BY RANDALL W. FORSYTH, BARRON’S – 09/16/2022
Interest rates have further to rise amid persistent inflation, while the labor market remains too strong for its own good. So says Charles Lieberman, former chief economist for one of the major New York banks that eventually was swallowed up by JPMorgan Chase. Of even greater interest to most Barron’s readers is what investment plays Lieberman favors in his present capacity as chief investment officer of Advisors Capital Management.
The benchmark 10-year Treasury note’s yield of 3.45% simply is unsustainably low with the Federal Reserve on track to lift its federal-funds target rate to around 4%-4.50%, Lieberman opined by telephone this past week. A further rise in bond yields would translate into a decline in their prices, worsening the negative returns that fixed-income investors have suffered this year.
One solution is to stick with short-term money-market instruments, such as Treasury bills, as our colleague Andrew Bary writes and as erstwhile bond king Bill Gross said a couple of months ago. One-year bills traded at more than a 4% bond-equivalent rate Thursday, putting them at the peak of the Treasury yield curve and above the yield on the widely watched two-year note.
Higher prospective bond yields means equity valuations are expensive, Lieberman continues. However, while many names—if they have earnings at all—still command stretched price/earnings multiples, he sees a lot of cheap stocks. Those include shares of quality companies trading at less than 10 times profits, and bond alternatives with higher yields and a measure of inflation protection.
That naturally leads to the energy sector, notably a number of master limited partnerships. Here he picks MPLX, a midstream play, and Sunoco ( SUN), a distributor of motor fuels, both of which sport dividend yields over 8%. Another favorite: Crossamerica Partners ( CAPL), a smaller motor-fuel retailer yielding over 10%.
Lieberman also names a few real estate investment trusts that he sees as being relatively less sensitive to higher rates than most of the breed.
Nursing-home REITs were hammered during the pandemic, but should now enjoy a tailwind as occupancy rises, he argues. Names he cites include Omega Healthcare Investors ( OHI), Sabra Health Care REIT ( SBRA), and LTC Properties (LTC). He also favors commercial mortgage REITs, including Starwood Property Trust (STWD) and Blackstone Mortgage Trust (BXMT)), with yields in the 8% range. That’s less than the double-digit yields found on more familiar residential mortgage REITs, but commercial mortgages have significantly lower risk from rising interest rates, Lieberman explains.
Less risky for REIT fans are these entities’ preferred stocks, specifically those with currently fixed dividends that convert at a future date to floating payouts at a large spread above short-term interest rates. His picks are AGNC Investment, series E (AGNCO), and Annaly Capital Management, series I ( NLY/PI ). Their current yields are in the 7% range, which is well below what’s offered on their riskier common shares.
These preferreds may convert to a floating dividend rate in 2024 at a spread nearly 5% above a short-term rate benchmark. That is, unless they’re called at their $25 par value. So investors should see either a step-up in yields to the 8% range (based on expected future yields priced into Eurodollar futures) or, if the paper is called, a capital gain.
Finally, Lieberman likes business development companies, or BDCs, which he calls banks without deposits. These lend to generally smaller companies, typically at hefty interest rates.
The key is to make good loans that actually get repaid, which makes BDC management the key criterion. His selections: industry leaders Ares Capital ( ARCC) and Hercules Capital (HTGC)), along with Sixth Street Specialty Lending (TSLX), which all sport yields in the 9% range.
Both the stock and bond markets face the prospect of the Fed doubling its current fed-funds target range of 2.25%-2.50% by early next year, according to CME’s FedWatch site. Finding high returns without taking on outsize risks is the daunting task investors now face.