How To Invest For Income In The Second Half Of 2013

by The Sizemore Investment Letter
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Submitted by Sizemore Investment Letter as part of our contributors program

“Sell in May” would have been terrible advice for stock investors in 2013.  The S&P 500 tacked on about 4% in the month, even if the last week and a half was a little rough.

But for investors in REIT and MLP shares—which up until this month were two of the best-performing asset classes—have suffered something of a bloodletting.  The MLP sector, as measured by the JP Morgan Alerian MLP ETN ($AMJ) is down 6% from its May 20 close, and REITs, as measured by the Vanguard REIT ETF ($VNQ), is down more than 8%.

Looking at individual securities, the numbers get worse.  Realty Income (O), National Retail Properties ($NNN), and Retail Opportunities Investment Corp ($ROIC)—three solid REITs I hold in my Dividend Growth Portfolio—are down 15%, 14% and 10%, respectively.  Martin Midstream ($MMLP), a  high-yielding MLP I hold in the same portfolio, is down by just under 10%.

Utilities, telecoms and other “widows-and-orphans-appropriate” stocks have also taken heavy losses.

For stocks that were purchased precisely for their low-volatility and high-income properties, it’s frustrating to see that much value evaporate overnight, particularly when the broader market is holding up well.  But as investors, it doesn’t do us a lot of good to dwell on our frustrations.  We have to look forward and allocate our capital based on the options in front of us.

So, what are our options?  Is the bull market in dividend paying stocks over?

No.  REITs, MLPs and other income-oriented investments have vastly outperformed the market in recent months, and they were due for a much-needed correction.  “Boring” sectors cannot lead a broad bull market forever; eventually cyclical, economically-sensitive need to take leadership.  And that is what appears to be happening today. Daimler ($DDAIF) and Cummins ($CMI), two industrial stocks held in some of my more aggressive portfolios, have been performing well, as have my Big Tech dividend payers Intel ($INTC), Microsoft ($MSFT) and Cisco Systems ($CSCO).

For the remainder of 2013, I see these stocks being in a sweet spot for income investors.  All pay respectable dividends, yet all should also benefit from a rotation from defensive sectors to growth sectors.

And what about REITs and MLPs?

I’m not quite ready to give up of those just yet.  The recent selloff was due to fears that the Fed would be unwinding its quantitative easing programs, and that bond yields would soar as a result.  But as the experience of Japan has proven, bond yields can stay much lower for much longer than most investors expect during a prolonged period of deleveraging.

Could the 10-year Treasury rise to, say, 2.5%-3.0% over the course of the next 12-18 months?  Absolutely.  But I would consider that the high-end of a long range that I expect to persist for the remainder of this decade.

In the meantime, both REITs and MLPs stand to benefit from durable trends that should continue irrespective of what the Fed does.  The American property market continues to heal, and the domestic energy boom continues to provide ample demand for pipeline assets.  Under even modest expectations, REITs and MLPs should be able to grow their cash distributions at a rate well in excess of inflation.

As you build your portfolio for the rest of 2013, overweight cyclical dividend payers, particularly those in the tech sector.  But make sure to save room for REITs and MLPs and be prepared to buy on any continued weakness.

Sizemore Capital is currently long every security mentioned. This article first appeared on MarketWatch.

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