Yesterday I introduced you to Jim Collins, Outsider Club’s newest financial expert.
Jim is an expert in income investing and has over two decades of stock analysis experience as an equity analyst and financial analyst with some of Wall Street’s biggest and most respected firms like Lehman Brothers; Donaldson, Lufkin & Jenrette; and UBS.
He currently has around $10 million in Assets Under Management for clients around the world.
Now, you can get his CFA-level guidance each week in the Outsider Club.
Today we’re going to dig into the Fed rate hike, what you should be buying and selling in the event of a correction, and some options for protecting and growing your money with “baby bonds.”
Let’s get to it…
Q: Let’s get right to the elephant in the room. What happens to stocks after the Fed rate hike, which could be coming up as soon as next month?
Well, I think that psychologically since there hasn’t been a hike for more than nine years now, I think it is going to, for lack of a better phrase, freak people out.
Q: So you think people will be panic selling?
My guess is that people are going to overreact to what the actual impact of 25 or 50 basis points higher short rates will be on the economy. Having been a former automotive guy, I don’t think there is that much impact — plus there is usually a six-to-twelve-month lag.
So higher interest rates aren’t the number one correlation here.
But I think this time, the market will forget about history — many investors weren’t even around nine years ago. So I definitely worry more about the psychological impact than the actual economic impact.
The way people will value the stocks is the spread between the dividend yield and some kind of benchmark. So, if raising interest rates makes the entire curve go up, the long rates go up — which is usually the benchmark — and you either have to price the stock down or you have to get yield.
Q: So what do you sell when rates are rising?
Utilities. That’s a classic way to do it.
Companies that aren’t growing and have people buying them simply for the dividend become far less attractive as interest rates go higher.
That’s one thing to watch out for when your goal is income generation. If we get too many of these non-growing behemoths, our returns are going to suffer when interest rates rise.
Which they will — because they have too…
If you own Exelon (NYSE: EXC) for example, and you are getting 4% and say the 10-year Treasury goes to 3.2% — you are working with 0.8% spread. Do you really want to own that when the company itself isn’t really growing?
If you are focused on income, it’s just not really worth it.
Q: So what are you looking at for short-term returns over the next year or so?
Well, some of these beaten down energy plays will start moving. One I’m looking at just went up 75% last Monday, for instance, which is insane.
What you are really trying to find is a bottom in oil — which is pretty tough. Personally, I like to find companies with a near-term catalyst — like a pipeline they are selling. If you find a couple of those types of energy stocks, that makes the fact that the market itself — which the DOW is down this year, by the way — it makes those far more attractive in this market.
So energy is going to snap back, and that’s pretty much it for the short term. I’m actually kind of bearish.
That is no fun at cocktail parties, where people will yammer at me about it, and I just say “the market is overvalued.”
Then we just talk about something else…
Q: Ok, so how about longer term? What do you buy when we see, say, a 5 or 10% correction?
Well, I’m not really a fan of buying what people would call “defensives”, like Pharma and consumer stocks like Merck and Proctor & Gamble. I’m not a huge fan of that…
So, I start looking at companies I haven’t owned but have wanted to. Companies that I wouldn’t buy today, but — if things really hit the fan — companies that will eventually be fine and start rising.
Some of the big tech names, the big bank stocks that are overvalued today, etc.
I’d love to see other sectors crash like oil stocks have. Then I try to go for best in breed: good cash flow and a stable increase in dividends.
Basically, I tend to wait for that correction and buy the stuff I always wanted to buy.
Q: One final question I had for you is based on an article you wrote for Outsider Club about “baby bonds.” I was not familiar with them. Can you explain what baby bonds are and what appeal they have for the average investor?
Definitely.
So, your normal bonds have a $1,000 par value and you then get coupon payments on that. It used to be really hard to get bond quotes — it’s still pretty hard today if you are using E*Trade or something.
What someone came up with around 25 years ago, is that you could cut those up in $25 increments and trade them on the stock exchanges and get a lot of retail demand for them.
While a classic GM (NYSE: GM) 2026, 7% bond was owned almost exclusively by institutions, baby bonds can be easily purchased by retail investors. They are fixed income — bonds and preferred stocks — and almost all of them have a $25 face value, and they are all listed on the stock exchange.
After living through 2008, my clients started demanding something like this. They’d say “we may need this money, we may need it quickly, and we want something liquid.” Baby bonds meet those needs.
Plus, they pay dividends more often than the normal bond’s semiannual payments. Many actually pay monthly dividends.
It’s a cool niche, and many people don’t know about it.
Q: Great advice, Jim. Thanks. We’re thrilled to have you aboard.
Thanks for having me, Jimmy. I enjoyed it.
Keep your eyes peeled, because Jim will be bringing you more of these little-known opportunities each week in Outsider Club. You can read his rundown on baby bonds right here.
