.

For example, if you invest $20 in a stock that trades for $100 per share, the DRIP will buy you one-fifth of a share of that stock. The dividend is reinvested accordingly, as well.

Over time, money is reinvested back into the stock, giving you more shares. And with more shares, the more dividend income you’ll receive.

Among other advantages, although there is usually a nominal transaction cost involved, the DRIPS’ automatic reinvestments allow investors to skip full-blown brokerage fees, which aren’t conducive to such small purchases.

Among the cons, most DRIPs require investors to be registered shareholders, which entails a little more paperwork than being a regular, or beneficial, shareholder. To enroll in a DRIP plan, investors must buy shares through a transfer agent. The process can take up to eight weeks before your account is opened and fully registered.

Some DRIP companies also have maximum amounts you can invest and hold in their stock. And they vary by time periods – monthly, quarterly, annually and lifetime.

For the public companies that offer the dividend plans, DRIPs provide a stable base of long-term shareholders. And often, these value-minded investors tend to buy more when share prices are down, as opposed to short-term traders, who are apt to bail out on a price decline.

For example, 71% of chemical company RPM Inc.’s (RPM) shareholders are enrolled in its DRIP. And more than 64% of Aflac Inc.’s (AFL) shareholders are enrolled in its DRIP, according to DRIP Central.

More than 1,600 public companies and American Depository Receipts (ADRs) have DRIPs, offering a wide choice of industry and market preference to potential investors.

But with so many to choose from, targeting the best ones can be a challenge without a broker helping you.

The Best DRIPs are…

The best DRIPs are from companies that have a high-yield and a track record of increasing their dividends.

In addition to RPM and Aflac, here are a few DRIP companies to keep your eye on. Not only have they hung onto their dividends in the worst financial crisis since the Great Depression, some have increased their payouts.

• Coca-Cola Co. (KO): There’s a reason “Coke” is the second most recognizable word in the world. The world’s biggest beverage-maker recently beat fourth-quarter earnings expectations, largely due to its ability to cut costs and promote demand with a rotating file of products. The company kicks out a 38-cent dividend every quarter. At its current share price of around $44.30, that’s a 3.45% yield. If that’s not enough, know that Warren Buffet owns 8.6% of the company.

• Intel Corp. (INTL): Intel is the market leader among chipmakers, dominating its competition by continually being the first to the market with the best product. It pays a 14-cent dividend every quarter, which at its current stock price represents a 4.07% yield.

• The Hershey Co. (HSY): The Pennsylvania-based candy and food maker has been a recession stalwart. It began paying dividends in 1930 – meaning it’s been making the quarterly payouts longer than most companies have even been around – and has been increasing them for 32 consecutive years, according to The Money Paper. Right now, its 30-cent quarterly dividend represents a yield of 3.32%. With its stock hovering a few dollars above its 52-week low, many of its DRIP investors are probably loaded up on Hershey shares like Halloween candy.

• Microsoft Corp. (MSFT): Microsoft is the largest software producer in the world, and has a firm grip on that title. The slowing demand for computers and computer software has taken a toll on Microsoft, but the projection of the industry and Microsoft’s dominance makes it one of the most stable tech stocks out there. Its current dividend yield is 2.72% on its shares, which kick out a 13-cent dividend every quarter. 

• Exxon Mobil Corp. (XOM): Like the above companies, Exxon doesn’t need much of an introduction. The oil giant is one of the world’s largest companies, having paid investors dividends since 1882. Its 2.13% yield isn’t the highest in this small group of companies, but Exxon’s share price is one of the most stable.

If that’s not enough, here’s an extensive list of DRIP companies, and their minimum and maximum investment requirement.

It also details how much dividend income a company pays, how often, how long its paid dividends and whether it increased its dividend over time.

By Mike Caggeso
Money Morning

But at the risk of receiving more than a few sharp emails from industry professionals who sell EIAs, let me tell you that you can achieve virtually the same degree of financial security using nothing fancier than a certificate of deposit (CD) and the SPDR Trust (SPY), which trades on the American Stock Exchange.

Here’s what you need to know.

First created on Feb. 15, 1995, equity indexed annuities are insurance products that typically promise a set minimum income level or rate of return, plus the ability to capture market gains without any risk of losing money. Theoretically, they’re easy to understand.

You invest a lump sum for a fixed-time period – often 10 years or more – and in return receive a guaranteed minimum rate of return, plus the market upside, with none of the losses if it goes down.

If the market to which an EIA is indexed – like the S&P 500 – rises by more than the minimum promised return, your money is supposed to grow proportionately. In exchange for making the investment, the insurance company offering the EIA guarantees that your money will never drop in value.

The devil, as they say, is in the details.

In reality, the paperwork that explains equity-indexed annuities is one of the toughest financial documents of all to decipher and understand. Not only are the sales documents filled with legalese, but assuming you can get through the 40 to 60 pages of stuff that comes with an EIA, chances are you’ll find a wide range of conditions, restrictions and terms that frequently change over time. There are guaranteed minimums, performance adjustments, participation rates, interest-rate caps and spreads to contend with, for instance. And that’s just a sampling.

In addition, many EIA’s also cap the returns you can achieve, no matter how far the markets rise, which would seem to defeat the purpose of investing in one of these things in the first place. And that means, more often than not, that you’ll be left in the dust if the markets really take off.

To put this into context, if you invest in an EIA with a performance cap of 10% and the markets actually rise 20%, you’ll leave over 50% of possible gains in the insurance company’s pockets … not yours.

Then there are the associated fees and charges, which are quite hefty. In fact, various studies suggest that the purchase of an annuity typically results in a wealth transfer of as much as 15% to 20% from the investors who buy them to the insurance companies and the sales forces who sell them. That’s something not a lot of folks realize when they consider purchasing one of these specialized investments.

Despite these shortcomings, sales of EIAs are better than ever. According to Jack Marrion of Advantage Compendium Ltd. (www.indexannuity.org), investors have plowed more than $123 billion into equity indexed annuities. He added that “more than 90% of EIAs are sold by independent agents,” like one I spoke with who privately told me that sales are “up 25% in the last 6 months alone.”

Another insurance company representative, who also wished to remain anonymous, told me that “fear rules the day, and we know that, so it’s only logical to assume that we’ll sell more EIAs when people are scared.”

Sad but true.

Many investors I’ve talked to over the years tell me that they find it especially frustrating that no two EIAs are exactly alike, which is why apples-to-apples comparisons are next to impossible.  The same is true for performance comparison, even if two competing offerings are tracking an identical index, such as the S&P 500.

The bottom line on EIAs is that the returns you think you’ll be getting if the markets rise may be nothing more than an illusion once all the contractual details are netted out. They’re basically being sold as alternatives to stocks, when the reality is that they’re much more of a bond-related instrument.

In the interest of fairness, EIAs have outperformed the S&P 500 over the last nine years, something Miguel Herce of CRA International points out in the January 2009 issue of Money magazine. But over time – 63% of the time since 1926, to be specific – the markets would have beaten EIAs.

Various studies reinforce this notion. One, in particular, conducted jointly by Dr. Craig McCann of UCLA and Dr. Dengpan Luo of Yale University, reflects that investors would be better off in a simple portfolio of U.S. Treasuries and large cap stocks – a whopping 97% of the time.

Boston University Economics Professor Laurence J. Kotlikoff summed it up nicely, noting in Money that “some of these products might pay off, but even a PhD in finance can’t tell you if it’s worth it because the returns are almost entirely at the discretion of the insurance company [that's offering the EIAs].”

Which is why we’ve never been big fan of these things.

But if the notion of a guaranteed return and all the market’s upside strikes you as compelling right now – like it does us – here’s a dramatically simpler and far less expensive way to achieve financial tranquility.

• First, visit CostCo.com (or your local bank). When I checked, the company was offering Federal Deposit Insurance Corp. (FDIC) insured seven-year CD paying 5.05% APY through Capital One Financial Corp. (COF). Assuming you’ve got $20,000 to invest, you’ll need to plop down ~$14,166.34 now to have $20,000 in seven years. (You can run whatever numbers you want using financial calculators available on the Internet).

• Second, take the remaining $5,833.66 and buy the SPY exchange-traded fund (ETF), which tracks the S&P 500.

That’s it. No extravagant fees. No surrender charges. And, most importantly, no upside-performance caps.

Plus, your investment is now guaranteed by the FDIC, which strikes me as a whole lot safer than a comparable EIA, which incidentally is only as good as the insurance company backing it. And lately, that’s suspect to say the least.

Worst case scenario, you get your $20,000 back in seven years. Best case, if stocks recover from here and achieve 7% annually for the next seven years, you’ll earn an additional $9,367.58, making your grand total $29,367.58.

What’s more, because there’s no complicated contract involved, you will understand what you’re getting into from the get go, and will get to keep 100% of the potential gains to boot.

In closing, it’s worth noting that EIAs are frequently touted as tax-advantaged investments in an attempt to make them more appealing. But if you simply buy the CD and the SPY in your IRA, you’re achieving the much the same thing – but without the 9% commission.

By Keith Fitz-Gerald
Money Morning

Dividend yields now rest close to 15-year highs. Plus, the premiums from writing covered calls (the only safe options strategy) are significantly higher thanks to the extreme market volatility.

As far as I’m concerned, that’s an attractive one-two income-earning punch we shouldn’t ignore.

So how do we play it?

Not with the usual suspects…

Income Investors: GE Is A Dog at Any Price

There’s something about an adolescent stock price on General Electric (NYSE: GE) that turns most income investors rabid. Much like they were last summer for Bank of America (NYSE: BAC). But I continue to get in arguments with friends and colleagues about this.

I don’t care if GE trades below $20 per share, $15 per share, even $10 per share. It’s a terrible stock to own right now.

I know in some circles, such an utterance is blasphemous. Before you conclude the same, at least hear me out…

First things first…

• Simple businesses make money.
• Investors can understand simple businesses.
• And therefore, stocks of simple businesses tend to perform best (consult Warren Buffett’s track record should you disagree).

But – you guessed it – GE doesn’t pass the simple test.

Its business is all over the place. Last quarter, it logged sales in the following segments: 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.

Try coming up with an elevator pitch for Jeff Immelt for that mess. Jack of all trades, master of none, perhaps?

To be fair, GE does provide exposure to compelling sectors and trends – like energy and infrastructure, water, and green technologies. But it only accounts for a small portion of the revenue pie. And meaningful growth in these segments will always be overshadowed by declines elsewhere.

Case in point, in the fourth quarter, GE’s energy business increased profits by 27%. A homerun by any measure. Too bad the rest of the team struck out – weakness in other segments caused GE’s overall profit to drop 44%.

Bottom line, even after a 60% stock decline in the last year, GE is still a $137 billion behemoth. Moving that earnings needle, and in turn the stock price, requires over a dozen business segments to be firing on all cylinders, simultaneously. That’s not happening. Not now or anytime in the near future.

But How Can We Turn Down a 9% Dividend Yield?

After considering the above, most GE defenders shove their security blanket – the hefty dividend yield – in my face, saying, “At least I get paid 9% to wait for the stock to turnaround.”

True.

But it could take years for the underlying businesses to turnaround. Moreover, as Bank of America proved, no dividend is immune to a cut.

Last summer CEO Ken Lewis said it was safe. Then in October, he ended the streak of 30 years of increases. And he cut it.

The same fate appears likely for Dow Chemical (NYSE: DOW). Last month CEO Andrew Liveris declared a dividend cut wouldn’t happen on his watch. Fast forward to this week, and he concedes a cut is now possible. Keep in mind, Dow Chemical’s dividend has never been cut since it was first instituted in 1912.

By now, Yogi Berra should come to mind, “It’s like déjà-vu, all over again,” because GE’s Immelt continues to deny the possibility of a dividend cut. He also wants to maintain the company’s coveted AAA rating. Yet, if current conditions persist, and management is desperate for cash, trust me, the dividend will get the ax.

For Income Investors – A Better Alternative Income Investment to GE

It wouldn’t be fair for me to bash GE as an income investment and not offer up a better alternative. So here it is – TEPPCO Partners (NYSE: TPP).

It’s one of the oldest publicly traded energy master limited partnerships (MLPs), with over 12,500 miles of pipeline. (For a thorough overview of MLPs, I recommend this MLP primer.) And it currently yields 11%.

Here are the five main reasons I believe the dividend is safe -

• Its business is simple. It gets paid to transport fossil fuels, based on total volumes, not the price of the underlying commodity. While the price of crude might be off significantly, I guarantee you worldwide demand, and the volumes to be transported, is not. Such a simple business makes it easy to spot breakdowns, and in turn, recognize when the dividend is truly in jeopardy.

• The revenue stream is highly reliable. We’re addicted to oil. And no matter how green the world gets, we’ll still consume plenty of it. That means the registers will keep ringing for TEPPCO, and there will always be cash in the till to pay out dividends.

• Management believes in conservative growth. Overdosing on debt to fund expansion is a recipe for disaster. If borrowing costs increase (like now), more cash needs to be set aside to make interest payments. If they jump too high, too fast, something has to give. And most times, it’s the dividend. Thankfully, TEPPCO believes in conservatism. For the past five years, it’s financed 75% of its growth through asset sales and equity contributions. In other words, interest payments won’t threaten the dividend one bit.

• Insiders keep buying. Insiders know best and Dan Duncan, the CEO of the general partner that controls TEPPCO, plunked down $7 million last September, at much higher prices. If the dividend was in jeopardy, he certainly wouldn’t be buying.

• Credit is not a concern. In these distressed markets, we can’t overlook this factor. If a business relies heavily on credit, and is having trouble getting it, look out. No worries for TEPPCO, though. It’s sitting on $600 million in liquidity, enough to fund almost all of its proposed capital expenditures for 2009.

Truth be told, I recommended TEPPCO to subscribers a month ago when it traded around $18. Now we’re up 48%. And we haven’t even received our first dividend payment, yet.

Even after such an impressive move, though, I estimate at least another 36% upside remains.

Here’s why…

• The company sports strong fundamentals: earnings, distributions and its operations are all growing.
• It owns prime assets. Namely, the only pipeline transporting liquefied petroleum gases from the Texas Gulf Coast to the Northeast and the sixth-largest U.S. inland barge operations.

Both make it a prime acquisition candidate.

And history dictates MLPs should only average a 7.83% yield, based on the Alerian MLP Index. To bring its yield back inline with the historical mean, TEPPCO’s stock needs to rally another 36%.

Add it all up and it’s a no brainer. If you want high and reliable income, with the potential for capital appreciation, too, forget GE and buy TEPPCO. Or at the very least, ensure any high dividend-paying stocks you’re considering boast the five qualities above.

Good investing,

Louis Basenese
Investment U

For investors, the message is clear: We’d better concentrate on those emerging markets whose inhabitants have hefty piggybanks of their own.

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The details of the investment slowdown are as alarming as the headline. Bank loans to emerging markets will decline from an inflow of $165 billion to a net outflow of $61 billion. Private non-bank debt investment will decline from $125 billion to $31 billion, and even official flows will decline from $41 billion to $29 billion.

Net portfolio equity investment will remain negative, though the outflow will be only $3 billion compared to 2008’s $89 billion. Only direct foreign investment will increase, rising 12% from 2008 to $195 billion.

In terms of regions, emerging Europe will suffer worst, with inflows plummeting from 13% of regional gross domestic product (GDP) in 2007 to just 1% in 2009. Latin America will also suffer, with inflows dropping from 11% of regional GDP to 3%.

Overall, inflows to emerging markets will drop by 5.8% of emerging market GDP between 2007 and 2009 – almost double the declines of the late 1990s crisis (3.7% of emerging market GDP) and early 1980s (3.2%). Emerging market cash flows will also be affected by the need to repay $223 billion of private market debt this year.

This will cause a reordering of the economic pecking order in the emerging markets.

From 2003 to 2007, the availability of natural resources and/or cheap labor was more important than high foreign reserves or a big domestic savings base, so Argentina (natural resources) and emerging Europe (cheap labor, relative to the EU average) did well. In 2009, access to capital will be more critical than either of those other strengths. Countries without a large domestic savings base, or with substantial balance-of-payments deficits, or with low foreign exchange reserves, are likely to suffer badly.

Many emerging Europe countries have balance of payments deficits exceeding 10% of GDP so will suffer badly. Within that region, the Baltic states – fairly uncorrupt and friendly to foreign investment – will do much better than Romania and Bulgaria, which are both corrupt and xenophobic.

In Latin America, Brazil has an excellent domestic savings base, which it has been nurtured by policies that keep interest rates much higher than the rate of inflation. It is also quite friendly to foreign direct investment. Hence, in spite of its high foreign debt, Brazil should do fine.

Conversely, Mexico has a lower domestic savings base, relies heavily on remittances from Mexicans in the United States (which have declined sharply) and is quite hostile to foreign investment, particularly in the energy sector. Hence it is likely to have a tough year.

In Asia, China – with huge domestic savings, $1.95 trillion in foreign exchange reserves, and low foreign borrowing – will do fine. Conversely, India’s high domestic savings are offset by a profligate government, which runs a wasteful deficit of more than 10% of GDP. Hence India is quite reliant on foreign borrowing, and is likely to have problems.

For investors, the message is clear. Our emerging markets investments must be concentrated in countries that will not be badly affected by the decline in foreign capital inflows, preferably where domestic savers have piggybanks that are large enough to fund expansion locally. In particular, without delving into particular stocks, the following country-specific exchange traded funds (ETFs) are worth looking at:

• The iShares MSCI Brazil Index (EWZ) has net assets of $3.4 billion, a Price/Earnings (P/E) ratio of 7.0, and a dividend yield of 6%. Money Morning Contributing Editor Horacio Marquez recently recommended this Brazilian ETF in this weekly “Buy, Sell or Hold” series.
• The iShares MSCI Chile investable index (ECH) has net assets of only $112 million and a P/E of 13. However, Chile is interesting because it built up a reserve fund of $21 billion (12% of GDP) during the years when copper prices were high – it is thus not dependent on foreign-fund inflows. 
• The iShares FTSE/Xinhua China 25 Index (FXI) invests in the 25 largest Chinese companies. Net assets are $5.9 billion, its P/E ratio 10, and its yield 2.7%.
• The iShares MSCI Taiwan Index (EWT) has net assets of $1.3 billion, a P/E of 9 and a yield of 8%. Taiwan is highly liquid, with large reserves, a high savings rate and almost no foreign debt
• The iShares MSCI Singapore Index (EWS) has net assets of $800 million, a P/E of 9 and a yield of 8%. Like Taiwan, Singapore is highly liquid, with large foreign exchange reserves and little debt. Taiwanese and Singapore companies may indeed benefit from the liquidity crunch by finding attractive investment opportunities in regional cash-short emerging markets with high growth potential, such as Vietnam.

By Martin Hutchinson
Money Morning

The only clear item to emerge from this last week’s trade is a decided shift in sentiment toward the pessimistic.  Yet whether this shift has been large enough to be used by contrarians appears doubtful.  There’s not enough genuine fear, in our view, to justify taking a bullish stance at this time. 

That said, it’s not always the case that rallies are predicated upon dire pessimism, or that we need to see more of the rich and famous arranging early acquaintance with the Creator in order to take a long position in stocks.  Wall Street will rally when it’s good and ready – regardless the VIX and put-call readings.

For us at the Residual Income Report, the situation is somewhat less confusing because there are currently good opportunities to purchase established companies with healthy prospects (despite the global economic climate), who also throw off income – either as dividends from common or preferred shares or semiannually from their bonds.

Indeed, our urgency in recommending both corporate and high yield bond ETF’s this fall has born fruit.  If yield is a buffer against general market downturns, then yield that is oversold is an even greater buffer.  And yield that is oversold and unqualifiedly secure offers the best chance of maintaining its value.

Though it’s always our goal to catch such animals, they’re not always so easily found.

A Look at Currencies on the Road to Dividend Riches

The European and American markets offer numerous dividend paying stocks that have much to commend them.  But what of currency considerations?  The U.S. Dollar was in a freefall until last summer and then did a rigid about face: the Euro now is in relative freefall against the buck.  Shouldn’t this weigh into our calculations?

No doubt, currency moves will have a dramatic effect on the profitability of any Euro-denominated stock pick.  The question each investor must answer for himself is what kind of holding period he intends for the stock.  For example, our November 11, 2008 recommendation of HSBC preferred “A” series – then selling at $17.01, now $16.56 – has maintained its value despite some significant gyrations in the value of the Dollar Index – and has paid subscribers over 9% to sit through those spikes and swoons.  In short, it’s been well worth it.

Yet what the future will bring in terms of the dollar is a little difficult to gauge.  Over the long term – call it two to five years and longer – we have little hope the dollar will be able to survive as the world’s reserve currency, let alone experience any sort of sustained appreciation in value.  We have serious doubts, too, about its viability as a currency altogether, given recent events.  In short, barring an unforeseen and miraculous economic turnabout, we see little reason to remain invested in American dollar denominated securities beyond roughly a year to eighteen months from now.

That said, the shorter term picture is very foggy.  It could well be that recent strength in the Greenback continues through 2009, despite the current global economic malaise – and for the sole reason that America is the least bad of a slew of desperate first world economies: a sort of monetary kingship by default.

And if that’s the case, certainly American shares will outperform their European counterparts over that period.

A Few Suggestions in a Time of Indecision

To begin, consider the following: there’s nothing wrong with short term money.  Over the past twelve years, three-month t-bill returns have beaten equities.  And since we expect a steep rise in Treasury yields to accompany the Fed’s efforts to hold back an Atlantic inflation wave now in the pipeline, you’ll be more than happy to ride it out with short term money.  Only a little patience is required until then.

As for income, take a look at the following two European based oil stocks, both of which will be household names to most:

British Petroleum, whose ADR trades as BP:NYSE, currently offers a 7.6% yield at a price of $44.21 per share.

While Royal Dutch Shell (RDS.A:NYSE) generates 6.32% and trades at $50.67.

Significantly, both of these stocks boast incredible earnings/share numbers and, therefore, rock solid dividend coverage figures.  In the case of BP, dividend coverage is 2.6x, and with Shell, 3.1x.  You will be hard pressed to find any company of this size in the financial world – not to mention the energy sector – whose dividend is as high, and whose cash flow secures it so well.  Exxon Mobil, for comparison purposes, offers a mere 2.05% annual dividend.

Consider also:

• Though it has fallen steadily since August, from nearly $150 to the low $30 range, the price of crude has had little to no effect on oil shares since mid-October of 2008.  The entire energy sector has been drifting sideways since then – even rising somewhat – despite the price contraction (see charts below).

• Chances of a dividend cut on either of these shares is as remote as it is unnecessary – and would result in a devastating loss to share value.  Management has no interest in this at this stage since it would make raising capital very expensive in an already expensive environment.

• Both the magnitude and the velocity of the selloff in crude point to an inevitable retracement.  The chart below shows a selling frenzy of sickly proportions.

Crude is due for a snapback.  When and how much is anybody’s guess, but it will be sharp and will be fed by significant short covering.

• Finally, the value of the U.S. currency has little material effect on share prices here, as both companies are highly diversified multinationals and sell their production in U.S. dollars.

The Residual Income Report recommends equal weight purchases of British Petroleum and Royal Dutch Shell stock at $44.21 and $50.67 respectively.

And let commodity be your currency.

Matt McAbby
Analyst, Oxbury Research

Stocks are beginning to move again – the Dow rose over 6% last week alone – but many investors are skeptical of how long the rally will last. Already the market has pulled back.

As I describe in the January Communiqué, I believe this will be a good year for stocks despite the economic downturn.

But if you’re feeling a little gun shy after last year’s rollercoaster ride, there is a second-best alternative: convertible bonds.

Convertibles are corporate bonds that can be converted into shares of the issuing company. At the time a convertible is created, the company spells out exactly the number of shares that can be converted, the price at which the conversion can occur and the time frame.

Typically, convertible bonds have a lower coupon rate than ordinary bonds. But since the holder is given the right to convert the bond into common stock – often at a substantial discount to the shares’ current market value – they offer superior upside potential.

Convertible Bonds – More Conservative Than Stocks

Convertible bonds are more conservative than stocks because they represent a senior claim on the company and will pay interest even if the underlying stock doesn’t rise. And they are more aggressive than ordinary bonds because a drop in shares of the issuer can negatively affect them.

If the underlying stock rises, however, the bond will climb along with it. So, in essence, you have the safety of a bond combined with the appreciation potential of equities.

Like virtually every asset class (with the exception of Treasuries and gold bullion), convertible bonds had a tough year in 2008. Why? Both corporate bonds and common stocks fell sharply.

But convertible bonds now represent excellent value, especially for investors who are only tiptoeing back into the waters.

For this reason, you should consider buying or adding shares of convertible bonds to your investment portfolio.

Good investing,

Alexander Green
Investment U

How can this be?

The stock market is a leading indicator. It generally falls before consumers and investors realize just how bad the economy is.

It also recovers long before economic activity picks up. Perversely, that means stocks often plummet during good economic times and rally during recessions… or worse.

In the January issue of The Oxford Club Communiqué, for example, I note that:

• In the 13-month recession in 1926-27, the market went up 41.1%.
• In the eight-month recession in 1945, it went up 19.5%. In the 11-month recession in 1948-49, it went up 15.2%.
• In the 10-month recession in 1953-54, the stock market went up 24.2%.
• In the 10-month recession of 1960-61, it went up 20.3%.
• In the 16-month recession in 1981-32, the market went up 14.6%.
• And so on.

The stock market doesn’t always rise during a recession, of course. And right now is particularly tricky because there is simply no precedent to today’s economic mess. We’ve never seen a real estate/mortgage crisis create a meltdown in the credit markets this way. Nor have we seen the Federal Reserve take such extreme measures to set things right.

However, investors can take some reassurance from one of the best – and most accurate – buy signals in the stock market. Here’s how it works…

20th Century Investing – Buying High-Yielding Stocks

Investors in the first half of the 20th century found that if you did nothing more than buy stocks when their yield exceeded the yield on Treasuries – and sell them when the yield on Treasuries exceeded the yield on stocks – you would have been in for every major rally and out for every major correction.

The returns were huge – and the system made sense. Stocks are riskier than bonds, market participants reasoned, so they should yield more to compensate for greater volatility and the likelihood of occasional losses.

The system worked like a charm until 1958. Then stopped cold. Stocks never yielded more than Treasuries for the next 50 years.

Public companies began using their cash flow to fund operations and acquisitions rather than paying out dividends to shareholders. With stock yields sharply lower, most analysts reasoned that the indicator was dead, that the yield on stocks would never again top bonds.

But after more than five decades, they have…

The S&P Yields More Than Treasuries For The First Time In 51 Years

Beginning on October 13, the 3.74% yield on the S&P 500 exceeded the yield on the 10-year Treasury for the first time since 1958.

If history is any guide, that means stocks are an excellent long-term buy and Treasuries – which have become a complete bubble (and table-pounding sell) in my estimation – are due for a long period of relative underperformance.

Don’t get me wrong. U.S. economic growth is likely to be negative over the next 12 months. But – shocking and surprising most investors – stocks should do well. And high-dividend paying stocks – especially those outside the troubled financial sector – may perform best of all.

One caveat, however. When focusing on yield, buy only healthy dividend-paying companies – those with rising sales and earnings – and reinvest those dividends for maximum total returns.

I’ll be highlighting many of these companies in the Communiqué in the weeks ahead.

Good investing,

Alexander Green
Investment U

The real news these days is happening under the radar, in the bond market, where peculiar pressures are sending confusing messages to traders and investors alike.

Powerful Fund Flows To Treasuries

It’s no secret that the global flight to quality that took place over the last several months landed hundreds of billions of new dollars in the treasury market, where yields have been driven literally to nothing and are priced for a worst case deflation scenario.

It’s also no secret that this happened because at the height of panic everyone rushes to cozy up to the biggest, most secure daddy they can find.  And for all their so-called failings and flailings and double takes and turnarounds – there is simply no one else on the planet that inspires as much confidence as Papas Paulson and Bernanke.  And the fact remains that the press’s howlings over their incompetence has failed completely to stanch that flow of funds that’s currently seeking a secure home in the laps of these two handsomely paid gentlemen. 

The screaming may yet rise to a pinnacle pitch, but at day’s end everyone runs to America and the dollar – not the Rupee or the Pound or the Peso – to find money comfort.

I’m a Steamroller, Baby

And it seems that run is far from over.  If at the short end of the curve the result has been a drop to zero interest, the race to capture yield is now rolling its way out to longer treasury issues.  Those same foreign nationals, and not a few fund managers, are looking to capture something for themselves, and, in the case of the latter, to achieve profitability.  As one fund manager so aptly put it:

“…it’s hard to sit there and buy a bond that yields less than any fees you charge.”

The result?  An overhaul in the way short term, fixed income managers operate.

A Connoisseur’s Guide to Pancaking and Steamrolling

I’m indebted to the bloggers at the Wall Street Journal for initially tuning me in to this; and perhaps I can now return the favor by explaining to them what it all really means.

They referred to it as the “pancaking” of the yield curve, but it should more properly be termed “steamrolling” – for reasons we’ll presently explain.

First, a look at how exactly this “steamrolling” is taking place.

The Feds’ Goal

The Feds want nothing more than to get you and your rich aunt Daisy to start buying corporate securities.  But you won’t.  You’re scared, and however you justify it, you’d rather not go swimming when the water’s ice cold.  Fine.  But when you continue to beggar out the yield curve, happy to be thrown bones with nary a cheekful of meat on them, then you’ve no one to blame but yourself when you end up hungry and sick.

It’s people like you (and your rich aunt Daisy) and the money market and bond fund managers at the short end who’ve succeeded in driving both the 10 year note and the long bond to levels not seen since the mid 1950’s.  Last we checked, yields on the two were stationed at 2.12% and 2.56% respectively.

What this means is that the average bond investor is setting himself up for the whamdoggy of a lifetime, when the biggest – and maybe swiftest – backup in bond yields that New Rochelle has ever witnessed is activated.

It’s a major no-no at this late date to be putting money into treasuries.  The upside is so miniscule – particularly for short dated issues – that you might as well put a gun in your mouth and call it a day.  All the pressures in the pipeline are inflationary and the good Lord only knows what will finally trigger the selloff; but it will come, and when it does, it’ll be more of a tidal reckoning than a bushwhack.

As for the U.S. government, what could be better than the current scenario?  As lending rates are pushed to zero, government costs to refinance the debt are also reduced to zero.  Which is why all the bailouts and stopgaps and payoffs and TARPs and ZIRPs and KRAKs and SPITs of the last quarter will be (more) manageable than many expect.  But it’s incumbent on the treasury to start selling debt now to take advantage of that current reality.  Unless they do so, a great opportunity – perhaps the greatest – to refresh the American people’s balance sheet will have been squandered.

That they haven’t done so demonstrates their well placed fear that treasuries are mispriced, and that new issuance will only serve the process of (true) price discovery.  That is, that treasury yields will back up significantly and jeopardize aggregate lending levels.

A Constant, “Drifting” Yield Spread

As the zero yield phenomenon works its way further out the curve, one would expect corporate spreads to grow vis-à-vis treasuries; but strangely enough they’ve stopped.  The spread levels are roughly the same, with corporate yields coming down at approximately the same rate as treasuries.  The spread is “drifting” lower, so to speak.

This points to two salient conclusions:

1. That the credit market is mispriced at the corporate end for a lack of liquidity (which is now correcting), and

2. Mispriced at the treasury end due to faulty risk aversion (and getting faultier).

There’s absolutely no reason why corporates should be pricing in a 15% U.S. GDP contraction.  Equally, there is absolutely no reason to expect an acute deflation on the immediate American economic horizon.

Plainly put: corporate yield movement is offering a saner assessment of economic reality than treasury yield movement.

Bet on the corporates.  Particularly those that have been beaten red but still have solid businesses.  And do it with a fund that has collected some of the best of them under one roof: Loomis Sayles Bond Fund (LSBRX).

The Residual Income Report recommends immediate purchase of the Loomis Sayles Bond Fund (LSBRX) at $10.04 for a yield of 15.99%.

Because a steamroller moves.

Matt McAbby
Analyst, Residual Income Report

I guess that’s a big part of why 55 million Americans now own them. That’s more than one in six Americans.

I’m talking about U.S. Savings Bonds. Over the years, they have become the ultimate “fall-back” gift for the tough people to shop for. Kids, infants, teens…savings bonds always seem to be a decent fit. But they’re no longer the gift that keeps on giving.

First of all, their yields are pitiful. The EE Bonds, the most common, yield a paltry 1.3%. The yield is low and going lower. The EE bonds will reset at an even lower rate in April. The I Bonds, which are indexed to inflation, aren’t much better. The I Bonds only yield 0.7% on top of inflation (as tracked by the Labor Department’s Consumer Price Index). Older I Bonds had fixed yields of inflation plus 2% or more.

The long-term outlook for them is even worse. The U.S. government is currently $10 trillion in debt and could easily double that in the next five years if the economy doesn’t recover. A U.S. Savings Bond is basically a loan to an otherwise bankrupt U.S. government.

Finally, there are just so many better options. Remember, the majority of savings bond recipients have 15 years or longer before they’ll probably need to cash out. That’s why I’m urging everyone I know to give better financial gifts; ones which will offer true prosperity to the young ones in our lives.

The Gift of Real Prosperity

When you think about it, most of us don’t have the luxury of a 15 or 20 year time horizon when it comes to investing. We’ve got to turn over a lot of stones to find investments which offer capital appreciation, high levels of current income, or both. But young people are in a much, much better position. And with the market collapsing this year, we’ve got the potential to give away a truly life-changing fortune within the next few years.

For instance, my nephew is almost two years old. He’s not getting any toys from me this year. He’s in for a big box of disappointment over the short-term, but he’ll be getting a lot more in the long-term. I’m buying him stocks in these three sectors which, even if only one pans out, will be worth a lot more than any savings bond in 15 years.

Stem Cells – In his book The Stem Cell Dilemma, Dr. Leo Furcht states, “No new approach to dealing with the monumental suffering and social costs of major diseases comes close to the promise of stem therapy.”

In 1968 the first successful bone marrow transplant was conducted at the University of Minnesota. The stem cells in the donated marrow rebuilt the recipient’s blood-producing marrow.

In the last five years dozens of blind people can see again after receiving stem cell treatments. Damaged spinal cords in mice were repaired with human neural stem cells. A new trachea (windpipe) was created with stem cells and transplanted successfully to a 30-year old woman in the United Kingdom.

We’ve already looked at how Corning (NYSE:GLW), a company which reinvents itself practically every decade, is moving big into stem cells. Pfizer (NYSE:PFE) is throwing a couple of hundred million dollars into research.

More than 40 years of stem cell research are working their way into real-life medicine. At the rate advances are coming, the medical industry will be completely changed over the next 10 to 20 years. Big Pharma, hospitals, medical equipment manufacturers, and everyone else in the healthcare industry will experience radical changes.

Owning a broad subsector of stem cells plays will certainly have one or two which pay off big. I believe there are tremendous opportunities in stem cells for long-term investors right now.

Farmland – This is a pretty simple one. The world’s population is growing and the world’s available farmland is not. The question here is not if there will be a big payoff, but when.

The recent agri-boom sparked a worldwide race to bring underutilized farmland into production. Venture capitalists scoured the world for farmland. Hundreds of millions of dollars were invested. Farms in the Ukraine, Russia, and South America were modernized.

There’s very little undeveloped farmland left in the world. The amount of arable (suitable for farming) land is in steep decline compared to the world’s population…and it’s only getting worse.

In 1961 there were only 3 billion people in the world. There was plenty of food to grow around. There were about 40 arable acres for every man, woman, and child in the world. That was more than enough to feed everyone. Add to all that a decline in the average quality of soil around the world and it’s pretty clear we’ve hit “Peak Soil.”

The fervor for agriculture-related investments may have cooled, but the fundamentals haven’t changed a bit. Farmland will be one of the dearest real estate in the world over the next 10 to 50 years. There will be advancements in fertilizer, genetically modified seeds, and other agriculture technology, but farmland will still be a very dear asset.

India – Last week, I had a chance to speak with Harry Dent. He’s written a few best-sellers like the “Roaring 2000s” and predicted the economic stagnation in Japan long before anyone else.  Harry is one of the best big picture guys in the world. He focuses heavily on age demographics, spending patterns, and has dozens of spot on predictions over the long-term.

We were both completely on the same page when it came to India.

In his newest book, The Great Depression Ahead (a book which will surely make its way to our recommended reading list when it’s released in a few weeks), he states, “There will be a more concerted global boom again from the early 2020s into the mid 2030s – and beyond in many countries from India.”

India has everything going for it. It has a relatively young population. Its workforce will be growing for decades. It has the government institutions in place to protect property rights to support a capitalist economy. As a result, it could very well be the best place to invest if you’ve got a long-term time horizon.

India stands head and shoulders above the rest of the other BRIC countries when you look 15 years out or longer. Brazil and Russia have gone up and down with commodity prices and China, as a whole, is getting old. I expect we’ll see the downside of China’s “one child policy” in the next 10 to 20 years. Don’t get me wrong, India’s not perfect, but it’s the best of the bunch and we’ve got time on our side.

There are so many great investments out there. Stocks are cheaper than they’ve been in years. As we looked at the other day, there are incredible values in convertibles bonds. Also corporate bonds are undervalued.

There are a lot of options, but you’ve got to stick to the plan. In this case, the plan would be to ride the waves which will likely have big payoffs over the next 15 or 20 years. When I’m investing money for a two year old with the understanding it’s not going to be touched for at least a decade, I’m betting on the big sweeping trends and looking for the biggest wins.

A long-term perspective gives us a lot of luxuries. The biggest luxury is not having to time a buying point (I still think there is going to be a significantly better time to buy over the next two or three years) and not having to worry about what will happen one or two years down the road.

I’m looking forward to passing on the savings bonds and giving a true gift of prosperity this holiday season.  At the Prosperity Dispatch, we believe there are fortunes to be made in stem cells, India, and farmland if you’ve got enough time.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

That’s what Bill Gross, Managing Director of PIMCO and the world’s “Bond King,” has been telling anyone who would listen for months now.

Stocks are cheap, but bonds are at irresistibly cheap levels. If you’re looking to buy low, sell high and collect 9% or 10% interest in between, corporate bonds are definitely worth a look right now.

The past year has been painful. Two million jobs have been lost, trillions of dollars in paper wealth has evaporated, the U.S. dollar is just off multi-year highs (showing its first signs of cracking though), and hurting exports…I could go on and on.

No one knows how bad it’s going to get for the U.S. economy. Or how long it’s going to last. As we looked at over the weekend, many of the leading economists and money managers predict 2009 to be, at best, a long recession and a slow recovery.

At this point, the markets have priced in most of the bad news.

We’re in a recession. Prices are falling, demand is falling, and earnings have already started to fall. Lower profits mean lower share prices. We all know it…the stock market knows it. Stocks have fallen back to 1998 price levels, erased a decade of gains, and look cheap.

Corporate bonds, however, are a completely different story. Corporate bonds, relative to government bonds, are cheaper than they’ve been in more than 70 years!

It’s all due to how investors look at bonds. In the bond market, earnings per share, P/E ratios, growth rates, and analyst estimates just don’t matter. All that matters is, “Can this company make good on this loan?”

That’s it. Bondholders just want their money back plus interest. All the other stuff, which drives share prices up and down, really doesn’t matter. (Note: the derivatives market has made it a bit more complicated, but it’s still basic borrowing and lending money at the core).

Recession or Depression

That’s why the most important consideration when it comes to owning a diverse bond portfolio (which you probably own if you own any investment-grade corporate bond funds) is the state of the overall economy.

In a recession, top-tier companies which generate loads of free cash flow (think Wal-Mart, DuPont, Johnson & Johnson, etc.) aren’t going anywhere. Revenues, margins, and profits will get squeezed a bit, but they’ll be around to pay the bills.

That’s all a bondholder really cares about. As a result, they have “investment grade” debt. There’s very little risk of them not being able to repay their debts, even when we know there will be more bankruptcies, mass layoffs, and corporate belt-tightening.

That’s why Gross says in his December note to investors, “[It’s] better to own corporate bonds than corporate stocks.” It’s because you get paid first.

Bonds are Best in Bad Times

At the end of the day, investing is all about risks and rewards. Every investment carries some element of risk. Even “risk free” U.S. government bonds are at risk of inflation and default (a long shot, but seemingly more possible by the day).

Corporate bonds are no different. And before buying a bond, stock, or real estate, you have to ask, “Does the rewards of bonds outweigh the risks?”

During good times, the answer is usually “No.”

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.

Mind the Gap

Since the credit crisis hit this summer, pools of capital for lending have dried up. When the government talks about frozen credit markets, this is what they’re talking about.

Banks have labeled most companies “too risky.” As a result, the banks won’t make the loan. Instead, they’ll turn and lend to the government by buying less risky U.S. government debt.

This is killing off some businesses, cutting deeply into the profits of others, and creating opportunities for others.

Take a look at the chart below. The yield from U.S. Treasury bonds has plummeted. Currently a 10- year Treasury bond yields a measly 2.5%. Meanwhile, the average yield on an investment-grade corporate bond (like Wal-Mart, DuPont, etc.) is 9%.

That makes the yield spread (the gap between corporate bonds and government bonds) between 6% or 7%. Compare that to 2006 and 2007 and the spread between yields on government and corporate debt was only 2%. Now, it’s 6% or 7%. It’s an absolutely staggering increase.

John Lonski, an economist at debt rating firm Moody’s, says, “The yield spread…still exceeds each of its previous monthly averages going back to 1932 despite how the current recession hardly resembles the slump of the early 1930s.”

That’s how bad it has gotten in the bond market. And it’s a big reason why I think high-quality corporate bonds are worth a look.

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

Stick to the Plan

I’d bet corporate bonds are cheap because, so far, everything is working the way it’s supposed to during a recession.

Take a look around you. Demand is falling for everything. Consumers and businesses have started saving for rougher times ahead. Businesses are selling down inventories. Businesses which lost their competitive edge, failed to adapt, or loaded up on debt to eke out slightly bigger profit margins, are closing up shop (i.e. newspapers, overleveraged REITs, retailers).

That’s what is supposed to happen. It’s not supposed to be fun. It’s a part of purging the excess out of the system.

Even though we go through this purging and resetting period every few years (granted to a varying degrees – recessions are never exactly the same) stocks nosedive, panic sets in, and tremendous values are created for investors willing to take the risk.

That’s why I turn to people who have been at this successfully for a long time.  One of those is David Dreman. Dreman is the chairman of Dreman Value Management and in October of 2007, while warning of the impending market collapse,  offered this sage advice:

Since coming to Wall Street in the late 1960s, I have been through seven such crises. Somehow, the market survived them and thrived…

During each crisis investors felt confused, uncertain and panicky. They believed nothing in their previous experience could help them cope with the ominous new world they faced. “Sell, sell, sell,” their inner worrywarts advised. “Save your capital before it’s too late.”

This almost always turned out to be a bad move. Selling in a crisis is foolish.

There you have it: Uncertain…panicky… foolish. Three words which describe average investors right now.

Of course, the average investor buys and sells at the worst times and consistently loses money. So it’s best to do the exact opposite.

I realize, volatility is high and it’s going to stay that way for awhile. There’s a lot of uncertainty (OPEC, oil prices, Fed rate cuts, etc.), but there are still opportunities for those willing to look for them.

The best thing to do now is to get a plan together and stick to it. At depression-level prices, corporate bonds should be a part of any plan and there couldn’t be a better time than now to start buying.

There are a lot of advantages to boring old bonds which tend to get thrown to the wayside when the Dow is setting new all-time highs. Corporate bonds provide a very steady stream of income which is now (and will continue to be) heavily valued in today’s market. Bonds can boost your retirement income, provide a safe haven where you earn safe and steady 8% annual returns, and provide you with some extra cash flow so you’re able to buy more stocks when the market drops.

That’s why now, with corporate bond yields at 70 year highs relative to government bonds, you should reserve a spot in your portfolio for them and fill it over the coming year or so. And if inflation fears really get out of control, there will be an even better time to buy coming soon.

In a market like this, when emotions are running wild, there’s no better way to avoid the pitfalls of fear (selling when the market is dropping) and greed (jumping in late fearing you’re missing the big rally) than patiently waiting. There is a historically proven conservative investing strategy that will help you to rebuild your portfolio.

It’s a buyer’s market and you get to set the price you’re willing to pay. Whether its stocks, bonds, real estate, or anything else, if you wait for the price to come to you, chances are you’ll probably get it. So as always, it’s time to buy, but it very well could be time to buy for another two years so buy smartly and sparingly. 

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

Some might call it a bull market.  Others would say that was heresy: “What, with the dollar on its way to becoming worthless?  How dare you speak of a bull market!”

And yet that’s exactly what it is.

On the 10th of October, when the Dow Industrials fell briefly below the 8000 level and the panic was general, 93% of all stocks traded on the New York Stock Exchange registered new 52 week lows.  Let me repeat that, because it’s going to be years before it happens again – if it ever does:

ALMOST ALL NYSE STOCKS TRADING
ON OCTOBER 10 RECORDED NEW LOWS

As difficult as it may be to process, this is perhaps the single most telling piece of evidence pointing to a bottom in the market.

How many more stocks would have to hit new lows before the zombies and one-way gold-dolts admitted that the panic was over?

An interesting (but relevant) aside: Bob Farrell, former head of Merrill Lynch Research for over 40 years and one of the premier market analysts on Wall Street, wrote a widely read and distributed piece on technical analysis and general market tendencies called “10 Market Rules to Remember.”

Rule #4 of the canon reads: Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.

In other words: these types of sharply moving markets tend to correct equally sharply – not allowing investors to contemplate their next move in tranquility.

The chance of a “bottoming process,” therefore, is next to nil.  There will be no basing or plateau-ing at these levels.  The next move will be a violent thrust up yer pantleg.  And if you’re not ready for it, you’ll be doubled over, gasping like a schoolboy who’s just discovered his acorns.

There’s money to be made here, Junior!  Get on board!

Here’s another one:

What you’re looking at is the anticipated and actual year over year growth in earnings for all ten S&P 500 stock sectors for the third quarter of this year (not all companies yet reported).

What the chart shows is that nearly all sectors surprised to the upside (particularly consumer discretionaries, by 30.90%), and that the financials were wholly responsible for the negative earnings of the index as a whole.

Considering the fact that the financials are now the property of the Government of the United States of America, you have nothing more to worry about.  And no excuses, either, for not climbing on board.

Cash Buildup Threatens to Break the Dam!

Related item: cash hoards at mutual funds have reached near record levels, standing currently at 25%.  The last time this happened was in the early 1980’s, at the outset of the current bull market.  The difference between that time and this, however, is that money market funds then paid you 10%+ for cash.  Today, if you can find 1.5%, you should consider yourself rich.

Not only that, but cash levels such as these are almost always a reliable predictor of significant bull moves in equities.  Ned Davis Research offers that the market regularly rises 12% whenever money-fund balances hit 11%.  So what might they do at 25%?

Perhaps last week’s 15% gain (the biggest one week Dow surge since 1974) can be attributed to this money starting to find its way back into circulation?

So given all of the above, what’s the best way to deploy at this point?

Good of you to ask. 

There are literally hundreds of good buys out there, but we want to highlight a single theme in today’s free Oxbury Chart of the Week.  (For more detailed information on this theme subscribe to Oxbury’s Residual Income Report).

Preferred shares have taken a thrashing since Dr. Paulson disemboweled Freddie and Fannie and tossed all their preferred organ meat in the garbage.  Since then the market wasn’t sure what to with the rest of the financial world’s perferreds and decided to practice a little of their own medicine, dumping anything that had ‘preferred’ written on it, regardless the issuer or fundamentals of the company, and using whatever tool was at hand to do the cutting.

The result is a bevy of great yielding securities with the full faith and backing of the U.S. Government.  And you don’t have to be Warren Buffet to get in on the action.  (For those out of the loop: the rich old arse recently took big positions in the preferreds of Goldman Sachs and General Electric, each yielding 10%.)  Financial preferred shares are widely available.  Here are just a few issues to consider.

We’ll start with the Citigroup Capital Vii preferreds (CPRV:NYSE), now yielding 9.58%.  As the chart shows, this issue is slowly finding a footing and reworking its way back towards par value at $25.  Capital gains potential here is significant.

JP Morgan’s JPMPRJ:NYSE is another issue worth mentioning.  JP Morgan has been, along with Wells Fargo, a beacon of strength among the financials.  Accordingly, its

preferred pays 7.3% — a good measure less than the competition’s.  Earlier this month, J.P. Morgan CEO James Dimon bought $10.5 million worth of his own JPM preferreds.  That should offer a little confidence.

And finally, lying somewhere between the two is Bank of America’s preferred ‘H’ series (BACPRH:NYSE), yielding 8.90%.  Like Citigroup and J.P. Morgan, Bank of America recently availed itself of the Federal Government’s $700 billion rescue fund to shore up its balance sheet. 

This alone should give investors a warm feeling.  After the Lehman Brothers bankruptcy, Dr. Paulson essentially decided which of the major financials would be allowed to live and which would die.  The above three were chosen as worthy of continued existence.

They’re now considered too big to fail.

Go eat your organs.

Matt McAbby
Analyst, Oxbury Research

Today the S&P is trading at 935 – a 40% drop from its high of 1,565.15. If you take the 14 bear markets since the Great Depression, the average decline was 38%. At the low on October 28, the decline was 45.5%.

So are we at the bottom? Perhaps. But consider this…

The average duration of these bear markets was 18.4 months. Given that we’re in the 13th month now, that puts us relatively close to the end, right?

Not quite. Bear markets aren’t created equal and if you only take the ones that saw declines in excess of 40%, the average duration is 28.4 months.

So if the current bear plays out in this way, we aren’t even half way through. Combine this with an unemployment rate of 6.1% – with the expectation that it will rise above 7% – and it seems much less likely that we’ve reached the bottom.

What does seem certain, however, is that we’re likely in for a long recovery, which could substantially jeopardize cash flows. And that’s a key issue when it comes to investing in companies on the basis of a dividend. 

To Pay Or Not To Pay?

Amid the market’s mess, many pundits have touted the benefits of dividend paying stocks. It’s an issue we wrote about here a couple of weeks ago.

While it’s true that dividends bring you a form of income, does it really put a floor under a stock? The argument is pretty simple. Many companies have products that are such an integral part of day-to-day life that they are…

1. Very unlikely to disappear.
2. They’ve built up balance sheets that are strong enough to survive a multi-year downturn. 

So instead of high share price appreciation, they repay their shareholders by passing along the profits in the form of dividends.

However, as cash flows dry up, companies cannot always support their dividends and investors can suffer a second whammy as the dividend gets cut and the stock finds a new level at the same yield.

Here’s the way to do it…

Follow The Cash

You have to be tactical. Buying dividend stocks in this type of prolonged downturn does provide a good return if the stock remains stable. But if a cash flow shock occurs, dividends could suffer and the stocks that were supported at the beginning of the bear market substantially underperform later on.

You can avoid this trap by looking at the key driver of dividends – cash flow.

In the heat of a bear market, investors will always be concerned about how far top-line growth can drop, but good management teams can handle this by cutting expenses.

However, the fixed depreciation of hard assets that are stuck to the balance sheet can make profit look worse than cash flow. While profit may look bad in the short-term, I have never seen a company cut a dividend that was 50% of free cash flow (or less).

The bottom line is that as long as free cash flow holds up, the management team has options and the dividend will be safe.

The last thing a company with a historically stable dividend will do is cut its dividend, as it would entirely change the shareholder base by boxing out value investors that have a yield hurdle.

So when it comes to dividend-paying stocks, while revenue and earnings growth are obviously important, be more concerned with the money on the cash flow statement.

Paul Moore
Smart Profits Report

When it comes to investing, the ability to play solid defense can ease you through turbulent times much better than most ordinary investors.

And the concept here is simple: Defensive investing means having some strong, dividend-paying stocks in your portfolio. Forget running to cash as a “last resort” because of negative market performance.

Instead, it’s better to look for long-term drivers – like earnings growth, cash and the ability of companies to pay dividends to their shareholders. In fact, history shows us that this is a particularly smart way to go. From 1935 to 2007, more than 40% of the S&P 500’s total return came from reinvested dividends.

The beauty of dividend-yielding stocks is that they work well in both rising and falling markets. During the bull market of 1982 to 2000, dividend stocks actually outperformed non-dividend payers by a considerable margin, despite the underlying share price appreciation.

And in volatile, sinking markets like we’re experiencing now, it’s comforting to know that you still have a source of income throughout the madness. You’re essentially being paid for your patience, rather than selling off like everyone else. Let’s take a look at some of the other benefits of dividend-paying assets.

The Benefits of Investing in Dividend-Paying Stocks 

The benefits of investing in dividend-paying stocks are numerous. Here are three that we feel are most important:

• Lower Your Average Cost: When you’re receiving a regular dividend payment, and reinvesting those shares, over time it reduces the price you originally paid. It’s essentially like buying a house, then renting it out to offset the payment and pick up income, while the underlying asset appreciates at the same time.
• Stability During Downturns: When the broader stock market is under pressure and share prices are falling, stocks that pay dividends are often considered one of the “safer haven” investments, since investors are still receiving income. In turn, it’s good PR for a company, with the stock attracting more investors and the share price potentially rising as a result.
• Get Management on Your Side: When a company is regularly distributing money back to its shareholders, it requires management’s discipline and long-term planning to keep that outflow consistent. Knowing that dividend payments must be met reduces the chances that they’ll fritter your money away. If they pay out too much, or invest in risky projects, they risk impacting their ability to pay a dividend. In many ways it can be the ultimate “check” on a management’s work.

The Pitfalls to Investing in Dividend-Paying Stocks

Of course, there are pitfalls when it comes to investing in dividend-paying stocks too. Here are three things to look out for:

• Beware Dividend Reductions: If a company reduces or suspends its dividend payments, it’s usually done as a last resort. Management recognizes that changing dividends results in an immediate negative reaction from shareholders. It could signal that the company is having trouble raising cash, or that the business is making less money.
• Consider Tax Implications: Naturally, the IRS wants to take its piece of the pie – and when it comes to dividends, it’s a double-whammy. First, it claims the regular corporation taxes from the company. Then, when the company passes what’s left down to its shareholders, those investors are then taxed on what they receive. In addition, the Jobs Growth and Tax Relief Reconciliation Act – which lowered the tax rate on dividends – expires in 2010, so we may see dividend taxes rise when it does.
• Question Growth Ability: Some argue that while companies should be praised for rewarding shareholders through dividends, it may also mean that it can’t find other investment options or projects. Generally larger companies return part of their profits in dividends when their growth slows.

Ultimately, dividend-paying stocks need to be thoroughly researched, like any investment. But adding them to your portfolio could be just the answer to defending your bottom line.

Good investing,

Martin Denholm
Investment U

One of the truest is also one of the most fundamental rules: If you want to be successful, it starts with playing solid defense.

Sadly, this is a concept lost on my favorite English soccer team, Everton, who’ve shipped a league-high 18 goals in just eight games this season. It’s also lost on the Denver Broncos, whose defense has more holes than the Old Course at St. Andrews and who got walloped 41-7 by New England on Monday night.

When it comes to investing, the ability to play solid defense can ease you through turbulent times much better than most ordinary investors. And the concept here is simple: Defensive investing means having some strong, dividend-paying companies in your portfolio.

A 72-Year History Of Top Performance

The two main concepts that dominate the stock market climate are fear and greed. While they’re always prevalent, smarter investors know better than to base their decisions on fluctuating sentiments like these.

Instead, it’s better to look for long-term drivers – like earnings growth, cash, and the ability of companies to pay dividends to their shareholders.

History shows that the latter is a particularly smart way to go. From 1935 to 2007, more than 40% of the S&P 500’s total return came from reinvested dividends.

The beauty of dividend-yielding stocks is that they work well in both rising and falling markets. SensibleStocks.com reports that during the bull market of 1982 to 2000, dividend stocks actually outperformed non-dividend payers by a considerable margin, despite the underlying share price appreciation.

And in volatile, sinking markets like we’re experiencing now, it’s comforting to know that you’ve still got a source of income throughout the madness. You’re essentially being paid for your patience, rather than selling off like everyone else.

Let’s look at some more benefits…

Dish Me Some Dividends… Three Reasons To Invest In Dividend-Yielders

Lowers Cost: When you’re picking up a regular dividend payment per share every quarter, over time, it reduces the price you originally paid for the shares. It’s essentially like buying a house, then renting it out to offset the payment and pick up income, while the underlying asset appreciates at the same time. And of course, since the Jobs Growth and Tax Relief Reconciliation Act of 2003, investors have paid lower taxes on dividends.

Provides Stability During Downturns: When the broader stock market is under pressure and share prices are falling, stocks that pay dividends are often considered one of the “safer haven” investments, since investors are still receiving income. In turn, it’s good PR for a company, with the stock attracting more investors and the share price potentially rising as a result. Pay attention to the level of insider ownership of a stock here. This is not a hard and fast rule, but if insiders hold a big chunk of the company themselves, they’re less likely to be reckless with its money through overly ambitious projects or ill-advised buyouts, and may well pay greater attention to shareholder interests and dividends.

Keeps Management In Line: When an executive team is dishing money back to its shareholders, not only does it show sound business acumen to be able to do that in the first place, it also keeps them honest. Knowing that dividend payments must be met reduces the chances that they’ll fritter your money away on wasteful projects.

Of course, there are pitfalls, too. So before I get to a couple of investment options for you, let’s look at those…

Dividend Drawbacks

Dividend Reduction Or Suspension: At a time when obtaining credit is tighter than ever before, it’s much more likely that companies will reduce or suspend their dividend payments. This is usually a last resort, as it signals to the world that the company is having trouble raising cash, which can, in turn, severely impact its share price.

Twice The Tax… And Higher In 2010? Naturally, the IRS needs to grab its piece of the pie – and when it comes to dividends, it’s a double-whammy. First, it claims the regular corporation taxes from the company. Then, when the company passes what’s left down to its shareholders, those investors are then taxed on what they receive. In addition, the Jobs Growth and Tax Relief Reconciliation Act that I mentioned a moment ago expires in 2010, so we may see dividend taxes rise when it does.

Lack Of Investment Options: Some argue that while companies should be praised for rewarding shareholder loyalty through dividends, it may also mean that it can’t find other investment options, or projects that would accelerate the company’s growth.

And beware companies that offer sky-high dividend yields. It could merely be a crafty way to mask bigger problems. Automakers like General Motors (NYSE: GM) and Ford (NYSE: F) are good examples, as are some of the beaten-up financial stocks like Citigroup (NYSE: C).

And as share prices drop, dividend yields rise, which can be a false dawn. Bottom line: If a company isn’t growing its earnings or its cash-flow has shrunk, it may well be a bad sign. Make sure you do your regular due diligence.

Where To Look For The Best Dividends

Right now, two of the best dividend-yielding sectors are Consumer Staples and Telecom.

In the upcoming November Xcelerated Profits Report issue, my colleague Jim Stanton is recommending one of the best companies within the Consumer Staples sector, which pays a dividend. One of the advantages that this sector has during a downturn or recession is that it continues to generate revenue through essential repeat business. After all, consumers always need everyday household items.

(As an aside, you can get your hands on Jim’s specific Consumer Staples recommendation by signing up for the Xcelerated Profits Report. Just click this link for more details).

In the telecom sector, firms like Verizon (NYSE: VZ) and AT & T (NYSE: T) boast some rock-solid financials, allowing them to pay a 6.8% dividend ($1.84 per share annually) and 6.3% ($1.60 per share annually).

In the current climate, though, if you don’t want to take the chance on individual companies, you can always diversify and lower your risk by buying ETFs that hold dividend-yielding companies. Take a look at…

SPDR S&P Dividend ETF (SDY: AMEX): Holding stocks like Bank of America (NYSE: BAC), Pfizer (NYSE: PFE), Fifth Third Bancorp (Nasdaq: FITB) and Consolidated Edison Inc (NYSE: ED), the fund tracks the price and yield performance of stocks in the S&P High Dividend Aristocrats index.

PowerShares High Yield Dividend Achievers (AMEX: PEY): This fund’s results try to correspond to the Dividend Achievers 50 Index. Around 80% of its holdings are in companies that have consistently raised their dividends. Its holdings include Bank of America, Keycorp (NYSE: KEY), American Capital Strategies (Nasdaq: ACAS), BB&T Corp (NYSE: BBT) and Comerica (NYSE: CMA).

Best regards,

Martin Denholm
Smart Profits Report

Today I want to point out one that is so rare it is without precedent. I’m talking about the current yield on municipal bonds relative to Treasuries.

As you know, investors have flocked to Treasuries as a safe haven during the current economic storm. T-bills are yielding less than a half of one percent. Ten-year and 30-year Treasuries are yielding about 3.5% and 4% respectively.

Yet municipal bonds of 15-year and higher maturities are currently yielding more than 5%. 

Why is that so unusual? Because the interest from municipal bonds is exempt from federal taxation. As a result, munis ordinarily offer yields at 90% of the level of Treasuries. Today they are yielding as much as 140% of Treasuries.

"Valuations have really gotten out of whack," says Paul Breenan of Nuveen Investments, who manages more than $13 billion of municipal bond assets. "They’re at historic levels we’ve never seen before."

2 Reasons To Buy Municipal Bonds Right Now

Besides the higher yields, there are two other reasons you should buy tax-free municipal bonds right now: 

• One is that this month, Moody’s is about to begin rating municipal bonds the same way it rates corporate bonds. 

  "There will be an uplifting of credit quality of many muni securities," says Jim Colby, senior municipal strategist for fixed income at Van Eck Global. "Chances are that when Moody’s changes its ratings, you’ll get higher credit ratings and better prices."

  Under the new system, many A-rated bonds will become AAA-rated. That will cause the price of those bonds to rise.

• The other reason to buy municipal bonds now is that it looks like Senator Obama will win the election next month. He has pledged to raise the top marginal tax rate. So it’s reasonable to expect a major uptick in the demand for tax-free bonds in the year ahead.

Why aren’t these investors swooping in to buy these bonds already? Some of them are. But a big source of muni buying is typically banks and insurance companies. Right now these companies are de-leveraging. Selling assets, in other words, not buying. This has pressured the market, creating the juicy tax-free yields we see today.

The Best Ways To Play The Municipal Bond Phenomenon

What are the best ways to play this unusual municipal bonds phenomenon?

• The first, of course, is to buy individual municipal bonds. If you own an individual bond, there are no annual expenses and you are assured of receiving $1,000 per bond at maturity.

  Pick your bonds depending on which state you live in. If you live in a high tax area like New York or California, for instance, you will definitely want to own your own state’s bonds to avoid both state and federal income taxes. 

  Follow the link to get information on your state’s individual municipal bonds.

• Another way to own munis is through Vanguard mutual funds. Why Vanguard? Because it has the lowest expenses in the industry. (The average mutual fund company charges expenses six times as high as Vanguard.) It’s a simple equation: The lower your annual expenses, the greater your net returns. 

  Follow the link for a complete menu of Vanguard tax-free municipal bonds.

• Yet another way to buy tax-free bonds is through a closed-end fund like Nuveen Insured Municipal Opportunity Fund (NYSE: NIO).

  This fund also holds a portfolio of tax-free bonds. The annual expense ratio is 1.15%. Although this is higher than Vanguard, it is actually cheap by closed-end fund standards. Many closed-end funds have expenses that total more than 2% per year.

  And NIO offers something that Vanguard cannot. You currently have the ability to buy this fund for 33% less than the net asset value. In other words, you can buy a dollar’s worth of assets for sixty-seven cents.

And you should. The deep discount is causing the fund to yield 7% tax-free. (If you’re in the top tax bracket, the taxable equivalent is over 10%.)

If the market price moves back to net asset value when things settle down, which is likely, you’ll have a 33% capital gain down the road as well.

The Risks of Buying Municipal Bonds

What are the risks of buying these municipal bonds? There are two mainly:

• The first is that all this government spending turns out to be inflationary and so bond yields rise. That would cause bond prices to decline, at least temporarily.
• Then there is the risk of default. But this is pretty negligible.  According to Moody’s, the 10-year default rate on all investment-grade bonds is 2.1%. For AAA-rated corporate debt it is 0.52%. The default rate for investment-grade municipal bonds is a scant 0.07%.

In short, these are three good ways to capitalize on the credit crisis that is gripping the nation.   They won’t last forever. So you ought to take advantage of them now. 

Good Investing,

Alexander Green
Investment U

Yes, dividend-paying stocks are usually more predictable. But after the gut-wrenching 12 months we have been through, “dull” suddenly becomes attractive. And it can be profitable as well. Studies of historic stock returns show that the combination of consistent dividends and an increasing stock price can offer powerful returns that out-strip the market averages.

When I search for stocks, I am always more interested in solid dividend payers that reward owners with cash. One of my favorite mantras is “show me the money.” And it’s why the pharmaceutical sector is particularly interesting right now…

Pharmaceutical Company Dividends

Fat dividends have attracted me recently to the largest pharmaceutical companies. Ten years ago, these firms were the darlings of growth investors. When Bill Clinton’s plan to reform and socialize medicine was defeated in the early 1990s, the shares of these firms rocketed higher.

However, near the end of the decade, shares of many of these stocks stalled, and, as a group, their prices have remained stable. But in the following decade, regular increases in the dividends and earnings of the shares have compressed the price-to-earnings and dramatically boosted the dividend yields.

When you approach dividend-paying stocks or companies, gauging their strength is sometimes difficult. Here is one way to know if they are actually going to pump up your returns:

-A common misconception is that a high dividend yield is the most important measure.

-But a yield that is higher than that of other stocks in a sector could actually be a sign of weakness.

-If the firm is in trouble, they could be preparing to cut, or in some cases, cease to pay a dividend.

A high yield preceded major downturns in financial stocks that had gotten in trouble with subprime and other bad loans. The dividends were slashed to improve the liquidity and cash position of the businesses.

The Dividend PayOut Ratio – An Important Indicator

The important indicator for you to watch is not just dividend yield, but the dividend payout ratio. This is the percentage of earnings directed to paying stock dividends, and it shows us if a company can maintain a level or growing annual payment.

For example, Pfizer (NYSE: PFE) currently has a 6.6% yield. With a stock price of $19.11, the firm must pay a dividend of $1.28 to maintain that yield. Since last year, Pfizer earned $1.33, and it has a payout ratio of 92% of earnings.

Pfizer generates more than enough profit to continue to pay the dividend, but if the company should stumble more – and make less than $1.28 next year – it would not have the earnings to cover dividends. Then the firm would have to dip into reserves or borrow money to pay the dividend. In such a case, the dividend would be at risk.

The best dividend paying stocks are those that hold the yield steady as they grow. In this case, the dividends are growing year after year, and you benefit from both the capital gains and the cash.

The Top 5 Dividend-Paying Stocks

For decades, buying shares of such franchise players as Coca-Cola, Johnson & Johnson, Altria and General Electric have been great dividend-paying stock plays.

In the current market, I like pharmaceutical stocks because the largest have become virtual cash machines. The dividends offer a protection against dramatic drops in share price. In addition to Pfizer…

-Johnson & Johnson (NYSE: JNJ) yields 2.6%
-Novartis (NYSE: NVS) yields 2.6%
-Glaxosmithkline (NYSE: GSK) yields 4.4%
-And Eli Lilly (NYSE: LLY) yields 4.0%.

All these are outstanding yields for growing firms. Pfizer grew revenue 9.4% last quarter. JNJ grew 8.7%, Novartis grew 14.7%, Glaxo grew 3.5% and Lilly grew 11.20% in the last quarter.

While a number of these drug firms have been under pressure from market perceptions of slow growth, shallow pipelines of new drugs and patent expirations, these negatives are already priced into the shares.

Investing in dividend stocks is not a sexy investment strategy, but it can be one of the most profitable. By following the “show me the money” mantra, these cash machines can start improving your portfolio and deliver outstanding returns.

Floyd G. Brown
Investment U

Buying shares for income has traditionally entailed investing in sectors that economically aren’t going anywhere. U.S.-focused investors find themselves owning railroads, trucking companies and electric utilities, not the most exciting of sectors, and most unlikely to grow your investment as a percentage of the global economy.

Even in those so-called tried and true sectors, in the modern U.S. economy of huge payouts, stock options and multi-millionaire management, you aren’t likely to get the dividends you deserve. For example, the railroad company CSX Corp. (CSX) yields 1.5%, trucking company J.B. Hunt Transport Services Inc. (JBHT) yields 1.0% and even electric utility American Electric Power Co. Inc. (AEP) yields a modest 4.3%.

All three companies pay out less than half their earnings. The remainder is retained in the company, or used for share buy-backs, to provide capital gains for top management’s greedy stock options. If you can’t get decent dividends from investing in these admirable operations, dividend investing in the United States is a lost cause.

But internationally, income investment is a horse of a different color.

First, international firms don’t follow the Wall Street model of huge salaries, generous stock options and seven-figure bonuses. Less money earmarked for executive compensation means more cash in investors’ pockets. And that’s a good thing, because international investors have a natural cynicism about retained earnings, believing that money that stays with the company is just management’s to waste. It’s much better to have the excess cash paid out in dividends, to do with, as you like.

Second, foreign markets are growing much faster than the United States. If the local economy is growing at 7% to 10%, even the railroads and electric utilities will grow at a similar pace, providing an increasing stream of profits.

Third, you don’t need to confine yourself to companies growing at the speed of an arthritic snail to get good dividends or sacrifice the capital gains that come from investing in sectors that provide the world’s new ideas, intellectual growth and economic advance. Unlike the technology firms in the United States, some international companies in growth sectors don’t feel they have a God-given right to keep ALL the earnings under management’s control. Instead, they pay out dividends to shareholders.

The international appeal of dividends makes more sense when you remember that many of these companies are still controlled by the founders or their immediate heirs. Large dividends on their holdings are understandably attractive to these rich founding families.

Furthermore, in some countries such as Taiwan, the tax system rewards paying dividends, by imposing an additional retained profits tax on companies that keep too much of their earnings without making good use of them. (The United States had a similar tax from 1936 to 1958, but the management lobby proved stronger than the investor lobby, so it was repealed.)

Internationally, you can find what seems impossible in the United States: Companies in growth sectors, with good track records, that nevertheless pay out good dividends, at least at the 4-5% level and sometimes more. By investing in such companies, investors can have the best of both worlds:

-A substantial dividend that they can live on.
-And the chance of capital gains in the future as the company expands.

It’s almost like U.S. investing in the halcyon days of 1949, when the Dow Jones Index had a Price-Earnings (P/E) ratio of 7% and a 6.9% yield (U.S. Treasuries yielded less than 3% at that time). And while we can’t go back in time, by investing internationally and picking carefully, we can get some of the advantages of an investor in 1949. And even possibly do as well as that investor did during the subsequent decade of Eisenhower growth and stock price rises.

Here’s how to have it both ways, when it comes to international income investing:

Administradora de Fondos de Pensiones Provida SA (ADR: PVD), commonly known as Provida, is the funds manager of the privatized Chilean social security funds, a business it has diversified to hold investments in fund administrators in Peru, Ecuador, Mexico and the Dominican Republic. Majority owned by the Spanish bank Banco Bilbao Vizcaya Argentaria with a P/E ratio at 9 times trailing earnings, and a dividend yield of 7.6%, this stock is especially juicy for income investors. Growth will likely come from increases in assets under management, as Chile becomes richer and some expansion of the Chilean pension fund model to other countries.

Acer (Taiwan) (London Stock Exchange: ACID) is the world’s third largest manufacturer of personal computers, with top technological innovation in Taiwan and the ability to manufacture in the cheap-labor rural China. P/E ratio 12 and a dividend yield of 5.6%, plus you get to participate in the growth of the PC industry.

Eni SPA (ADR: E) is Italy’s entry in the Big Oil stakes. Because of Italy’s neutral foreign policy posture, it has the advantage of being able to operate in countries like Kazakhstan, Libya and Venezuela where U.S. companies have difficulty. At a price-earnings ratio of only 6.7 with a dividend yield of 6.6%, it currently offers excellent value with chances for growth if oil prices stay high and new oil sources remain attractive.

By Martin Hutchinson
Money Morning

In this column we’re going to explore income alternatives available from short-term investments in foreign currencies, a strategy that capitalizes on both the general sogginess of the dollar and the higher yields available from some markets abroad.

Investments in short-term foreign-currency assets can potentially offer much better returns than U.S. investments for income investors, for the following reasons:

-The United States continues to run a $700 billion payments deficit annually. While that continues, the dollar will tend to be weak against other currencies. Sometimes, even low-risk investments in the right foreign currency can provide substantial capital gains – and it’s not always the obvious currencies. Did you know you could have made over 30% in dollars over the past year from a bank deposit in Czech crowns? And that wasn’t some wild-eyed risk; the Czech Republic is a perfectly solid middle-income democratic EU member with an admirable free-market president, Vaclav Klaus.

-Because U.S. interest rates are so low, many countries have higher interest rates right now, but without the escalating rates of inflation that currently appear to be afflicting the U.S. economy. Australian, Brazilian and New Zealand bank deposits all pay more than 5%. All three currencies have recently been strong against the dollar, and that’s likely to continue, even as the inflation rates in these countries remains comparable to, or lower than, that of the United States.

Foreign currency short-term assets are ideal for that portion of an investment portfolio that seeks to avoid exposure to both the risks of equity markets, and to the risks of global inflation. For the income investor who is seeking to live off some of the returns on his investments, a portfolio with too much investment in stocks – domestic or international – is vulnerable to a general global downturn, when worldwide stocks may decline in price and force investors to sell at the bottom of a bear market. International investments in bonds suffer if inflation rises, because bond yields are forced higher, causing capital losses on bond investments.

But international investments in short-term instruments do not suffer either penalty. They are safe from stock market downturns. They are also safe from inflation, since short-term investments are continually reinvested, and in an inflationary period the new investments will generally offer higher yields, offsetting the inflationary erosion in purchasing power.

As an illustration, remember that when U.S. inflation hit 10% in 1980, short-term-investment yields rose as high as 17%, providing investors with an ample return to cover inflation’s cost.

Investment in international short-term instruments or deposits is not the same as buying a money market fund; their dollar value will fluctuate as the dollar fluctuates in value against other currencies. Needless to say, in a period such as the present (when the dollar is generally weak), the strategy that I’m detailing here can provide additional capital gains for the dollar-based investor.

There are two ways easily available to U.S. investors to invest in foreign currency short-term assets:

One is to invest in foreign currency deposits. These are available through Everbank, with which Money Morning has a relationship. Because Everbank is a U.S. bank, its foreign-currency deposits benefit from a guarantee by the Federal Deposit Insurance Corp. of up to $100,000. Everbank offers deposits of 3-, 6-, 9- and 12-months’ maturity in a number of foreign currencies, with a minimum investment of $10,000. For example, Everbank currently offers deposit yields of 5.5% in Australian dollars, 6.13% in New Zealand dollars, 4.25% in Norwegian krone and 8.75% in South African rand, compared with deposit rates of around 3% to 4% available in the domestic U.S. market. All those currencies appear to have good prospects to rise against the dollar over the next 6-month period, except the South African rand where local inflation is above 10%.

Everbank also offers a range of multi-currency-index CDs, which provide currency diversification as well as an attractive yield. For example, its commodity index CD – containing equal amounts of Australian dollars, Canadian dollars, New Zealand dollars, and South African rand, with a yield of 5.5% – might be expected to appreciate against the dollar in periods such as the present when commodity prices are rising and commodity-based economies are doing well.

The main disadvantage of the Everbank system is that your money is physically converted into foreign currencies, incurring a foreign exchange cost of up to 1% in the process. For short-term deposits, this obviously can be expensive.

The other possibility is to invest in one of the funds that have recently opened that specialize in investments in short-term foreign currency assets. These funds have the advantage of being quoted in dollars, so there is no foreign-exchange cost in purchasing them. Three of these in particular appear attractive:

-The Franklin Templeton Hard Currency Fund (ICPHX), part of the well-known Franklin Templeton group, rated as a five-star fund by Morningstar, has a minimum investment of $1,000, but the disadvantage of a 2.25% front-end “load.” That load, or fee, is important when considering an investment in short-term assets. There is also the “advisor-class fund” (ICHHX), with identical holdings and a minimum investment of $50,000. This has no front-end load, but it appears you have to buy it through a broker, incurring additional costs. The two funds have combined assets of $693 million and were established in 1989. ICHHX has an average annual return of 7.76% over 3 years, and a yield on a trailing-12-month basis of 7.75%. The funds invest primarily in hard currency (low inflation) deposits and short-term bonds, with an average maturity of 0.16 years (2 months) – they may invest 20% of their funds in other assets, such as gold and inflationary currencies.

-Specialist currency fund manager, Merk Investments LLC, offers the other two funds. The Merk Hard Currency Fund (MERKX) , founded in 2005, also is given a five-star rating by Morningstar, and has $435 million of assets invested in hard currency short-term bills offered by governments and prime corporations, as well as modest holdings of gold. It is up 11.62% over 3 years and offers a yield of 6.79% on a trailing 12-month basis. It has no sales load and a minimum investment of $2,500.

-The Merk Asian Currency Fund (MEAFX), was established only in April 2008, too recently to have obtained a Morningstar rating or reliable performance data, and has assets of only $45 million. Its attraction is that it specializes in short-term instruments in Asian currencies; at present, for example, it has 41% of its fund in short-term Chinese Renminbi (yuan). Again, the fund has a minimum initial investment of $2,500 and no sales load.

By Martin Hutchinson
Money Morning