In Trying Times, Think Preferred Stocks

Well before the market's dramatic plunge Monday, a liquidity crisis existed in preferred stocks.

Right now, a liquidity crisis is evident all over the bond market (for instance, GE (GE) 12-month commercial paper is yielding 7%). We do not have a sufficient number of buyers to absorb the sellers' supply of securities.

It's a vicious circle. After the price declines 10%, or even 20%, more sellers emerge, and without market makers at investment banks providing a bid, the stocks drop like rocks -- in irrational fashion. The reason we know it is irrational, is that these preferred stocks have declined 20% and even 30%, while the common stocks of the same company fell less than 10%.

You don't need me to tell you that these are not common times. Most preferred shares are yielding between 9% and 14% while experiencing extreme daily volatility. I expect the volatility to go away as the financial markets and credit system heal themselves over the next 24 months. For the patient, rational investor, preferred stocks offer significant value at today's prices.

Preferred shares have been hammered this year. They crashed in mid-July, and then recovered. But when the government nationalized Fannie Mae (FNM) and Freddie Mac (FRE) and wiped out the FNM and FRE Trust Preferred shareholders, confidence in the preferred market, particularly the trust preferreds, was eviscerated.

Trust preferreds are a significant part of the preferred market. In contrast to regular preferreds, trust preferreds are usually noncumulative securities issued by financial companies.