Income Investing In Uncertain Times

Please do not pay any attention to the elephant in the room. While you read this commentary, it won't help to focus on the elephant. So it is the end of 2010 and I would like to take this opportunity to make a few observations about the economy, the demographics of the United States and the future. And remember: don't think about the elephant as I will discuss the elephant towards the end.

In the beginning of 2010, most prognosticators were negative on the stock market and skeptical about the resilience of the recovery. For example, Fortune Magazine predicted a coming collapse in the market because stock prices were "startlingly expensive." During the first nine months of 2010, mutual fund investors pulled over $150 billion out of equity funds and poured it into bond funds. This occurred as the stock market rose. In fact, the Standard and Poor's 500 total return was around 15% for the year.

During the month of December, the yield on the ten year U.S. Treasury bond rose from 2.5% to 3.5%. Because bonds trade inversely with interest rates, the ten year Treasury lost about 8% in market value. Those who bailed out of the stock market in order to invest in these "safe" bonds will not be encouraged when they open their year end bond fund statements. They will have missed the recovery in stocks and experienced a loss in "secure" ten year U.S. Treasuries. The rise in ten year rates is an early indication of inevitable inflation because when the "Fed prints dollar bills, inflation, its value kills."

Demographics - Once our Friend!

The final 2010 U.S. Census data is not yet out, however, there are some disturbing estimates based on the previous census. Between 2010 and 2025, the number of the most productive people (age 50) will decline by over ten percent. The number of retirement age folks (people reaching age 65) will increase by almost eighty percent. I really don't like these numbers. In fact, I hate them. Because it makes me feel that no matter what stimulus the government provides, no matter what tax cuts are enacted, no matter how much more deficit spending the government creates, no matter how much we mortgage our children's future, there are going to be eighty percent more retirement age workers to care for and ten percent less workers to do the job.

So I will take the positive stock market returns from 2010 and I will be very happy. I will keep my eye on the short term swings. I, along with everyone else, will endeavor to keep my head in the sand and simply refuse to look at the demographics.

The Elephant

Maybe if we all ignore the elephant in the room, he will go away. The elephant grows bigger as the Federal debt grows larger. He is so big now that he can no longer exit through the door. I am worried that if he tries to force himself through the door, he may bring the house down. And we keep feeding him! A trillion dollars this year, two trillion last year, one and half trillion dollars next year - he is getting really big!

OK. We have an elephant in the room. At some point he is going to start smelling like inflation. He will reek of lower GDP. And he is going to require more than deficit spending to survive. He is going to need higher taxes.

How to Protect Yourself from the Elephant

You need to create (and live in) your own insulated protective biosphere. That is why most MLP experts are recommending Master Limited Partnerships. Income advisors, who really understand MLPs, recognize that MLPs have historically raised distributions during periods of inflation. They also have paid out tax deferred income. They also have a record of reliability. Tax deferral, tax deferred income, reliability, inflation protection, and a history of performance, make MLPs a great way to build you're your protective biosphere. Even though you may still see the elephant, you won't have to smell him. He is not leaving.