Why Preferred Stocks Are Not Traded at a Premium in the Current Market
Many investors and financial analysts have long assumed that preferred stocks typically trade at a premium. However, this is not the case. The recent market conditions, particularly the economic recovery and subsequent inflation, have led to a significant shift in the behavior of preferred stocks.
Market Trends and Changes
The perception that preferred stocks often trade at a premium stems from a period of more than four decades during which long-term interest rates had been steadily declining. During this time, preferred stocks appeared to offer a relatively stable and attractive option for investors. However, the trend that pushed rates lower came to an end at the beginning of the Pandemic and was dramatically reversed as inflation escalated in 2022.
Preferred stocks, which are essentially corporate bonds with no maturity date, have faced significant changes in recent years. When inflation increases, new issues of preferred stocks have to offer higher interest rates, or preferred dividends, to remain competitive. Consequently, A-rated borrowers such as Wells Fargo now issue preferred stocks at a higher rate compared to previous years. For example, an A-rated borrower like Wells Fargo was paying 6% two years ago but is now offering preferred stocks at 7.5%.
Impact of Interest Rates on Preferred Stocks
The higher required yields on newly issued preferred stocks have led to a notable decline in the prices of older preferred stocks. Specifically, A-rated preferred stocks issued more than 18 months ago are now offering inferior rates of return. These older preferred stocks are trading at a significant discount, dropping from their face value of 25 to around 22 or 23 per share.
The Changing Face of Preferred Stocks
Traditionally, investors favored preferred stocks due to several advantages over common stocks. These advantages include higher dividends, priority in receiving dividends, and assets during liquidation. Additionally, preferred stocks typically exhibit more stable prices compared to common stocks, further attracting investors.
However, as interest rates rose and market conditions changed, these perceived advantages have diminished. The higher interest rates required for newer preferred stocks have overshadowed the previous benefits, leading to their diminished trading value.
Conclusion
While preferred stocks have historically offered certain advantages that made them attractive to investors, the current economic environment has significantly shifted the landscape. The rise in interest rates and the economic shift following the Pandemic have disrupted the traditional perception that preferred stocks trade at a premium. Investors should be aware of these changes and consider them when making investment decisions.