Income from the shutdown

banker xPoliticians are self-serving. You don’t have to look at some despotic regime in South America or the Middle East to figure that out; you have to look no further than the clowns in Washington DC to get a clear view of why term limits are the best idea for all members of Congress.

But, through their hopeless inaction, they are doing a favor for investors in the short-term. The politicians have just handed the Federal Reserve of the United States a mandate for keeping interest rates low and that will be a boon for the stock market in the months to come and also re-ignite interest in a particular sector that’s been mauled and left for dead in recent months. It’s time to make a jump onto this sector before the masses realize what’s happening.

The government shutdown will result in one thing for sure – slower growth in GDP and slower growth in employment. The Federal Government spends billions of dollars each week on everything from groceries to paychecks to keeping the National Parks open. When they stop spending money, there is a ripple effect in the economy. But that ripple effect does not take place overnight. It shows up weeks or months later as dollars that would have been spent by the government and those that it supports are not being spent. Call it the reverse multiplier effect.

The multiplier effect is when a single dollar is spent and re-spent by the recipients. In other words, one dollar spent can have the effect of multiple dollars spend once it reaches its final destination. For example, if you receive $1,000 in pay, you then spend $800 to pay various bills and buy various items. When you buy an item, that manufacturer the produces a replacement for which he needs to spend money on labor and materials. The money you pay for a bill keeps another company going and funds the payroll and supplies that company needs and so on.

But, when you take that $1,000 out of the system, the worker gets laid off, the materials don’t get bought and so on. A bit simplified, but you get the idea. Now, consider that the Federal Government employs 3.4 million people, most of who are not getting a paycheck or will delayed payment weeks from now and you can see how there will be a shock to spending.

That shock will result in dismal economic numbers; just what the Federal Reserve doesn’t want to see. They will be forced to keep interest rates low as their mandated targets for inflation, GDP growth and employment growth will not be met anytime soon. That spells opportunity!

It’s spells opportunity for the fixed income sector, which has been decimated by the threat of higher rates. I am talking specifically about two sectors, Municipal Bonds and Preferred Stocks. They are two interest sensitive sectors and when rates moved higher earlier this summer, the bottom fell out of both sectors, sending prices lower and yields higher. That is about to reverse and you should consider jumping on board before the general public figures this out.

There are two plays worth considering. In the Muni space, look to closed end municipal bond funds that are trading at a discount to Net Asset Value. This means you can buy $1 worth of assets for less than $1. With Muni bonds, interest payments are exempt from Federal taxes so the higher your tax bracket, the better the deal. And, you want to stick to non-leveraged muni funds. For example, the Nuveen Municipal Income Fund (NMI) currently trades around $10, down form a high close to $13. It pays a dividend of 5.6% which is more than 7.25% taxable equivalent if you are in the 30% bracket. Compare that to your passbook account returns!

Next week I’ll share a couple of ways to take advantage of rates through the preferred stock market where some solid plays are paying close to 8% today!

To your wealth,

Banker X.


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