Last Week’s Markets in Review: Understanding the Appeal of Preferred Stocks

Global equity markets moved lower for the week, with U.S. stocks trailing their developed international counterparts. In the U.S., the S&P 500 Index fell to a level of 4,174, representing a 1.35% loss, while the Russell Midcap Index finished 1.39% lower last week. Meanwhile, the Russell 2000 Index, a measure of the Nation’s smallest publicly traded firms, lost 2.04% over the week. Moreover, developed and emerging international markets returned -1.28% and -2.99%, respectively. Finally, the 10-year U.S. Treasury rose to 1.63%, three basis points higher than the prior week.

Regular readers of our weekly updates will likely recall that one of the three investing themes we’ve identified in 2021 calls for a rotation from defensive, growth-oriented stocks to more cyclically exposed, value-oriented stocks. This view is supported by our belief that the economy has firmly entered the expansionary phase of the economic cycle, a phase which has historically been associated with the outperformance of cyclical, value-oriented stocks relative to the broader stock market. As a reminder, growth-oriented stocks typically have higher Price-to-Earnings (P/E) ratios and are usually associated with companies that are growing earnings and/or revenue faster than their respective industry or the overall market. Conversely, value-oriented stocks are known for having higher relative dividend yields, low price-to-book ratios, and/or low P/E ratios. They also tend to trade at a lower price relative to their fundamentals and are thus considered undervalued.

One security type that investors tend to overlook, or are possibly less familiar with, is preferred securities. Preferred securities represent ownership in a corporation and have both bond and stock-like features. They usually pay a fixed and higher income level, have a par value, hold a credit rating, and trade on a major exchange. Preferred securities, which are often referred to as preferred stocks, generally experience less daily volatility when compared to common stocks, have a dividend that is paid out before dividends to common shareholders, and typically have a higher stated dividend payout than the corporation’s common shares.

What may be even more relevant to investors right now is that preferred stocks have shown an 83% correlation to U.S. value stocks over the last two years. The high correlation between U.S. value stocks and preferred stocks makes them a potential consideration for those investors looking to add a value allocation to their portfolios, along with income potential, without being fully exposed to the potential risk that a pure value strategy might entail. Moreover, investors concerned about rising interest rates might appreciate that preferred stocks tend to exhibit less sensitivity to rising interest rates than traditional fixed income asset classes.

It’s essential to keep in mind that preferred securities, although generally less risky than value-oriented stocks, still carry their own unique set of risks that should be reviewed and understood before considering an investment. As such, preferred stocks may not be appropriate for all investors. Overall, we encourage investors to stay disciplined and work with experienced financial professionals to help manage their portfolios through various market cycles within an appropriately diversified framework consistent with their objectives, timeframe, and tolerance for risk.

Best wishes for the week ahead!

Disclosures: Past performance does not guarantee future results. We have taken this information from sources that we believe to be reliable and accurate. Hennion and Walsh cannot guarantee the accuracy of said information and cannot be held liable. You cannot invest directly in an index. Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against loss.
Other Data Sources: Equity Market and Fixed Income returns are from JP Morgan as of 5/14/21. Rates and Economic Calendar Data from Bloomberg as of 5/14/21. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index, U.S. Large Cap defined by the S&P 500. Sector performance is measured using GICS methodology. S&P 500 sector performance represents total return figures sourced from Bloomberg.

Diversification can help mitigate the risk and volatility in your portfolio but does not ensure a profit or guarantee against loss.

Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.

Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.

Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than the original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.

Definitions

MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.

MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.

Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.

ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.

ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.

Investors cannot directly purchase any index.

LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.

The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.

The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.

DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.