Income Investing: Light in a Dark World

08/19/2008 12:00 am EST

Focus: MARKETS

Richard Lehmann

Publisher, Forbes/Lehmann Income Securities Investor

Richard Lehmann, editor of the Forbes/Lehmann Income Securities Investor, tells why income investing is particularly important now.

No, we are not in a recession.

Despite all the media hype and almost universal consensus, pain to your pocketbook does not amount to a recession, which is two quarters of declining gross domestic product (GDP).

The only reason we aren’t in a recession is that the election outcome is still uncertain and Congress is pumping enough stimulus into the economy to postpone the inevitable. After November, no matter who wins, inflation fears will prompt the Federal Reserve to finally hike interest rates without fear of triggering a new financial crisis. They don’t mind triggering a recession, which in some schools of economics is a necessary step to turning an economy around.

Making matters worse, the US is still the economic engine that powers the world economy. Hence, managing a short, sharp recession versus drawn-out stagflation will be the greatest challenge.

The current financial crisis is now one year old and still of significant concern. How did subprime home mortgages mushroom into a full-blown meltdown of the entire home mortgage market? It happened because excessive leverage and a lack of transparency became evident once the credit ratings, credit insurance, and faulty structure of the mortgage securities all proved to be deficient.

Markets froze up, forcing the price of mortgage securities down to ridiculous price levels.
Accounting rules, in turn, forced financial institutions to write their holdings down to these levels, impairing their statutory capital. This in turn forced them to raise additional capital at depressed stock prices.

As we enter this second year of the crisis, this last phase is still being played out and may go on for a good while. As the months go by and the mortgage default rate proves to be less onerous than expected, the value of these securities will recover. In fact, I suspect that in two years we may be asking the question, “What was that all about?”

It was about a lack of adequate financial controls over a worldwide system that has outgrown the old rules. We have a multitrillion-dollar derivatives market which promotes speculation—much of which is sheer gambling. It allows Wall Street firms and hedge funds to operate as financial institutions with few constraints and with a degree of leverage that assure that spectacular failures will become routine. There clearly need to be changes in the rules on an international scale.

The current stock market malaise provides me with another opportunity to express my favorite investment theme: when you invest for income, the dividend and interest stream is not affected by the swings in market prices. Yes, you may see the price of your investment decline 10% or 15% and stay down for one or two years, but meanwhile you are earning 6% to 9%.

If you believe that the roaring 1990s is not likely to be repeated or if you don’t have enough saving years left to wait out another bear market, then you want to seriously consider using the present opportunities in income investing to lock in yields that will provide you a steady income.

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