The Only Asset That’s Less Risky Than Usual…
Covid-19 has increased risk in almost everything. But the most overlooked risk in the financial markets we recently learned about was that prices are not limited to zero on the downside, at least in the futures markets.
I’m referring, of course, to last week when the May contract in oil futures traded as low as -$37.63 a barrel.
When you think about it, though, it actually makes sense. Oil futures involve a contract to buy or sell 1,000 barrels of oil. Buyers have the obligation to accept delivery of 1,000 barrels at expiration. This is different than the equity options we trade where buyers have an option to accept delivery.
As the May contract expired, no one wanted to accept physical delivery of oil. That’s a problem. It costs money to store oil and, at current prices, it was cheaper to pay someone to close the contract than to accept delivery.
On that day, all other contracts (for future months) traded above zero, so negative pricing was unique to that one contract.
Unique does not mean it will never happen again, however. We could see the same thing next month when the June contract expires. But honestly, that seems unlikely because traders now know that prices can be negative. Traders have always known that expiration day can be brutal. The rational ones will close their positions at least a day or so sooner next month.
Almost Everything Is Riskier Right Now…
Rational traders will also recognize that almost everything has become riskier in the past few months. The pandemic changed the demand for oil and other commodities, made asset-backed securities riskier by endangering payments from businesses and consumers, and had other effects on markets.
That’s why I was surprised to see that one group of stocks is less risky after the pandemic.
In a recent report, Standard & Poor’s noted…
“Supply chains have been disrupted, unemployment rates have skyrocketed, and the public health crisis has escalated in many countries.
Despite the implementation of unprecedented government stimulus packages and interest rates dropping to near zero, the pandemic is still affecting many industries. In this blog, we update our prior analysis and explore the top five industries most impacted by COVID-19 during the month of March 2020.
This time around, the analysis also includes an assessment of the industries least impacted by COVID-19, giving an indication of relative strength.
Our approach is consistent to the prior analysis; we leveraged the Credit Analytics Probability of Default Model Market Signals (PDMS) which uses stock price movements and asset volatility as inputs to calculate a one-year probability of default (PD).”
The details are technical, but the result of the analysis was interesting to me – healthcare REITs are less risky than they were a month ago. The PD for this group fell from 0.55% to 0.52%. That’s a small change, but it’s the only improvement in outlook.
How I’m Trading This Information
My most recent trading recommendation is in a healthcare REIT, LTC Properties (NYSE: LTC).
LTC is a real estate investment trust (REIT) is a company that owns, operates, or finances income-generating real estate. To qualify as a REIT, the company is required by the IRS to pay a minimum of 90% of taxable income as dividends very year
LTC invests in senior housing and health care properties. The company uses sale-leasebacks, mortgage financing, joint ventures, and other financial tools to gain exposure to the properties. It holds more than 200 investments in 28 states with 30 operating partners. The portfolio is about evenly split between senior housing and skilled nursing properties.
Like other stocks, LTC is beaten down. The weakness is due to the broad market selloff rather than a problem unique to the company.
Covid-19 has been especially deadly at many senior properties, and there will be changes in the industry. LTC is well-positioned for those changes. The company could acquire less well-managed properties, something management is focused on.
Recently, the company decided to suspend its share buyback program. According to the CEO, this is “to further increase our liquidity and help maintain our strong and flexible balance sheet. With a rising level of uncertainty in all aspects of corporate life, we believe it is prudent to enhance our already high level of conservatism. Additionally, increased financial flexibility and liquidity will allow LTC to complete and compete for accretive transactions when this crisis passes.”
Action To Take
LTC has about $693 million in debt and pays an average interest rate of 4.2% on that debt. It has access to at least $500 million in financing under existing agreements. The monthly dividend of $0.19 is well covered by cash flow from operations and is likely to be maintained or even increased in the next year.
This makes it a compelling choice for investors looking for income. But rather than buy and simply wait for our dividends to roll in, I have a better plan…
Over at my Maximum Income premium service, we recently executed what I like to call a “bonus” dividend trade. This conservative, proven strategy allows us to earn income upfront from stocks we already own. And this allows us to earn thousands in extra income each month.