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Recession Plays: Preferred Stock and Corporate Bonds

The worsening employment and housing news on Friday only confirmed what most investors already believed: Now is a lousy time to buy stocks.

But there's good news: corporate bonds and preferred stock—with their high yields and relative safety—offer some of the best investment opportunities in years.

The reason: though many think the worst might be over for common stocks—and the economy—there's no indication that either is going to recover anytime soon.

As a result, investors will be looking for someplace safe to put their money—and get some kind of a return. And with US Treasurys now offering little or no yield, the preferred shares and debt of publicly traded companies are looking better and better.

"The opportunities that have been created by the meltdown in the market are in things that we never used to talk about before," says Peter J. Tanous, president of Lynx Investment Advisory in Washington, D.C.

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These include "preferred stocks, convertible bonds, master limited partnerships, and even junk bonds, which are now trading at a ridiculous spread from risk-free bonds," Tanous says. "You can buy a closed-end preferred stock fund today that yields 8 1/2 percent. It's an equity return but without anywhere near the equity risk."

Preferred stock and corporate bonds aren't without risk, of course. But they offer more safety than common shares—which are the first to lose out in a bankruptcy—and much higher returns.

There are plenty of ways to invest in these types of instruments as well.

Exchange-traded funds, such as the iShares iBoxx Investment Grade Corporate Bond Fund , have gained 5 percent in the past month. The iShares fund holds nearly $4 billion in net assets and is invested a bunch of different corporate bonds.

"When I see a triple-A rated corporate or decently funded municipal bond paying 5 percent—and going out 10 years—those are things we'll be invested in more than normal," says Michael D. Kresh, president of M.D. Kresh Financial Services in Islandia, N.Y. "Atypical bond investments will increase faster than in the market."

Stay Cautious

While there will be temptations to put those allotments into high-dividend plays, investment pros say corporate bond buys should be limited to companies with a strong expectation of surviving the difficult 2009 economy.

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Tanous advises a broad range of company debt, with the thought that even if some of the debt is defaulted on, investors will have enough diversification that they'll be covered by other stronger-performing companies.

"You basically want investment-grade corporate bonds," he says. "If you're a little more adventurous, Pimco has high-yield bond funds selling at a 15 percent spread between risk-free bonds. The implication of that spread is that over a 10-year period half the S&P 500 will go bankrupt. It's not likely to happen."

As a cautionary play, Power Shares has a variety of BuyWrite exchange-traded offerings, one of which Tanous plays called the CBOE S&P 500 BuyWrite Index which provides a variety of long plays and short option strategies to hedge risk on stock funds.

"You don't ever want to be completely out of equities, but you've got to do more than make dumb statements like 'stay the course'" Tanous says. "The fact is that, yes, you should have exposure to equities, but now some in a BuyWrite ETF, and maybe some equities in preferred stocks and convertibles. Equity mangers and mutual funds now have to look at safer types of instruments that have equity kickers."

CNBC.com-parent General Electric is one of those companies that offers alluring yield returns to investors, says Kresh, who likes the company's preferred stock and its 7 percent yield.

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With a global economic change taking hold, lower fuel prices, and the company's focus on green energy, Kresh thinks GE offers a safe investment with reasonable return.

"GE is extremely attractive at this point," he says. "Also, I think a lot of corporate bonds and even municipal bonds are extremely improperly priced. Where we normally stay away from bonds that are high-yield relative to Treasurys, 2 percent is now high compared to Treasurys."

One of the biggest challenges in this climate is avoiding the panic sometimes generated by the dismal reports that rained down Friday.

The reaction on Wall Street was fairly tepid following the economic news. Such muted optimism could be a critical factor to keep stocks above water.

"Psychologically it's horrible for the markets," says Peter Miralles, president of Atlanta Wealth Consultants. "When we do come out of this, which we will, we're going to be leaner and the companies are going to be more profitable. It's just part of the economic cycle. It's going to make markets more profitable in the longer term."