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Wednesday, September 4, 2013 - 11:30

The 'New Normal' For High-Yield Stocks -- And What It Means For You

Wednesday, September 4, 2013 - 11:30am

We get a lot of emails here at StreetAuthority... and we read every single one of them.

We don't have time to respond to all of them, but we try. Recently we started getting a rather persistent email from a subscriber to my High-Yield Investing newsletter.

Here's what the subscriber wrote:

"The newsletter is called 'High-Yield Investing!' Stocks with 4% yields do not constitute high yield. Maybe 'Conservative-Yield' would be a more appropriate title. I am deeply disappointed... High Yields [start] at 9% minimum." -- H.W.

I appreciate the feedback from H.W., but the truth is, I think he may not be paying attention to what's going in the market today.

My short answer to H.W.: It's not 1980 or 2009. But here is my long answer...

I would love to be able to showcase high-quality, low-risk stocks and bonds with robust yields of 9% or better to my High-Yield Investing readers week in and week out. If I did, I would likely be writing to you from my own private island somewhere in a tropical paradise -- because it would mean that I had access to a secret asset class that had eluded even the sharpest hedge fund managers.

Even assuming these 9% yielders had zero capital appreciation, we would still be whipping the market, which has delivered an average total return of 7.4% per year over the past decade. It's not easy to beat the market, period, but it's next to impossible to do so with income alone.

The fact is securities with 9% yields were commonplace after the 2008 crash. But today they are exceedingly rare.

Let's start with bonds, which typically offer higher yields than equities. The current yield on the 10-year Treasury is 2.79%. If you're willing to tie up your money for longer, the 30-year "long bond" will get you 3.77%.

What if I accept lower credit quality and expand the search overseas? That won't even get me to the "conservative" threshold of 4.0% H.W. mentioned. The Bloomberg Global Investment Grade Corporate Bond Index has a current yield of 2.82%. Even the highest-paying asset class in the bond world (with a commensurate amount of risk) still falls well short of your goal.

Keep in mind that all borrowers (from homeowners to corporations to foreign sovereign governments) pay rates based on the current yield environment and their own credit standing. And the benchmark federal funds rate, which influences other rates, is at historic lows near zero.

Think back to what yields were like back in 1984, when even a 1-year bank CD paid 10.8%. If a 10-year risk-free loan to Uncle Sam paid 5%, a AAA-rated blue-chip corporate borrower might have had to pay 7% or 8% to attract capital and a shakier company might have had to offer 10%.

But inflation was also running at double digits at the time. So while the nominal payouts appeared high, the real return (net of inflation) probably wasn't much better than it is today.

In any case, we can only take what the market gives. And right now, there are precious few bonds with 9% yields.

OK, so what about stocks? Well, the average member of the S&P 500 currently offers a dividend yield of 2.02%. What about traditionally higher-paying sectors? The SPDR International Utilities ETF (NYSE: IPU) has a trailing yield of 4.22% -- less than half of H.W.'s goal of a 9.0% yield. Banks won't get you there, either.

Out of curiosity, I just ran a simple stock screen. Out of 12,592 stocks and ADRs listed on U.S. exchanges, just 170 offer yields above 9%. And most are questionable companies like African Bank Investments (OTC: AFRVY), which, incidentally, has lost 58% of its value over the past year.

That means 12,422 stocks don't make the 9% cutoff. If I restrict myself to that criterion, then I'm automatically eliminating 99% of the pool of potential investment candidates. Needless to say, that includes the overwhelming majority of the market's biggest winners.

All of this is to say that while I strive to hunt down and recommend attractive securities with double-digit yields -- and own a few, like Medley Capital Corp. (NYSE: MCC) -- they are the exception in this environment, not the rule.

Even Warren Buffett, the greatest investor of our time, has counseled investors to tone down unrealistic expectations. Here's what he had to say:

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

Translation: We need to learn to be happy with a 9% annual total return, not expect it as a minimum yield.

And remember, I don't just invest in a stock based on a snapshot of what it looks like today. I look at its long-term earnings potential. If you had to choose between a new job that paid a $75,000 fixed annual salary with little chance of a pay raise or one that starts at $60,000, but with a 10% pay hike each year, which would you prefer?

Most of us would go with option B, knowing that our paychecks would rise to $66,000 in year two, hit $72,600 in year three, and then jump to nearly $80,000 the following year.

Investors must typically make the same choice, which is why High-Yield Investing is dedicated to stocks like Enterprise Product Partners (NYSE: EPD) -- which trades with a current 4.6% yield but has raised its dividend 37 times in a row and 48 times since first paying a dividend in 1998.

And when the right 9%-yielder DOES come my way, rest assured that I'll be here to report on it.

P.S. -- Have you heard about the wealth-crushing American Retirement Betrayal? In a just released report, I predict a possibly devasting "October Surprise" for a key area of of the U.S. economy... and it's all Ben Bernanke's fault. This collapse could happen as soon as next month, and anyone not prepared for it could have their savings wiped out. To learn how I plan to ride out the storm, click here.

Nathan Slaughter does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of EPD, MCC in one or more of its “real money” portfolios.