Eurozone Debt Contagion Telling Us It’s Time to Buy Dividend Stocks, REITS and MLPs

By: Money_Morning

Jon D. Markman writes: With the escalating Eurozone-debt-contagion fears of recent weeks, a significant shift is taking place in the global stock-and-bond markets.

The powerful bull cycle that grew out of the early March 2009 market lows - the quickest and strongest stock-market rebound of the past 50 years - has been losing some of its youthful verve as it matures. That means we can expect the pace of gains to moderate as asset classes (stocks, bonds, currencies, commodities) begin to differentiate themselves.

But that doesn't mean the profit opportunities are gone. As that differentiation plays out, such income-oriented plays as high-yielding dividend stocks, real estate investment trusts (REITS) and master-limited partnerships (MLPs) will prove to be major beneficiaries, experiencing a handsome run-up in price. Shrewd investors will move into those investments before their prices increase.

What Junk Bond Yields Are Telling Us
Investors considering these moves shouldn't dawdle: The global debt contagion emanating out of Europe could accelerate the afore-mentioned differentiation. Investors were reminded of these fears again yesterday (Monday), after the rescue of a regional bank in Spain added to concerns about the health of Europe's economy.

Over in the credit market, we can already see that junk bonds have decoupled from higher-quality investment grade issues. Byron Douglass of Credit Derivatives Research told clients last week that concerns over Greece and the demise of the euro have ''shocked'' investors who had piled into junk bonds without realizing the risks that they were taking. Now these latecomers to the junk-bond rally are fleeing the high-yield debt securities, which is causing their spreads over U.S. Treasury bonds to widen.

Here's why this is important.

A bond spread is a quantification of risk. Historically, U.S. Treasuries have been perceived to have little or no default risk. In periods of uncertainty, fears of default risk escalate, inducing investors to jettison higher-risk debt securities. That, in turn, raises bond spreads.

But there's an interesting twist to consider here.

As debt-contagion fears have risen in the past few weeks, high-yield bonds have taken the biggest hit. But Douglass, the Credit Derivatives senior analyst, reports that the pace of the spread widening is outpacing the pressure being placed on junk bonds from the credit-derivatives market.

This is significant because the credit bears at predatory hedge funds prefer to assault bond derivatives rather than cash bonds because that's where they can get more leverage, and because derivatives are less-regulated. This means that the increased yield (decline in price) of junk bonds is happening because "real" investors - pension funds and private citizens - are stepping back, not because opportunistic traders are attacking.

The message: Quality is once again starting to matter. And that means that the initial enthusiastic rally that saw the junkiest bonds (and stocks) move the most is likely coming to an end.

Fund flow data corroborates what the cash bond market is telling us. According to EPFR Global, a Cambridge, Mass.-based credit-research firm, the 54-week net inflow streak for global bond funds ended last week. Most of the money formerly flowing into those international bond flows now appears to be heading into ultra-safe money-market mutual funds.

Once the euro crisis settles down, my expectation is that a lot of this money will start seeking out high-quality, high-dividend stocks in the utility and industrial sectors - as well as the bond-like real estate investment trusts (REITs) and master limited partnerships. We're positioned for this in our Strategic Advantage advisory service.

It's worth making sure that you are correctly positioned, too.

So what does this all mean for the stock market? According to the folks at Lowry Research Corp. it means that the market might be moving from what they call the "primary buying phase" - a low-risk/high-return environment - to a more stable "holding-and-upgrading zone." This change is represented by the intermediate-term trend breaks in their proprietary measures of the supply and demand for stocks, and usually begins with a stronger-than-normal correction.

The best way to interpret all this information is to imagine that, as investors, we're all in a train on a long journey. The action in the credit-and-equity markets over the past two weeks suggests we're about to pass an important milestone as the economy transitions from recovery to expansion and the bull market matures. Veteran analysts like Barry Knapp at Barclays Capital (NYSE ADR: BCS) believe that means that the strategies that have worked well over the last 14 months - focusing on high-beta, early cyclical stocks - will start underperforming. The train is still moving forward, but at a slower pace.

Knapp is telling clients to focus next on higher-quality cyclicals that have attractive valuations, particularly industrial and tech manufacturers. Knapp also likes attractively priced defensives such as telecom, utilities, and healthcare.

I think his point of focusing on high-quality, dividend-paying cyclicals and economically sensitive defensive stocks is the way to go over the next few months. Some choices are aerospace, energy master limited partnerships (MLPs) and foodmakers - and not the large-cap bank or energy stocks that make up a large portion of the major market indexes.

Source : http://moneymorning.com/2010/05/25/debt-contagion-3/

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