Why We’re Buying This US Debt Downgrade (Starting With This 9% Dividend)

by Michael Foster, Investment Strategist

This latest US debt downgrade is a buying opportunity for us contrarians. I say that because we had the same (profitable) setup the last three times the ratings agencies took Uncle Sam’s credit rating down a peg.

You might find that last sentence surprising. Three times? Indeed, the US government has seen its debt downgraded on three different occasions: 2011, 2023 and most recently a couple of weeks ago.

You can be forgiven for not remembering all of these: In some cases (2023 comes to mind), they didn’t really make headlines. In others, they set up a small dip in stocks (and stock-focused closed-end funds yielding 8%+) that was well worth buying.

Let’s go through all three occasions and see what they can tell us. We’ll also look at how they affected the performance of the Adams Diversified Equity Fund (ADX), a holding in my CEF Insider service.

ADX pays a roughly 9% dividend as I write this and sports a discount to net asset value (NAV, or the value of its underlying portfolio) of around 8%. The fund holds some of the biggest (and most credit-worthy!) US stocks, like Apple (AAPL),Microsoft (MSFT) and Visa (V), not to mention top-quality lenders like JPMorgan Chase & Co. (JPM).

Let’s start in August 2011, when debt-ceiling wrangling in Congress prompted Standard & Poor’s to downgrade US government debt. At the time, this move was historic: No agency had ever downgraded the US government’s credit, which was considered incredibly safe.

What happened next? US long-term Treasuries (in blue below) surged some 20% from the day of the downgrade through the end of 2011. The S&P 500 (in orange) also had a good run, returning nearly 6% over those few months. ADX (in purple) trailed behind, but as we’ll see next, this lag made it the best opportunity of the three.

Bonds Sprinted Ahead After the 2011 Downgrade …

Buying the S&P 500 was clearly a smart move here. But playing the contrarian and buying bonds after the downgrade delivered even faster returns. Over the long run, however, it was ADX (in purple below) that won out, with dividends reinvested:

… But ADX Was the Clear Long-Run Winner

Now let’s look at the next downgrade, in August 2023. This time it was Fitch that cut Uncle Sam to the agency’s second-highest rating.

Another Downgrade, Another Win for ADX

ADX (in purple above) has returned about 44% since then, as of this writing, well ahead of the S&P 500’s 30% gain (in orange). Meantime, Treasuries (in blue) are in the red.

Why the difference in government-bond action between this downgrade and the first one? That’s another article on its own, but suffice it to say, it had more to do with slower-than-expected Fed rate cuts than the downgrade.

The most recent downgrade, just a couple weeks ago, did cause a dip in stocks, ADX and bonds, however – though ADX has fallen the least as I write this. These declines are likely the result of tariff uncertainty, which has caused more anxiety than we saw in late 2023, when stocks were recovering from the 2022 pullback.

Tariff Worries Drive a Short-Term Dip

As you can see above, all three stayed flat until falling a little on May 20, then falling sharply the next day, when Walmart warned about price increases (and therefore lower consumer spending), and Target reported disappointing sales.

The smart money did not sell when the news was first released on the 16th, but we are probably seeing more selling pressure as the retailers’ warnings have added anxiety.

In the coming days, we could see stocks go flat or slightly negative if the sour attitude sticks around. But that would be a buying opportunity – especially for equity CEFs like ADX – similar to the openings we saw in 2023 and 2011.

Downgrade Only Covers Some Types of Debt

Another important point: the downgrade doesn’t impact all US assets. In its announcement, Moody’s makes clear that the downgrade impacts America’s “long-term issuer and senior unsecured” debt, but “the US long-term local- and foreign-currency country ceilings remain at Aaa.”

In other words, the downgrade applies to US Treasuries greater than one year in duration (government bonds, basically, up to and including 30-year issues). Those bonds now have the second-highest rating from all three ratings agencies.

At the same time, non-government debt issuers in the US can still have the top rating – including American companies. In fact, Apple (AAPL), Microsoft (MSFT) and Johnson & Johnson (JNJ) still have the Aaa rating from Moody’s. (Note that ADX holds Apple and Microsoft, so it’s a good pick if you’re still concerned about credit quality.)

I’ve just bought this 7.5%-yielding REIT to give me a second income

Our writer recently bought shares in a real estate investment trust (REIT) that he hopes will provide him with a healthy second income.

Posted by James Beard

Published 1 June

SUPR

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

In my opinion, investing in the stock market is a great way to generate a second income. The majority of UK-listed companies and investment trusts regularly return cash to shareholders by way of dividends.

With this in mind, I recently took a position in Supermarket Income REIT (LSE:SUPR). I was particularly attracted by its yield of 7.5%. But as well as its potential to provide a decent income stream, it also has defensive qualities that could make it an ideal stock for the uncertain times in which we live.

What does it do?

The investment trust buys large grocery stores and then leases them to retailers. It currently has 82 premises on its books and can boast Tesco, J Sainsbury and Carrefour among its tenants.

The quality of its customer base meant it had no bad debts during the year ended 30 June 2024 (FY24). Also, it reported a 100% occupancy rate.

To maintain certain tax advantages, a real estate investment trust must return at least 90% of its annual profit to shareholders. In FY24, it reported adjusted earnings per share of 6.1p and paid all of this as dividends.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.

How does it fund its growth?

With large amounts of cash being distributed, the trust’s acquisitions are usually funded by borrowings. This makes it vulnerable to interest rate rises on its variable-rate loans. However, it appears to have its debt under control.

Following a recent re-financing of some of its borrowings, it claims to have a loan-to-value (LTV) of 31%. This is based on a portfolio valuation of £1.8bn.

I’m wary of commercial property valuations as the market can be volatile and, given the size of these stores, there are relatively few retailers that are large enough to occupy them. But the £1.8bn estimate would have to be massively over-stated — which I think is unlikely — for the LTV to be a concern to me.      

Encouragingly, the group’s borrowings are due to be repaid over a shorter period than the length of its customer contracts. All things being equal, this means the cash flows from each lease should improve over time. The weighted-average term of its unexpired leases is 12 years.

Slow and steady

The trust’s currently trading at a 9.3% discount to its net asset value. This implies its shares are a bit of a bargain. But a discount is common among REITs.

However, the gap has closed over the past six months or so, suggesting that more and more investors are attracted to the trust’s defensive qualities and its dividend. The average discount over the past 12 months has been 18.1%.

However, the commercial property market in the UK and France is unlikely to be affected by Trump’s tariffs or a global trade war. Supermarkets will always need premises, even if their earnings fall. This makes them ideal tenants. And they’re tied in via long-term contracts, some of which have provisions for inflation-linked rent increases.

These reasons — along with its above-average dividend — are why I recently added Supermarket Income REIT to my portfolio. Other income investors could consider doing the same.

Currently changing it’s Investment Trust status, possibly to issue new shares ?

£50k to invest? These dividend shares could provide a £4,100 second income just this year!

Looking for ways to make an abundant and reliable second income in retirement? Buying quality dividend shares could be worth considering.

Posted by

Royston Wild

Published 2 June

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services.

With a sizeable retirement pot, individuals have a variety of ways they can use their wealth to target a second income.

For instance, they can:

• Draw down a percentage each year (4% is a popular figure that provides money for around 20 years).
• Invest in rent-generating real estate.
• Purchase an annuity product.
• Load up on corporate and government bonds.
• Invest in dividend-paying shares.

I plan to purchase dividend shares to fund my own retirement. I’m confident it can deliver a long-term passive income while providing potential for further portfolio growth.

Six of the best

Investing in dividend shares can be a riskier choice than, say, purchasing an annuity that provides a set income every year. Dividends are never guaranteed, and a range of internal and external issues can arise that cause companies to slash, postpone, or cancel shareholder payments.

Individuals can substantially reduce this risk by investing in a range of companies, however. Take the following selection of UK dividend shares as an example:

Dividend share	Sector	Forward dividend yield
Legal & General Group (LSE:LGEN)	Financial services	9.1%
The Renewables Infrastructure Group	Renewable energy infrastructure	9.7%
HSBC	Banking	5.8%
Global X SuperDividend ETF	Exchange-traded funds (ETFs)	11.1%
Assura	Real estate investment trusts (REITs)	6.8%
Pennon Group	Utilities	6.9%

This portfolio spans a variety of sectors and geographies, reducing the risk of isolated problems and ensuring (in theory) a stable return over the economic cycle. The Global X SuperDividend ETF alone has holdings in 100 high-yield companies (including Phoenix Group and M&G) from multiple industries worldwide.

Pleasingly, each of these businesses carries an ultra-high yield right now. If broker forecasts are correct, a £50,000 investment spread equally across these UK shares would provide a £4,100 passive income over the next year.

That’s not all. I’m optimistic that this portfolio will deliver a growing cumulative second income over time as well.

A FTSE 100 dividend hero

Out of this selection, I think Legal & General shares are worth particular attention from dividend investors. I own them in my own portfolio, and plan to buy more when I next have cash to invest.

As I say, dividends are never certain, even among companies with excellent payout records like this. Payouts here haven’t been cut since 2011, and have risen every year (bar one) since then.

This year’s predicted dividend is covered just 1.1 times by anticipated earnings, leaving little wiggle room if profits are blown off course. If tough economic conditions dent demand for discretionary financial products, dividends here could well disappoint.

Yet I’m optimistic that Legal & General could still hit the City’s dividend projections. With a Solvency II capital ratio of 232%, it has substantial financial resources to hit its dividend growth goals (2% per year) and share buyback targets through to 2027.

And beyond then, I think dividends could keep rising as demographic changes supercharge demand for retirement and wealth products.

We think earning passive income has never been easier

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Because The Global X SuperDividend ETF pays a monthly dividend, whilst you re-invest the dividends back into your snowball the total yield will be higher.

There are two emotions in the market fear and greed,
the problem is we hope when we should fear and
fear when we should hope.

William J O’Neil

Summary for 5 3/8% Treasury 2056

Key Information
ISIN GB00BT7J0241
TIDM T56
Exchange LSE
Par Value £100
Maturity Date 31/1/2056
Coupons per year 2
Next coupon date 31/7/25 e
Coupon 5.375%
Income Yield 5.39%
Gross redemption yield 5.38%
Accrued interest 49.51p
Dirty Price £100.43

Summary for 5 3/8% Treasury 2056

Key Information
ISIN GB00BT7J0241
TIDM T56
Exchange LSE
Par Value £100
Maturity Date 31/1/2056
Coupons per year 2
Next coupon date 31/7/25 e
Coupon 5.375%
Income Yield 5.39%
Gross redemption yield 5.38%

An alternative to using the 4% rule would be to buy a gilt ladder or a U$ Treasury ladder.

Pointers to know.

If you buy a gilt below or around its issue price, with a gilt it’s £100, you will not lose any of your hard earned if you own until maturity.

Using the table above.

The yield is 5.38%, so you would receive two income payments a year.

If you hold until 31/01/2056, you will receive your cash back without taking any action. Between now and 2056 a lot will happen with interest rates.

If they continue to fall, you should be able to flip your position at a profit. Although you might find it difficult to re-invest the funds at a decent interest rate.

If/when interest rates rise, the price of your gilt will fall and you will be locked into your position, although you could then add to your position at a better rate than 5.38%

In general if your want to buy gilts outside a tax free wrapper, you need to buy a low coupon as any capital gains are tax free.

Key Information
ISIN GB00BL68HH02
TIDM TG30
Exchange LSE
Par Value £100
Maturity Date 22/10/2030
Coupons per year 2
Next coupon date 22/10/25 e
Coupon 0.375%
Income Yield 0.45%
Gross redemption yield 4.04%

Inside a tax wrapper, the world’s your onion.

One strategy would be to buy several different years, then when the gilt matures you may or may not be able to re-invest at a higher rate but you could spend your hard earned on you or your family.

The bond market: a once-in-a-decade opportunity to lock in passive income?

Story by Dr. James Fox

Bonds have long been a cornerstone for investors seeking steady, predictable passive income. But with yields at multi-year highs, the bond market is now offering a rare chance to lock in attractive returns with relatively low risk. This combination is drawing new attention from UK investors.

How do bonds work ?

A bond is essentially a loan an investor makes to a government or corporation. In exchange for the money, the issuer promises to pay the bond holder regular interest (known as the coupon) and to return the original investment (the principal) when the bond matures. Bonds are considered fixed-income investments because they typically pay a set interest rate over their life, making them a popular choice for those seeking reliable income streams.

The appeal of bonds for passive income is straightforward, especially now. For example, UK government bonds (gilts) are currently offering yields not seen in over a decade. The 10-year gilt yield stands at around 4.65%, while the 30-year yield is just over 5.4%.

This means that if someone were to invest £10,000 in a 10-year gilt, they could expect to receive £470 per year in interest — more than double what they would have earned five years ago. The only significant risk is if the UK government were to default on its obligations. However, this is widely considered extremely unlikely, making gilts far less risky than most stocks.

Looking overseas
Across the Atlantic, US Treasury bonds are also offering attractive yields. The 10-year US Treasury yield is currently about 4.46%, and the 30-year yield is just under 5%. These rates are historically high for such safe assets. This higher-than-usual yield reflects near-term economic uncertainty and Trump’s plans for potentially unfunded tax cuts. But it also offers investors a rare window to lock in high passive income for years to come.

For those willing to look further afield, some overseas bonds offer even higher yields, especially in emerging markets or countries facing economic challenges. While these can provide eye-catching income, they also come with increased risk, including currency fluctuations and the potential for default. For example, the South African 10-year bond yields over 10%.

Alternative exposure
Bond investing might not be for everyone. And thankfully lots of stocks offer exposure to the bond market. One of the best known is Berkshire Hathaway (NYSE:BRK.B) which offers partial bond market exposure due to its massive holdings in US Treasury bills, which provide steady interest income and stability.

Berkshire now holds over $300bn in US Treasury’s — accounting for nearly 5% of the entire market for short-term government debt. While Berkshire is a conglomerate, its defensive cash position, debt holdings, and diversified business operations help buffer against market volatility, offering shareholders indirect benefits from bond market returns.’

However, this Warren Buffett company is not a direct substitute for bond funds, as most of its value comes from operating businesses and a concentrated equity portfolio, not fixed-income assets.

And while the company has performed well in recent years, there’s going to be some uncertainty for this US-focused business going forward. It’s a stock I own and recently bought more of, but I appreciate that Trump’s policy may cause some volatility. Also, it doesn’t pay a dividend, so there’s no yield — just growth, hopefully.

A great plan has an end destination, which is impossible with a TR strategy as you are a hostage to the fate of the markets.

The choices for the end destination for your plan.

Buy an annuity. We have discussed that option on the blog and is the least favoured end destination.

Use the 4% rule, the latest research stated it would be better to use a withdrawal rate of 3.5% but we will use 4% as the comparison.

The current fcast for the Snowball is £9,120.00

The TR control share is VWRP and the current ‘pension’ using the 4 rule would be £5,188.00

With compounding it’s likely the gap will continue to widen.

If Peter had held on to that $90,000 inheritance, it would be worth a cool half a billion today. That’s the magic of Warren Buffett’s famous snowball philosophy: keep reinvesting, let it grow, and watch as your money works harder than you ever could.

The current fcast for the Snowball is to earn dividends of £9,120 to be re-invested back into the portfolio. The target is 10k which will be met as there is a return of capital from VPC, which part of can be used as a dividend top up if required.

The fcast for next year could be increased to £9,800, which is the figure in the plan for the year ending 2028 but the target as yet undecided. Remember if you can compound your dividend income at 7% pa it doubles every ten years. Compounding takes a while to grow, so the sooner you start the better your retirement will be. Better if you can ‘add fuel to the fire’ but the Snowball will only use seed capital.

At present the Snowball should receive around £3,200 in dividends in June and when re-invested should provide some income for this year but an additional £250 for next year, plus all dividends earned and re-invested in the second half of this year.