Income-seeking investors have faced the same problem for four decades — declining bond yields. But it keeps getting worse.
Richard Saperstein, chief investment officer of Treasury Partners in New York, tailors strategies across asset classes for clients. He narrowed two approaches for investors who need to find a way to squeeze more income from their portfolios.
On Tuesday, the Federal Open Market Committee lowered the federal funds rate by 50 basis points to a target range off 1% to 1.25%. Yields on short-term U.S. Treasury bills declined, as expected, but the yield on 10-year Treasury notes TMUBMUSD10Y, 0.974% declined by 8 basis points to 1.02%. That was down from 1.92% on Dec. 31. Then on Wednesday, the 10-year yield dipped below 1.00%.
“A 1% 10-year yield reflects recession concerns and global negative debt,” Saperstein said during an interview March 4. He sees a long-term risk of a bursting of the bond-market “bubble,” pointing to about $14 trillion in bonds with negative yields issued outside the U.S., with some denominated in dollars. “At some point this dollar-denominated debt is going to have to be paid off. The risk is the dollar continues to strengthen. It could come home to roost at some point.”
Saperstein, 60, founded Treasury Partners in May 2009 as a division of High Towers Advisors, after his team left J.P. Morgan Chase, which had acquired the advisory group as part of its acquisition of the distressed Bear Stearns in May 2008. Treasury Partners manages $8 billion in client assets.
What income-seekers can do now
Investors who need income “now have a fundamental decision to make,” Saperstein said. “Do they take more risk for returns or keep this risk profile and accept massively lower returns?”
For investors who cannot take additional risk, the answer is simple: Your income will fall.
For investors who can only assume moderately higher risk, Saperstein pointed to corporate bonds with short maturities, which have had improving spreads over the yields of U.S. Treasury securities with the same maturities. He named three examples:
• Notes issued by Kraft Heinz KHC, +3.72% that now have a yield to maturity of about 2.40% and mature in July 2022.
• Canadian Natural Resources CNQ, -0.08% notes that yield about 2.10% and mature in February 2025.
Newell Brands NWL, -0.90% notes that yield about 2.69% and mature in April 2023.
Those yields are low, but they are attractive when compared to a yield below 1% for 10-year Treasury notes or 0.71% for five-year Treasury notes TMUBMUSD05Y, 0.715%.
“If [investors] are looking to generate equivalent levels of yield that they have been used to over the past 10 years, they cannot do it in the fixed-income market,” Saperstein said “If return is critical and the investor is willing to assume more risk, our discussions center around shifting your allocation away from fixed income and toward equity.”
Richard Saperstein, chief investment officer at Treasury Partners in New York.
That means stocks with attractive dividend yields well-supported by cash flow. Saperstein said he also prefers companies that are deploying some of their free cash flow by repurchasing shares. A lower share count means shareholders’ percentage ownership increases, and that per-share results are boosted.
Saperstein cautioned that this approach “changes your risk profile.”
“Your fixed-income investor now owning equities takes on a much greater volatility perspective in their portfolios,” he added. So if you have had difficulty tolerating the volatility since the S&P 500 SPX, +4.22% hit its last closing record Feb. 19, you may have to rethink your approach.
Saperstein named as examples three stocks of companies that are buying back shares and also have attractive dividend yields:
• Shares of CVS Health CVS, +5.59% have a dividend yield of 3.20%. One way to gauge a company’s ability to support its dividend is to look at its free cash flow yield. This can be done by dividing the past 12 reported months’ free cash flow per share by the current share price. On this basis, CVS’s free cash flow yield is 12.68%, leaving massive “headroom” for dividend increases, share repurchases, business investment or other corporate purposes.
• AT&T’s T, +5.17% dividend yield is 5.73%. The free cash flow yield is 10.90%, leaving headroom of 5.17%.
• Gilead Sciences GILD, +2.42% has a dividend yield of 3.67% and a free cash flow of 8.81%, with headroom of 5.14%.
One thing to consider is these are trailing free-cash-flow yield calculations. Disruptions in supply chains and demand for products and services as the coronavirus unfolds may lower cash flow considerably over the next two quarters.
Saperstein said his “base case” is that “by April, the virus will be under control.” He expects slower, or even negative, economic growth in the U.S. for the first half of 2020, but also said: “We have tremendous factors that can lead to a second-half recovery,” including monetary policy and pent-up demand.
Screening more dividend stocks
The three companies that Saperstein named are quite large, with an $81.5 billion market capitalization for the smallest, CVS. So here is a screen of the 15 S&P 500 companies with market-caps of at least $50 billion that have had the highest free cash flow yields over the past 12 months while also having current dividend yields of at least 3.00% and stock-repurchase plans in place. The list is sorted by dividend yield:
|Company||Ticker||Dividend yield||Free cash flow yield – past four quarters||‘Headroom’|
|Altria Group Inc.||MO, +4.84%||8.02%||9.75%||1.73%|
|AT&T Inc.||T, +5.17%||5.73%||10.90%||5.17%|
|AbbVie Inc.||ABBV, +4.77%||5.39%||9.82%||4.43%|
|Wells Fargo & Co.||WFC, +2.14%||5.03%||17.38%||12.35%|
|International Business Machines Corp.||IBM, +4.12%||5.03%||10.84%||5.81%|
|Broadcom Inc.||AVGO, +4.08%||4.74%||8.12%||3.38%|
|Verizon Communications Inc.||VZ, +4.34%||4.42%||7.72%||3.30%|
|PNC Financial Services Group Inc.||PNC, +3.11%||3.67%||12.38%||8.71%|
|Gilead Sciences Inc.||GILD, +2.42%||3.67%||8.81%||5.14%|
|U.S. Bancorp||USB, +1.21%||3.64%||11.34%||7.70%|
|Cisco Systems Inc.||CSCO, +3.37%||3.60%||8.69%||5.10%|
|CVS Health Corp.||CVS, +5.59%||3.20%||12.68%||9.49%|
|Morgan Stanley||MS, +1.89%||3.15%||44.31%||41.15%|
If you see any securities of interest here, it is important to do your own research and not only look at yields and cash flow, but also to consider a company’s business strategy and its ability to remain competitive for the next decade, at least, before considering an investment.