For the last few weeks, we have been warning investors of alarming deflationary trends such as the decline in commodity prices, growth slowdowns in emerging markets, tepid growth in developing economies. And up until now we believed our Global Income edge portfolios were well insulated.

But new market developments and upcoming changes in U.S. monetary policy demand action on some portfolio holdings, please see the subscriber section for ratings changes. 

The wave of selloffs in the last two weeks in stock and commodities markets of the U.S., China, Europe, and around the world, suggests that global growth may have decelerated more significantly than previously believed, which has significant investment implications for a whole host of industries in our portfolios.  

And there is a growing concern that the Federal Reserve’s anticipated rate increase in mid-September could derail the U.S. and global recovery. This from some economists who believe the U.S. economy is still too weak for such an action, given lower-than-projected inflation rates and still weak capital investment. The strengthening of the U.S. dollar also has not helped, being a drag on growth as it makes our exports more expensive and so less competitive.  

The Federal Reserve on Aug. 19 released its minutes of the July 28-29 Federal Open Market Committee session, which offered no clear sign whether it would raise rates in its September 16-17 meeting.  The Fed officials said conditions for raising interest rates were approaching, though they saw more room for labor market healing and need more confidence that inflation is moving toward their goal, according to a Bloomberg news report.

Long-term bond markets are signaling that the Fed rate hike could be a mistake if it happens.  Even as short-term U.S. bonds continue to signal that the that the Fed is poised for a rate hike soon, U.S. 30-year yields are down more than 30 basis points since hitting 3.25 percent in early July, falling to a low in late August of 2.84%.

The assumption of a global recovery has been a major pillar of Global Income Edge’s investment thesis, but we have long acknowledged that this recovery could come in fits and starts. However, these recent events introduce the greater possibility of a global recession that requires pairing down holdings that were more positioned for growth, as these investments will likely be casualties of a selloff as a result of a greater investor flight to safety.   

Further, the ideal time to reposition income portfolios is now, whether the Fed raises rates or not, as there is evidence that investors will become more fearful a major market correction over the next six months.   

We see income opportunities in the coming months as some great long-term growth and income investments will be oversold in the shakeup.  For example, we continue to believe the REIT space and utilities will be a beneficiary of bond investors looking for a safe place to preserve gains as high yield bond markets are expected to continue to sell off on global weakness.  

As such, in the next few weeks, Global Income Edge plans to unveil new holdings that are better positioned for this higher risk market environment.

Portfolio Update

Upon our one-year anniversary, Global Income Edge has identified a number of holdings that could be hurt by slower than anticipated global growth. We are making the following changes to the portfolios.

Conservative Portfolio Actions

Sell Dividend 15 Split (TSX: DFN)

Dividend 15 Split (TSX: DFN) has delivered a 10% annualized dividend yield but recent market declines have clawed back a lot of the gains. Recent weakness in the Canadian economy – where it’s expected that a second consecutive quarter loss will be reported – has given us pause as these conditions typically put pressure on high dividend payers. That’s why we prefer to be safe than sorry and wait for the Canadian economy to fully recover.  Sell DFN

Sell Pearson (NYSE: PSO)

Pearson (NYSE: PSO) recently sold its ownership stakes in the London Financial Times and the Economist to focus on the education market, assets which we thought gave the firm cache and prestige and separated it from every other flavor of digital learning provider. The future of education may be digital but we’re not ready to pick winners in what is a highly competitive and crowded space. Sell PSO

Sell Huaneng Power International (NYSE: HNP)

Chinese power utility Huaneng Power International (NYSE: HNP) has held its own for the last few weeks during the mass market selloffs. But with experts unsure where the bottom is, and the utility starting to take on single digit losses, we’re not willing to stick around and find out.

Sell HNP

Aggressive Portfolio Actions

Sell Ares Capital Corporation (NYSE: ARCC)

Ares Capital Corporation (NYSE: ARCC) has been a stellar business development company, achieving at different times an annualized dividend yield of almost 10%, and presently a total return of 5.37%. But given recent signs of a global growth slowdown, these types of firms are the first to be impacted as they lend to small and medium businesses that could be hurt by a downturn. Sell ARCC 

Sell Marine Harvest (NYSE: MHG)

Marine Harvest (NYSE: MHG) offered a good fish story. It made a good case for why this business would work given growing global middle class incomes and increasing demands for fish. The idea of a global fish company with economies of scale made sense. But its financial and operational performance over the year has reeked, and so has the performance of its breakeven stock. This is one stock that should sleep with the fishes. Sell MHG

Sell KKR & Co. (NYSE: KKR) 

Private equity firm KKR & Co. has much potential to become a major investment bank in the future, that’s what drew us to this investment. We’ve been impressed with its moves into lending and syndication and overseas initiatives to diversify its business model. But if there is to be a correction in the coming months KKR will find it difficult to sell companies that it has invested in its principal business right now. And private equity firms typically have a rough time during market corrections as earnings suffer on write downs

KKR last quarter said distributable earnings to shareholders fell 30% to $491.4 million from last year. KKR said it will pay a dividend of $0.42 per share, down from $0.67 per share last year. We believe these declines in earnings are early indicators of the weakness in the business. KKR is a Sell.   

Hold PDL BioPharma Inc. (Nasdaq: PDLI)

PDL BioPharma Inc. (NYSE: PDLI) just doesn’t seem to get any respect. As my colleague Ben Shepherd reported in August, PDL owns a portfolio of patents used for making humanized antibodies, a key component in the development and manufacture of many drugs collects royalties when its patents are used.

Many of those patents are nearing expiration, so investors have been wondering if the company will be able to replace that income stream and maintain its dividend. But PDL has been providing financing to other biotech companies, making sound returns. 

But the market still seems skeptical whether it will be able to recreate the success of its expiring patents, and the stock has experienced serious declines as a result. For me money talks, and after having spent hundreds of million, I’d bet there is a good possibility of PDL investing in a break out drug. I just wouldn’t bet at current stock values, and until the firm starts delivering more substantially on its investments. Hold on PDLI.

Hold on Seaspan (NYSE: SSW)

Seaspan (NYSE: SSW) has been a stellar run company whose stock has been caught up in the fear selling going on in Asia on weakness in China.  The firm recently reported that net profit jumped by 170% year-over-year, hitting $102.7 million in the first six months of 2015 as compared to just $38 million in the same period last year. Revenue jumped 13.4% to $387.8 million.

As my colleague Khoa Nguyen reported, while the company did have unscheduled downtime on some of its ships and won lower than expected charter rates on others, that weakness was offset by the delivery of 10 new ships in the period that were already chartered. It also as 23 new ships on order which are expected to be delivered in 2017, most of which are already committed to charters as long as 17 years.

With all this good news you’d think the stock would be reaching new levels of overvalued, rather than being pummeled with the entire Chinese selloff. As we do not know what the bottom is or how long these levels will hold, we counsel investors to stop accumulating until markets stabilize.  Hold on SSW

Hold on Banco Bradesco (NYSE: BBD)

As we reported recently in a report entitled Banco Bradesco: Blame it on Rio, Banco Bradesco (NYSE: BBD) is a well-run bank that finds itself in a Brazilian economy that is contracting. This top-performing bank, Brazil’s second-largest, has had its valuation dragged down by a wave of negative sentiment, causing investors to lose sight of the fundamentals.

We believe over the long-term, Banco Bradesco will be of great value when the Brazilian economy starts to recover. But given recent market declines, we’ve reached a threshold where the stock is only a suitable investment for only the most aggressive of investors. And we’re not in the business of calling bottoms in falling economies. Until Brazil start to get its economic house in better order, Hold on BBD. 

REIT Portfolio Actions

Sell Government Properties (NYSE: GOV)

Given the recent REIT selloff we’ve been willing to extend a lot of latitude to REIT companies as we thought the selling was overdone. Further, we believe bond holders may pile in to alternative income investments such as REITs as bond values decline and they seek to preserve value.

But Government Properties has been experiencing something that cannot be ignored, falling occupancies and falling earnings on government cutbacks on office space. And our Early Warning System, which identifies weakness in corporate balance sheets, has spotted declines on return on equity (ROE), dropping 18% in the last quarter. Two quarters of negative ROE have been exhibited in many firms that later eliminated their dividend.  GOV is a Sell.

Hold on Senior Housing Properties (NYSE: SNH)

Beyond some very light weakness in occupancies in some of its businesses, we really can’t find a good reason for why Senior Housing Properties (NYSE: SNH) stock has sold off except that analysts want faster growth in the healthcare trend, according to some reports.  

In August, its last quarter, the firm reported normalized funds from operations (FFO) of $0.45 per share for the second quarter, up almost 5% compared to the same period last year and in line with consensus. This is the third straight quarter that SNH has posted 5% year-over-year growth in normalized FFO on a per-share basis.

The need for senior housing for baby boomers is an absolute in our mind. And according to our Early Warning System,  return on equity for Senior Housing Properties has been consistently the same every quarter around 1%, whereas net profit margins, though slightly lower, are still in the mid- to high- teens.  Given investors would flock to REITs for safety, we advise investors to stop accumulating  Senior Housing Properties until its valuation stabilizes. Hold on SNH