Why do preferred stocks go down more than Dow Jones stocks?
Why do preferred stocks go down more than Dow Jones stocks?
As a rule, they don't. I would not expect them to have long term volatility of much more than the corporate bond market. However, in recent weeks they have been hit hard. Here is why I think that has happened:
(1) Index funds have seen redemptions. The biggest -- iShares (PFF - 34) has seen 49 million shares of redemptions since the end of August. That's over 10% of its market cap. As a result the fund has had to sell approximately $1.7 billion of its portfolio, or about 80 million shares. The market has had a tough time absorbing this volume. As a result, yields are at post-crisis highs both on an absolute basis and relative to the 10-year Treasury. I think this is a gigantic buying opportunity.
(2) Bonds in general have declined as a result of rising short-term rates.
(3) At year-end, investors with useful tax losses are harvesting them.
I don't think the decline has anything to do with underlying fundamentals. As a rule, preferred-stock issuers tend to be clustered on either side of the BBB/BB divide, and you might argue that lower-rated companies ought to pay higher yields. Granted; but not to this extent. Remember that many preferreds pay qualified dividends so the yield differential is even greater than it might seem. If you own a portfolio of preferreds, hang on. If you have money, buy more.
Preferred stocks are generally "debt alternatives" and not technically "stock" in how you are thinking of them. Look at the long term lock up nature of the interest rate they pay. These securities usually act like super long duration bonds (bad in a rising rate environment) unless they have reset rates that float.
I do not know how you came up with that conclusion as it varies. GE, the last original DOW stocks, was down so much they removed it from the DOW. In fact, over the past few years GE is down over -70%. Retail investors need to realize that the indices are managed over time & they weed out the "losers." This is one is reason indices have a positive bias.
Preferred stocks are sort of a hybrid between a stock & bond. Sometimes they act like stocks, and sometimes bonds. But they are definitely interest rate sensitive and you don't have as much upside as common stock. They are purchased primarily for income and are supposed to be less volatile, but that is not always the case. All asset classes have their day in the sun and other times you want to avoid or get burned. This is why I do not subscribe to a completely diversified "pie chart."
Many people also believe you can simply buy preferred stock & just stick in your drawer. I don't subscribe to this either. At our shop we say that "Price is Truth." It's ok to be wrong, but don't stay wrong. The good news is that the charts appear to be stabilizing on preferred and we just took a position a few days ago in a preferred ETF. This offers us a basket of preferreds for some diversity specifically that sector, but we can quickly exit with on trade.
If you are specifically asking why preferreds came under pressure in recently times (past year), it is because of fear of rising rates and preferreds were trading like bonds. But now that the Fed has become more dovish, preferreds appear to be stabilzing & finding support. BTW, this is NOT advice and we could change our mind in a week or month.
Hope this helps and best of luck, Dan Stewart CFA®
We as human beings like to find reasons for everything that occurs. The lamp broke because someone knocked it over, a car crashed because the breaks failed. However, sometimes those reasons are too complex for us to understand. For example, why did the stock market go up today vs going down yesterday? News stories will give you reasons, but those reasons are not always accurate. The markets are overly complex, making the answers to these questions almost unanswerable. However, it makes us feel better that we have an answer to the question. I mention this because it is an important context for this question.
The real answer is that it will be different every day. Today it might be because of X and tomorrow it might be because of Y. In general Preferred stocks do not go down more than Dow Jones stocks, but sometimes they do. If you are asking about correlations, preferred stocks do correlate to equities, but not entirely. Correlation does not imply causation. If you are not familiar with this concept, you should consider it.
So, knowing that the reason will different each day, I'll give you a common reason for preferred stocks to drop unexpectedly with no obvious reason. One thing that is important to understand about preferred stocks is that they are not liquid (in general). Some preferred stocks may have an average daily volume of 5,000-20,000. If you are trying to buy or sell 50,000 shares, it will move the market. If the stock market is selling off, and someone needs liquidity and needs to sell shares of their preferred stock, it may unintentionally cause havoc with the stock price. It especially becomes apparent when the stock market gets rocky. The liquidity is one important component that most people ignore when they are investing in traded securities.
I hope you found this helpful
You are probably referring to the recent December swoon across all markets. On a day to day basis stocks will have more volatility then a preferred stock. However, a preffered stock should be looked at as a credit instrument. Credit concerns are usually exacerbated by a crash in the stock market like we saw in December. Because of this people will liquidate anything that is considered risky. Because preferred stocks have very little liquidity the prices will drop rather dramatically in a crash like scenario. The easiest way to illustate this is take whatever preferred stock you own and compare the volume to the common stock over the last year. The volume will be significantly less than the stock, so when investors panic and sell there is less volume to buy the shares thus dropping the share price quickly.
While this can be unfortunate in short time periods, the important thing to understand is that these liquidity disruptions will have little to do over the long term of holding a preffered stock. It is imperitave that you do a solid credit analysis on the company and how it will meet its debt obligations. As long as there is little danger of a bankruptcy the preferred shares should recover.