In Trying Times, Think Preferred Stocks

More bank failures will sorely test the patience of preferred share holders. Preferred prices are unlikely to strengthen considerably before spreads begin to narrow. Preferreds are valued as long-term high-yield bonds, and as spreads stay wide, it means that investors are demanding higher yields as a margin of safety. As systemic risk subsides, we expect spreads to narrow, though possibly not until 2009. Spreads look as if they want to widen before they narrow. Even so, it seems unlikely that spreads will widen too much more from here.

I like to use preferred stocks in retirement accounts and in some taxable accounts because many preferred shares are qualified, meaning that a significant amount or the entire dividend is taxed at the 15% tax rate, as opposed to bonds, which are taxed as ordinary income, 30% or higher for many investors.

Preferred stocks may struggle for the next few quarters. And while the market for new issue trust preferreds is probably closed for the foreseeable future, existing preferred shares offer good value for long-term, patient investors.