Summary
Preferred stocks are an alternate source of income for investors focused on income, but there are times when the asset class has the volatility of common stocks. Our review of the history of drawdowns in the asset class shows that volatility is modest between epic events like the Global Financial Crisis (GFC) and the global pandemic. Moreover, investors in the asset class avoid permanent loss of capital and see a continued stream of income.
Key Points
We reviewed the history of drawdowns by examining a broad measure of the asset class, the S&P US Preferred Stock Index (SPTREFTR). Index data became available in 2003. We drew the following conclusions:
Selloffs in the preferred stock asset class are usually modest in size and short in duration. Of the ten biggest drawdowns, the average of eight was less than 8%.
Two were severe but they might be considered Black Swan events. One was during the worst economic slowdown since the Great Depression of the 1930s. The other was caused by another rare event, a global pandemic.
In five of the ten drawdowns, investors recovered their losses in less than six months and only one full recovery took more than a year.
Credit Risk Drives Volatility
The primary risk for preferred stocks is the deterioration of credit quality during economic downturns. The big selloffs of 2007-2009 and 2020 occurred during periods of financial instability and extreme economic weakness. The others correspond to times when the Federal Reserve was tightening monetary conditions and investors were reassessing the risk of cyclical slowdowns.
The Greenspan/Bernanke Cycle
In the years leading up to the Global Financial Crisis, the Fed Funds Rate rose relentlessly during the years of 2004, 2005, 2006 and into the first part of 2007. There were three minor selloffs during this period. When economic growth continued, the stocks rebounded and investors recovered their losses quickly.
The GFC plunge in preferred stock prices corresponded to slowing and then steeply dropping economic activity. The low in the benchmark occurred in the third quarter of 2009, when the environment began to improve. The recovery of losses was slow, taking more than three years, just as the rebound in economic activity was slow and tepid. (The Fed Funds Rate remained near zero for almost seven years.)
The GFC selloff was far deeper than the pandemic-related downturn, probably because financial issuers were at the heart of the GFC. The benchmark’s largest weighting is in issues from the financial sector. As measured by the benchmark Index, the asset class sold off 66% in 2007 as compared a fall of 33% in 2020.
The Bernanke/Powell Cycle
The years 2016, 2017, 2018 and early 2019 were also marked by a steady tightening of monetary conditions and minor selloffs in preferred stocks. Like in the earlier decade, investors quickly recovered their losses as economic growth remained steady and credit quality remained strong.
It took a wildcard event like the global pandemic to bring an end to this period and trigger another epic selloff in preferred stocks. It is important to note that, once again, the rebound in preferred stocks was as quick as the turnaround in economic activity. In 2020, investors recovered their losses in about eight months.
The Chronological Detail
The following table chronicles the history of drawdowns since 2003:
For more information, visit InfraCapFunds.com
DISCLOSURE
The information contained herein represents our subjective belief and opinions and should not be construed as investment advice. The information and opinions provided should not be taken as specific advice on the merits of any investment decision. Investors should make their own decisions regarding any investments mentioned, and their prospects based on such investors’ own review of publicly available information and should not rely on the information contained herein. Infrastructure Capital Advisors, LLC nor any of its affiliates accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein. This article includes information based on data and calculations sourced from Bloomberg and third-party sources. We believe that the data is reliable, we have not sought, nor have we received, permission from any third-party to include their information in this article. Many of the statements in this article reflect our subjective belief.
Performance Data: Performance data quoted backtested results. Backtested Performance was derived from the retroactive application of a model developed with the benefit of hindsight. Backtested performance is no guarantee of future results and current performance may be higher or lower than the performance shown.
Data and Opinions: This data was prepared using Bloomberg data and sources of information generally believed to be reliable; however, its accuracy is not guaranteed. Opinions represented are subject to change and should not be considered investment advice.
Indices: Index information and performance is compiled from Bloomberg data. The S&P U.S. Preferred Stock Index (SPTREFTER) is designed to measure the performance of the U.S. preferred stock market. Preferred stocks pay dividends at a specified rate and receive preference over common stocks in terms of dividend payments and liquidation of assets. The index is unmanaged, its returns do not reflect any fees, expenses or sales changes, and is not available for direct investment.
Drawdowns and Days to Recovery: Drawdown measures peak-to-trough percent declines, while days to recover measures the number of days required to recover the estimated initial loss in the index.
Asset Class: Discussions of preferred stocks or investments in preferred stocks broadly refers to the performance of the S&P U.S. Preferred Stock Index, not the performance or returns achieved by any individual investor in preferred stocks or a particular preferred stock.
Investors Loss Recovery: The loss recovery discussed is based on holding a hypothetical investment in the S&P U.S. Preferred Stock Index through each event scenario, without selling. If an investor were to invest in single preferred stocks or sell their investment during a downturn the outcome of this hypothetical scenario would be different.
©Copyright 2021 Infrastructure Capital Advisors