Posts tagged ‘dividends’
Investors Perilously Wait for Goldilocks Market
Like Goldilocks searching for the “just right” porridge, chair size, and bed, so too are investors searching for the Goldilocks stock market that is not too hot or too cold. Many are aptly calling this the “most hated” bull market in recent history as Goldilock investors have decided to stay home rather than look for an investment prize. What many investors don’t quite realize is that waiting too long for an elusive, perfect Goldilocks scenario will only lead to your portfolio getting eaten by unhappy bears.
Waiting on the sidelines for a perfect buy signal is a hopeless endeavor (see also Getting Off the Market Timing Treadmill). The evidence for extreme risk aversion is extensive. From a corporate standpoint, it’s clear executives and board members have been scarred by the 2008-2009 financial crisis. Management teams have been quick to cut expenses and slow to invest and hire. And speaking of hiring, the post-crisis expansion has led to the slowest job recovery since World War II.
In the face of all the investor pessimism, the economy has been adding a few million jobs per year on average, resulting in a unemployment level below 5%; corporate profits at/near record levels; and trillions of dollars of cash piling up on corporate balance sheets. Rather than accelerate investments, companies have by and large chosen to spend that mountain of cash into trillions of rising dividends and share buybacks.
Risk aversion is evident at the individual level as well. Part of the explanation of why corporations have increased dividends to record levels is due to 76 million Baby Boomers approaching or entering retirement. Boomers need more income just as interest rates are rapidly approaching 0%, and in many cases negative interest rates, which effectively means they are earning $0 on their bank savings and losing to inflation.
Collecting fatter dividend checks from stocks actually sounds pretty attractive when individual investors are scared silly about geopolitics, terrorism, elections, Zika virus, and other horror story headlines of the day. Fortunately, it’s profits, interest rates, valuations, and contrarian sentiment indicators that control the stock market (see Follow the Stool), and not Fox, CNN, ABC, NBC, and internet bloggers (myself included).
With all this scary news, no wonder investors are afraid to invest. Gallup conducted a survey earlier this year asking investors whether they were invested in the stock market. With the stock market at or near record all-time highs, stock ownership should be up…right? Wrong! The Gallup results showed stock ownership at its lowest level in 18 years, as long as results have been tabulated (1998).
In case you are still skeptical, we can point to other evidence of investor skepticism. If you believe, like I do, that actions speak louder than words, then the actions of individuals are screaming with risk aversion at the top of their lungs. In order to understand how frightened individuals are, all you have to do is look at the more than $8 trillion (with a “t”) of cash sitting in personal savings accounts earning nothing (see chart below).
Source: Calafia Beach Pundit
You can see from the chart above, the slope of cash accumulation accelerated at a steeper slope after the Great Recession. Besides allowing the mountain of cash to pile up, what else have investors been doing with their greenbacks? One thing for sure is individuals have been spooked into paying down debt (reducing leverage), as you can see from the chart below.
Source: Calafia Beach Pundit
As Warren Buffett reminds investors, it is best to “buy fear, and sell greed.” There is plenty of other evidence, including the examples above, that shows most average investors are destructive by doing the opposite…they buy greed, and sell fear. Sadly, sitting on the sidelines with cash stuffed under your mattress, earning nothing and losing to inflation, is not the optimal strategy for long-term wealth creation and preservation. Investors can continue waiting for Goldilock conditions, but unfortunately, history reminds us that market timing, sideline-sitters are likely to get eaten by the bears.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Cleaning Out Your Investment Fridge
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2016). Subscribe on the right side of the page for the complete text.
Summer is quickly approaching, but it’s not too late to do some spring cleaning. This principle not only applies to your cluttered refrigerator with stale foods but also your investment portfolio with moldy investments. In both cases, you want to get rid of the spoiled goods. It’s never fun discovering a science experiment growing in your fridge.
Over the last three months, the stock market has been replenished after a rotten first two months of the year (S&P 500 index was down -5.5% January through February). The +1.5% increase in May added to a +6.6% and +0.3% increase in March and April (respectively), resulting in a three month total advance in stock prices of +8.5%. Not surprisingly, the advance in the stock market is mirroring the recovery we have seen in recent economic data.
After digesting a foul 1st quarter economic Gross Domestic Product (GDP) reading of only +0.8%, activity has been smelling better in the 2nd quarter. A recent wholesome +3.4% increase in April durable goods orders, among other data points, has caused the Atlanta Federal Reserve Bank to raise its 2nd quarter GDP estimate to a healthier +2.9% growth rate (from its prior +2.5% forecast).
Consumer spending, which accounts for roughly 70% of our country’s economic activity, has been on the rise as well. The improving employment picture (5.0% unemployment rate last month) means consumers are increasingly opening their wallets and purses. In addition to spending more on cars, clothing, movies, and vacations, consumers are also doling out a growing portion of their income on housing. Housing developers have cautiously kept a lid on expansion, which has translated into limited supply and higher home prices, as evidenced by the Case-Shiller indices charted below.
Source: Bespoke
Spoiling the Fun?
While the fridge may look like it’s fully stocked with fresh produce, meat, and dairy, it doesn’t take long for the strawberries to get moldy and the milk to sour. Investor moods can sour quickly too, especially as they fret over the impending “Brexit” (British Exit) referendum on June 23rd when British voters will decide whether they want to leave the European Union. A “yes” exit vote has the potential of roiling the financial markets and causing lots of upset stomachs.
Another financial area to monitor relates to the Federal Reserve’s monetary policy and its decision when to further increase the Federal Funds interest rate target at its June 14th – 15th meeting. With the target currently set at an almost insignificantly small level of 0.25% – 0.50%, it really should not matter whether Chair Janet Yellen decides to increase rates in June, July, September and/or November. Considering interest rates are at/near generational lows (see chart below), a ¼ point or ½ point percentage increase in short-term interest rates should have no meaningfully negative impact on the economy. If your fridge was at record freezing levels, increasing the temperature by a ¼ or ½ degree wouldn’t have a major effect either. If and when short-term interest rates increase by 2.0%, 3.0%, or 4.0% in a relatively short period will be the time to be concerned.
Source: Scott Grannis
Keep a Fresh Financial Plan
As mentioned earlier, your investments can get stale too. Excess cash sitting idly earning next-to-nothing in checking, savings, CDs, or in traditional low-yielding bonds is only going to spoil rapidly to inflation as your savings get eaten away. In the short-run, stock prices will move up and down based on frightening but insignificant headlines. However, in the long-run, the more important issues are determining how you are going to reach your retirement goals and whether you are going to outlive your savings. This mindset requires you to properly assess your time horizon, risk tolerance, income needs, tax situation, estate plan, and other unique circumstances. Like a balanced diet of various food groups in your refrigerator, your key personal financial planning factors are dependent upon you maintaining a properly diversified asset allocation that is periodically rebalanced to meet your long-term financial goals.
Whether you are managing your life savings, or your life-sustaining food supply, it’s always best to act now and not be a couch potato. The consequences of sitting idle and letting your investments spoil away are a lot worse than letting the food in your refrigerator rot away.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Flat Pancakes & Dividends
Over the last 18 months, stock prices have been flat as a pancake. Absent a few brief China and recessionary scares, the Dow Jones Industrial Average index has spent most of 2015 and 2016 trading between the relatively tight levels of 17,000 – 18,000. Record corporate profits and faster growth than other developed and developing markets have created a tug-of-war with countervailing factors. A strong dollar, reversal in monetary policy, geopolitical turmoil, and volatile commodity markets have produced a neutralizing struggle among corporate executives with deep financial pockets and short arms. In this environment, share buybacks, stable profit margins, and growing dividends have taken precedence over accelerated capital investments and expensive new-hires.
With flat stock prices and interest rates at unprecedented low levels, it’s during times like these that stock investors really appreciate the appetizing flavor of stable, growing dividends. To this day, I still find it almost impossible to fathom how investors are burning money by irrationally speculating in $7 trillion in negative interest rate bonds (see Retire at Age 90).
Historically there are very few periods in which stock dividend yields have exceeded bond yields (2.1% S&P yield vs. 1.8% 10-Year Treasury yield). As I showed in my Dividend Floodgates article, for roughly 50 years (1960 – 2010), the yield on the 10-Year Treasury Notes have exceeded the dividend yield on stocks (S&P 500) – that longstanding trend does not hold today.
In the face of the competitive stock market, several trends are contributing to the upward trajectory in dividend payments (see chart below).
#1.) Corporate profits (ex-Energy) are growing and at/near record levels. Earnings are critical in providing fertile ground for dividend growth.
#2.) Demographics, plain and simple. As 76 million Baby Boomers transition into retirement, their income needs escalate. These shareholders whine and complain to corporate executives to share the spoils and increase dividends.
#3.) Low interest rates and disinflation are shrinking the available pool of income generating assets. As I pointed out above, when trillions of dollars are getting thrown into negative yielding investments, many investors are flocking to alternative income-generating assets…like dividend paying stocks.
Source: FactSet
The Power of Dividends (Case Studies)
Most people don’t realize it, but over the last 100 years, dividends have accounted for approximately 40% of stocks’ total return as measured by the S&P 500. In other words, using history as a guide, if you initially invested in a stock XYZ at $100 that appreciated in value to $160 (+60%) 10 years later, that stock on average would have supplied an incremental $40 in dividends (40%) over that period, creating a total return of 100%.
Rather than using a hypothetical example, here are a few stock specific illustrations that highlight the amazing power of compounding dividend growth rates. Here are two “Dividend Aristocrats” (stocks that have increased dividends for at least 25 consecutive years):
- PepsiCo Inc (PEP): PepsiCo has increased its dividend for an astonishing 44 consecutive years. Today, the dividend yield is 2.9% based on the current share price. But had you purchased the stock in June 1972 for $1.60 per share (split-adjusted), you would currently be earning a +188% dividend yield ($3.01 dividend / $1.60 purchase price), which doesn’t even account for the +6,460% increase in the share price ($104.96 per share today from $1.60 in 1972). Over that 44 year period, the split-adjusted dividend has increased from about $0.02 per share to an annualized $3.01 dividend per share today, which equates to a mind-blowing +16,153% increase. On top of the $103 price appreciation, assuming a conservative 5% dividend reinvestment rate, my estimates show investors would have received more than $60 in reinvested dividends, making the total return that much more gargantuan.
- Emerson Electric Co (EMR): Emerson Electric too has had an even more incredible streak of dividend increases, which has now extended for 59 consecutive years. Emerson currently yields a respectable 3.6% rate, but if you purchased the stock in June 1972 for $3.73 per share (split-adjusted), you would currently be earning a +51% dividend yield ($1.92 dividend / $3.73 purchase price), which doesn’t even consider the +1,423% increase in the share price ($53.31 per share today from $3.73 in 1972).
There is never a shortage of FUD (Fear, Uncertainty, and Doubt), which has kept stock prices flat as a pancake over the last couple of years, but market leading franchise companies with stable/increasing dividends do not disappear during challenging times. Record profits (ex-energy), demographics, and a scarcity of income-generating investment alternatives are all contributing factors to the increased appetite for dividends. If you want to sweeten those flat pancakes, do yourself a favor and pour some quality dividend syrup over your investment portfolio.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and PEP, but at the time of publishing had no direct position in EMR or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Stock Market Tug-of-War
Image by © Royalty-Free/Corbis
Some things never change. There are several certainties in life, including death and taxes. And when it comes to investing, there are several other certainties: the never-ending existence of geopolitical concerns, and incessant worries over Fed policy.
Let’s face it, since the dawn of mankind, humans have been programmed to worry, whether it stemmed from avoiding a man-eating lion or foraging for food to survive (see Controlling the Investment Lizard Brain). Investors function in much the same way.
There is always a constant tug-of-war between bulls and bears, and if you are obsessed with following the relentless daily headlines about a Grexit (European Greek Exit) and an imminent Federal Reserve rate hike, you like many other investors will continue to experience sweaty palms, heart palpitations, and underperformance.
Despite the gloomy headlines, the bulls are currently winning the tug-of-war as measured by the 6-year boom in global stock prices, which has breached a record $70 trillion in value (see chart below).
Source: Mark J. Perry (Carpe Diem)
If you become hostage and react to the headlines about Greece, China, Fed policy, Ukraine, ISIS, Russia, Ebola, North Korea, QE Tapering, etc., not only are you ignoring the key positives fueling this bull market (see also Don’t Be a Fool, Follow the Stool) but you are also costing yourself a lot of money. While I have been watching the “sideliners” for years, they have missed a market driven by generationally low interest rates; improved employment picture (10% to 5%); tame inflation; steady improvement in housing market; fiscal deficit reductions; record corporate profits; record share buybacks and dividends; contrarian investor sentiment (leaving plenty of room for converts to join the party), and other fundamentally positive factors.
Yes, stocks will eventually go down by a significant amount – they always do. Stocks can temporarily go down based on the fear du jour (like the 10-20% declines in 2010, 2011, 2012, and 2014), but the nastier hits to stock markets always come from good old fashion cyclical recessions. As I’ve discussed before, there are no signs of a recession on the horizon, and the yield curve has been a great predictor of this trigger (see Dynamic Yield Curve in Digesting Stock Gains). Until then, the bears will be fighting an uphill battle.
Independent of recession timing, investing is a very challenging game, even for the most experienced professionals. The best long-term investors, including the likes of Warren Buffett and Peter Lynch, understand the never-ending geopolitical and Fed policy headlines are absolutely meaningless over the long run. However, media outlets, blogs, newspapers, and radio shows make money by peddling fear as economic and political concerns jump like a frog from one lily pad to the next. At Sidoxia we have a disciplined and systematic approach to creating diversified portfolios with our proprietary S.H.G.R. model (“sugar”) that screens for attractively valued investments. We believe this is the way to win the long-term tug-of-war.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
F.U.D. and Dividend Shock Absorbers
As the existential question remains open on whether Greece will remain a functioning entity within the eurozone, investor anxiety and manic behavior continues to be the norm. Rampant fear seems very counterintuitive for a stock market that has more than tripled in value from early 2009 with the S&P 500 index only sitting -3% below all-time record highs. Common sense would dictate that euphoric investor appetites have contributed to years of new record highs in the U.S. stock market, but that isn’t the case now. Rather, the enormous appreciation experienced in recent years can be better explained by the trillions of dollars directed towards buoyant share buybacks and mergers.
With a bull market still briskly running into its sixth year, where can we find the evidence for all this anxiety? Well, if you don’t believe all the nail biting concerns you hear from friends, family members, and co-workers about a Grexit (Greek exit from the euro), Chinese stock market bubble, Puerto Rico collapse, and/or impending Fed rate hike, then here are a few confirming data points.
For starters, let’s take a look at the record $8 trillion of cash being stuffed under the mattress at near 0% rates in savings deposits (see chart below). The unbelievable 15% annual growth rate in cash hoarding since the turn of the century is even scarier once you consider the massive value destruction from the eroding impact of inflation and the colossal opportunity costs lost from gains and yields in alternative investments.
Next, you can witness the irrational risk averse behavior of investors piling into low (and negative) yielding bonds. Case in point are the 10-year yields in developing countries like Germany, Japan, and the U.S. (see chart below).
The 25-year downward trend in rates is a very scary development for yield-hungry investors. The picture doesn’t look much prettier once you realize the compensation for holding a 30-year bond (currently +3.2%) is only +0.8% more than holding the same Treasury bond for 10 years (now +2.4%). Yes, it is true that sluggish global growth and tame inflation is keeping a lid on interest rates, but these trends highlight once again that F.U.D. (fear, uncertainty, and doubt) has more to do with the perceived flight to safety and high bond prices (low bond yields).
In addition, the -$57 billion in outflows out of U.S. equity funds this year is further evidence that F.U.D. is out in full force. As I’ve noted on repeated occasions, when the tide turns on a sustained multi-year basis and investors dive head first into stocks, this will be proof that the bull market is long in the tooth and conservatism should be the default posture.
Dividend Shock Absorbers
There are always plenty of scary headlines that tempt investors to bail out of their investments. Today those alarming headlines span from Greece and China to Puerto Rico and the Federal Reserve. When the winds of fear, uncertainty, and doubt are fiercely swirling, it’s important to remember that any investment strategy should be constructed in a diversified manner that meshes with your time horizon and risk tolerance.
Consistent with maintaining a diversified portfolio, owning reliable dividend paying stocks is an important component of investment strategy, especially during volatile periods like we are experiencing currently. Sure, I still love to own high octane, non-dividend growth stocks in my personal and client portfolios, but owning stocks with a healthy stream of dividends serve as shock absorbers in bumpy markets with periodic surprise potholes.
As I’ve note before, bond issuers don’t call up investors and raise periodic coupon payments out of the kindness of their hearts, but stock issuers can and do raise dividends (see chart below). Most people don’t realize it, but over the last 100 years, dividends have accounted for approximately 40% of stocks’ total return as measured by the S&P 500.
Source: BuyUpside.com
Markets will continue to move up and down on the news du jour, but dividends overall remain fairly steady. In the worst financial crisis in a generation, dividends dipped temporarily, but as I explain in a previous article (The Gift that Keeps on Giving), dividends have been on a fairly consistent 6% growth trajectory over the last two decades. With corporate dividend payout ratios well below long term historical averages of 50%, companies still have plenty of room to maintain (and grow) dividends – even if the economy and corporate profits slow.
Don’t succumb to all the F.U.D., and if you feel yourself beginning to fall into that trap, re-evaluate your portfolio to make sure your diversified portfolio has some shock absorbers in the form of dividend paying stocks. That way your portfolio can handle those unexpected financial potholes that repeatedly pop up.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and SPY, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on ICContact page.
Fink & Capitalism: Need 4 Kitchens in Your House?
Do you need four kitchens in your house? Apparently financial industry titan Larry Fink does. If Mr. Fink were a designer for millionaire homeowners, he would advise them to use their millions to build more kitchens in their house (reinvest) rather than distribute those monies to family members (dividends) or use that money to pay back an equity loan from mom and dad for the down payment (share buybacks). Essentially that is exactly what is happening in the stock market. Companies that are generating record profits and margins (millionaires) are increasingly choosing to pay out larger percentages of profits to stockholders (family members) in the form of rising dividends and share buybacks. Contrary to Mr. Fink’s belief, corporate America is actually doing plenty with room additions, landscaping, and roof replacements – I will describe more later.
As a consequence of corporate America’s increasingly shareholder friendly practices of returning cash, Fink believes this trend will stifle innovation and long-term growth in American companies. Here’s a snapshot of the supposed dividend/buyback problem Mr. Fink describes:
Source: Financial Times
Fink Mails Letter from Soapbox
For those of you who do not know who Larry Fink is, he is the successful Chairman and CEO of BlackRock Inc. (BLK), an investment manager which oversees about $4.65 trillion in investment assets. Mr. Fink ignited this recent financial controversy when he jumped on his soapbox by mailing letters to 500 CEOs lecturing them on the importance of long-term investing. What is Mr. Fink’s beef? Fink’s issues revolve around his belief that CEOs and corporations are too short-term oriented.
In his letter, Mr. Fink had this to say:
“This pressure [to meet short-term financial goals] originates from a number of sources—the proliferation of activist shareholders seeking immediate returns, the ever-increasing velocity of capital, a media landscape defined by the 24/7 news cycle and a shrinking attention span, and public policy that fails to encourage truly long-term investment.”
He goes on to bolster his argument with the following:
“More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders, such as buybacks or dividend increases, while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
What Mr. Fink does not say in his letter is that large, multinational S&P 500 corporations driving this six-year bull run are sitting on a record hoard of cash, exceeding $1.4 trillion (see chart below). In this light, it should come as no surprise that CEOs are forking over more cash to investors in the forms of dividends and share repurchases.
What’s more, despite Fink’s assertion that share buybacks and dividends are killing innovation, he also fails to mention in his letter that 2014 capital expenditures of $730 billion are also at a record level. That’s right, CAPEX has not been cut to the bone as he implies, but rather risen to all-time highs.
It’s true that generationally low (and declining) interest rates have accelerated the pace of dividends/repurchases, however dividend payout ratios (the percentage of profits distributed to shareholders) of about 32% remain firmly below the long-term payout ratio of approximately 54% (see chart below) – see also Dividend Floodgates Widen. I find it difficult to fault many companies doing something with the gargantuan piles of inflation-losing cash anchoring their balance sheets. Don’t cash-rich companies have a fiduciary duty to borrow reasonable amounts of near-0% debt today (see Bunny Rabbit Market) in exchange for share buybacks currently providing returns of about 5.5% (inverse of 18x P/E ratio) and likely yielding 7%+ returns five years from now?
Source: Financial Times
The “Short-Term” Poster Child – Apple
There is no arguing that excessive debt eventually can catch up to a company. Our multi-year expanding economy is eventually due for another recession in the coming years, and there will be hell to pay for irresponsible, overleveraged companies. With that said, let’s take a look at the poster child of “short-termism” according to Mr. Fink …Apple Inc. (AAPL).
Of the roughly $500 billion in buybacks spent by S&P 500 companies in 2014, Apple accounted for approximately $45 billion of that figure. On top of that, CEO Tim Cook and his board generously decided to return another $11 billion to shareholders in the form of dividends. Has this “short-term” return of capital stifled innovation from the company that has launched iPhone version 6, iPad, Apple Watch, Apple Pay, and is investing into exciting areas like Apple Television, Apple Car, and who knows what else?
To put these Apple numbers into perspective, consider that last year Apple spent over $6 billion on research and development (R&D); $10 billion on capital expenditures; and hired over 12,000 new full-time employees. This doesn’t exactly sound like the death of innovation to me. Even after doling out roughly -$28 billion in expenditures and -$56 billion in dividends/share repurchases, Apple was amazingly able to keep their net cash position flat at an eye-popping +$141 billion!
Mr. Fink abhors “activist shareholders seeking immediate returns” but rather than deriding them perhaps he should send the greedy, capitalist Carl Icahn a personal thank you letter. Since Icahn’s vocal plea for a large Apple share buyback, the shares have skyrocketed about +85%, catapulting BlackRock’s ownership value in Apple to over $19 billion.
With respect to these increasing outlays, Mr. Fink also notes:
“Returning excessive amounts of capital to investors—who will enjoy comparatively meager benefits from it in this environment—sends a discouraging message.”
This would be true if investors took the dividends and stuffed them under their mattress, but an important message Mr. Fink neglects to address as it relates to dividends and share buybacks is demographics. There are 76 million Baby Boomers born between 1946 – 1964 and a Boomer is turning age 65 every 8 seconds. With many bonds trading at near 0% yields (even negative yields) it is no wonder many income starving retirees are demanding many of these cash-rich corporations to share more of the growing spoils via rising dividends.
Capitalism Works
After looking at a few centuries of our country’s history, one of the main lessons we can learn is that capitalism works – especially over the long-run. With about 200 countries across the globe, there is a reason the U.S. is #1…we’re good at capitalism. As our economy has matured over the decades, it is true our priorities and challenges have changed. It is also true that other countries may be narrowing the gap with the U.S., due to certain advantages (e.g., demographics, lower entitlements, easier regulations, etc), but the U.S. will continue to evolve.
In many respects, capitalism is very much like Darwinism – corporations either adapt with the competition…or they die. I repeatedly hear from pessimists that the U.S. is in a secular state of decline, but if that’s the case, how come the U.S. continues to dominate and innovate in major industries like biotechnology, mobile technology, networking, internet, aviation, energy, media, and transportation? Quite simply, we are the best and most experienced practitioners of capitalism.
Certainly, capitalism will continue to cultivate cyclical periods of excess investment/leverage and insufficient regulation. But guess what? Investors, including the public, eventually lose their shirts and behaviors/regulations adjust. At least for a little while, until the next period of excess takes hold. If Apple, and other balance sheet healthy companies allocate capital irresponsibly, capital will flow towards more aggressive and innovative companies. BlackBerry Limited (BBRY) knows a little bit about the consequences of cutthroat competition and suboptimal capital allocation.
While I emphatically share Mr. Fink’s focus on long-term investing values (including his self-serving tax reform ideas), I vigorously disagree with his attacks on shareholder friendly actions and his characterization of rising dividends/buybacks as short-term in nature. In fact, increasing dividends and share buybacks can very much coexist as a long-term investment and capital allocation strategy.
The question of proper capital allocation should have more to do with the age of a company. It only makes sense that younger companies on average should reinvest more of their profits into growth and innovation. On the other hand, more mature S&P 500-like companies will be in a better position to distribute higher percentages of profits to shareholders – especially as cash levels continue to rise to record levels and leverage remains in check.
BlackRock’s Larry Fink may continue to urge CEOs to reinvest their growing cash hoards into superfluous corporate kitchens, but Sidoxia and other prudent capitalist investors will continue to exhort CEOs to opportunistically take advantage of near-free borrowing rates and responsibly share the accretive gains with shareholders. That’s a message Mr. Fink should include in a letter to CEOs – he can use BlackRock’s lofty, above-average dividend to cover the cost of postage.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including AAPL and iShares ETFs, but at the time of publishing, SCM had no direct position in BLK, BBRY or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Bunny Rabbit Market
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (April 1, 2015). Subscribe on the right side of the page for the complete text.
With spring now upon us, we can see the impact the Easter Bunny has had on financial markets…a lot of bouncing around. More specifically, stocks spent about 50% of the first quarter in negative territory, and 50% in positive territory. With interest rates gyrating around the 2% level for the benchmark 10-Year Treasury Note for most of 2015, the picture looked much the same. When all was said and done, after the first three months of the year, stocks as measured by the S&P 500 finished +0.4% and bonds closed up a similarly modest amount of +1.2%, as measured by the Total Bond Market ETF (BND).
Why all the volatility? The reasons are numerous, but guesswork of when the Federal Reserve will reverse course on its monetary policy and begin raising interest rates has been (and remains) a dark cloud over investment strategies for many short-term traders and speculators. In order to provide some historical perspective, the last time the Federal Reserve increased interest rates (Federal Funds rate) was almost nine years ago in June 2006. It’s important to remember, as this bull market enters its 7th consecutive year of its advance, there has been no shortage of useless, negative news headlines to keep investors guessing (see also a Series of Unfortunate Events). Over this period, ranging concerns have covered everything from “Flash Crashes” to “Arab Springs,” and “Ukraine” to “Ebola”.
Last month, the headline pessimism persisted. In the Middle East we witnessed a contentious re-election of Israeli Prime Minister Benjamin Netanyahu; Saudi Arabia led airstrikes against Iranian-backed, Shi’ite Muslim rebels (Houthis) in Yemen; controversial Iranian nuclear deal talks; and President Barack Obama directed airstrikes against ISIS fighters in the Iraqi city of Tikrit, while he simultaneously announced the slowing pace of troop withdrawals from Afghanistan.
Meanwhile in the global financial markets, investors and corporations continue to assess capital allocation decisions in light of generationally low interest rates, and a U.S. dollar that has appreciated in value by approximately +25% over the last year. In this low global growth and ultra-low interest rate environment (-0.12% on long-term Swiss bonds and 1.93% for U.S. bonds), what are corporations choosing to do with their trillions of dollars in cash? A picture is worth a thousand words, and in the case of companies in the S&P 500 club, share buybacks and dividends have been worth more than $900,000,000,000.00 over the last 12 months (see chart below).
Source: Financial Times
Case in point, Apple Inc (AAPL) has been the poster child for how companies are opportunistically boosting stock prices and profitability metrics (EPS – Earnings Per Share) by borrowing cheaply and returning cash to shareholders via stock buybacks and dividend payments. More specifically, even though Apple has been flooded with cash (about $178 billion currently in the bank), Apple decided to accept $1.35 billion in additional money from bond investors by issuing bonds in Switzerland. The cost to Apple was almost free – the majority of the money will be paid back at a mere rate of 0.28% until November 2024. What is Apple doing with all this extra cash? You guessed it…buying back $45 billion in stock and paying $11 billion in dividends, annually. No wonder the stock has sprung +62% over the last year. Apple may be a unique company, but corporate America is following their shareholder friendly buyback/dividend practices as evidenced by the chart below. By the way, don’t be surprised to hear about an increased dividend and share buyback plan from Apple this month.
Source: Investors Business Daily
Despite all the turmoil and negative headlines last month, the technology-heavy NASDAQ Composite index managed to temporarily cross the psychologically, all-important 5,000 threshold for the first time since the infamous tech-bubble burst in the year 2000, more than 15 years ago. The Dow Jones Industrial also cracked a numerically round threshold (18,000) last month, before settling down at 17,779 at month’s end.
While the S&P 500 and NASDAQ indexes have posted their impressive 9th consecutive quarter of gains, I don’t place a lot of faith in dubious, calendar-driven historical trends. With that said, as I eat jelly beans and hunt for Easter eggs this weekend, I will take some solace in knowing April has historically been the most positive month of the year as it relates to direction of stock prices (see chart below). Over the last 20 years, stocks have almost averaged a gain of +3% over this 30-day period. Perhaps investors are just in a better mood after paying their taxes?
Source: Bespoke
Even though April has historically been an outperforming month, banker and economist Robert Rubin stated it best, “Nothing is certain – except uncertainty.” We’ve had a bouncing “Bunny Market” so far in 2015, and chances are this pattern will persist. Rather than fret whether the Fed will raise interest rates 0.25% or agonize over a potential Greek exit (“Grexit”) from the EU, you would be better served by constructing an investment and savings plan to meet your long-term financial goals. That’s an eggstra-special idea that even the Easter Bunny would want to place in the basket.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including BND and AAPL (stock), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
March Madness – Dividend Grandness & Volatility Blandness
March Madness has arrived once again. This NCAA basketball event, which has been around since 1939, begins with a selection committee choosing the top 68 teams in the country. These teams are matched up against each other through a single-elimination tournament until a national champion is throned. The stock market does not have a selection committee that picks teams from conferences like the SEC, Big East, Pac-12, and ACC, but rather millions of investors select the best investments from asset classes like stocks, bonds, real estate, commodities, venture capital, and private equity.
In the investment world, there are no win-loss records, but rather there are risk-return profiles. Investors generally migrate towards the asset classes where they find the optimal trade-off between risk and return. Speculators, day-traders, and momentum traders may define risk differently, but regardless, over the long-run, capital goes where it is treated best. And over the last six years, the U.S. stock market hasn’t been a bad place to be (the S&P 500 has about tripled).
Why such outperformance in stocks? Besides a dynamic earnings recovery from the 2008-2009 financial crisis, another major factor has been the near-0% interest rate environment. When investors are earning near nothing in their bank and savings accounts, it is perfectly rational for savers to look for riskier options, if they are compensated for that risk. In addition to loose central bank and quantitative easing policies fueling demand for stocks, rising dividends have increased the attractiveness of the stock market. In fact, as you can see from the chart below, dividends have about doubled from 2008-2009 and about tripled from the year 2000.
Source: Buy Upside
Stock prices have moved higher in concert with rising dividends, which, as you can see from the chart below, has kept the dividend yield flat at around 2% over the last few years. Treasury bond yields, on the other hand, have been on steady declining trend for the last 35 years. So, while coupons on newly issued bonds have been declining for virtually the last three and a half decades, stock dividends have been on a steadily upward moving rampage, excluding recessions (up +13% in the most recent reported period).
Source: Avondale Asset Management
Declining interest rates have made stocks look attractive relative to investment grade corporate bonds too as evidenced by the chart below. As you can see, over the last half-century, corporate bond yields have predominantly offered higher income yields than the earnings yield on stocks – that is not the case today.
Source: Calafia Beach Pundit
What does all this stock dividend, earnings yield stuff mean? In the grand scheme of things, income starving Baby Boomers and retirees are slowly realizing that stocks in general stack up favorably in an environment in which interest payments are going down and dividend payments are going up. One of the areas highlighting the underlying demand for stocks is the Volatility Index (VIX) – a.k.a., the “Fear Gauge.” Despite Greece, Russia, ISIS, the Fed, and the Dollar dominating the headlines, the hunger for yield and growth in a declining interest rate environment is cushioning the blow during these heightened periods of volatility (see also A Series of Unfortunate Events).
Since the end of 2011, the monthly close of the VIX has stayed above its historical average of approximately 20 only two times (see chart below). In other words, over that timeframe, the VIX has remained below average about 95% of the time. When the VIX has spiked above 20, generally it has only been for brief periods, until cooler heads prevail and bargain hunters come in to buy depressed stock bargains.
Source: Barchart
I’m not naïve enough to believe the bull market in stocks will last forever, but as long as interest rates don’t spike up and/or corporate earnings crater, underlying demand for yield should provide a floor for stocks during heightened periods of volatility. We may be in the midst of March Madness but volatility blandness is showing us that investors are paying attention to dividend grandness.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) and SPY, but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Supply & Demand: The Lesson of a Lifetime
Between all the sporting events, road trips, and parties, I had a difficult time balancing my academic responsibilities just like any other college student. Nonetheless, after a few jobs and a few decades post my graduation, it is refreshing to see my economics college degree was able to teach me one valuable lesson…”supply & demand” actually works.
Emotions and animal spirits can separate fact from fiction in the short-run, but over the long-run, the economic forces of “supply & demand” will ultimately determine the direction of asset prices. If you can think of any bubble market, ranging from tulips and tech stocks (see Bubbles and Naps) to commodities and houses, sooner or later new supply will enter the market, and/or some other factor, which will prick the demand side of the bubble equation.
The same economic rules apply to currencies. Gut-based, day-traders may be skeptical, but economics’ longest enduring axiom shined last week when we saw the Swiss franc spike +20% against the euro in a single day. On the heels of a weakening euro currency and heightened demand for the franc, the Swiss National Bank (SNB) decided to remove its artificial peg to the euro. Effectively, the SNB has been selling francs and buying $490 billion in reserves (the majority of which is in euros and U.S. dollars). As a result, exports of Swiss army knives, watches, and industrial equipment will be more expensive now, which could potentially crimp demand for the country’s goods and services. The SNB, however, could no longer afford to buy euros and dollars to artificially depress the franc. Swiss bankers were very worried about the possible amplified costs of a currency war in the face of this week’s expected European Central Bank (ECB) announcements on quantitative easing (QE) monetary stimulus, so they decided to allow the franc to free-float versus global currencies.
Another asset class heavily impacted by volatile supply-demand dynamics has been the oil market. Weaker demand from Europe/Russia combined with the higher supply from U.S. shale has created a recipe for a crude price collapse (> -50% declines over the last year). Thus far, OPEC (Organization of Petroleum Exporting Countries) has remained committed to maintaining its supply/production levels.
Interest Rates and Supply-Demand
Not every asset price is affected by direct supply-demand factors. Take for example the stock market. I have been writing and commentating about the fascinating persistence and accelerated decline in global interest rates recently (see Why 0% Rates?). Near-0% rates are important because interest rates are just another name for the “cost of money” (or “opportunity cost of money”). When the Prime Rate was 20% in the early 1980s, the cost of money was high and a 16% CD at the bank looked pretty attractive relative to rolling the dice on volatile/risky stocks. Any economics, finance, or accounting student knows through their studies of the “time value of money” that interest rates have a tight inverse correlation to asset values (i.e., lower interest rates = higher asset values, and vice versa).
More practically speaking, we see stock prices supported by the lower borrowing costs tied to low interest rates. Just look at the $500,000,000,000+ conducted in share buybacks over the past 12 months (chart below). Economics works quite effectively when you can borrow at 3% and then purchase your own stock yielding 6% (the inverse percentage of the current 16x P/E ratio). What makes this mathematical equation even more accretive for corporate CFOs is the 6% rate earned today should double to 12% in 10 years, if a company resembles an average S&P 500 company. In other words, S&P 500 earnings have historically grown at a 7% annual clip, therefore the 6% earnings yield should double to 12% in about a decade, based on current prices. This basic arbitrage strategy is a no-brainer for corporate execs because it provides instantaneous EPS (earnings per share) growth with minimal risk, given the current bullet proof status of many blue-chip company balance sheets.
Source: Financial Times
I have provided a few basic examples of how straightforward supply-demand dynamics can be used to analyze market relationships and trends. Although supply-demand analysis is a great rudimentary framework at looking at markets and various asset classes, unanticipated exogenous factors such regulation, terrorism, politics, weather, and a whole host of other influences can throw a wrench into your valuation conclusions. Until rates normalize, the near-0% interest rates we are experiencing now will continue to be a significant tailwind for stock prices. As interest rates have been declining for the last three and a half decades, it appears I still have time before I will need to apply the other important concept I learned in college…mean reversion.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions, including positions in certain exchange traded funds positions , but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
The Gift that Keeps on Giving
There have been numerous factors contributing to this bull market, even in the face of a slew of daunting and exhausting headlines. Contributing to the advance has been a steady stream of rising earnings; a flood of price buoying stock buybacks; and the all-important gift of growing dividends that keep on giving. Bonds have benefited to a lesser extent than stocks over the last five years in part because bonds lack the gift of rising dividend payouts. Life would be grander for bondholders, if the issuers had the heart to share generous news like this:
“Good day Mr. & Mrs. Jones. As your bond issuer, we value our mutually beneficial relationship so much that we would like to reward you as a bond investor. In addition to the 2.5% we are paying you now, we have decided to increase your annual payments by 6% per year for the next 20 years. In other words, we will increase your $2,500 in annual interest payments to over $8,000 per year. But wait…there’s more! You are such great people, we are going to increase the value of your initial $100,000 investment to $450,000.”
Does this sound too good to be true? Well, it’s not…sort of. However, the scenario is absolutely true, if you invested $100,000 in S&P 500 stocks during 1993 and held that investment until today. Unfortunately, the gift giving conversation above would be unattainable and the furthest from the truth, if you invested $100,000 into bonds. Today, if you decided to invest $100,000 in 20-year government bonds paying 2.5%, your $2,500 in annual payments will never increase over the next two decades. What’s more, by 2034 your initial principal of $100,000 won’t increase by a penny, while inflation slowly but surely crushes your investment’s purchasing power.
To illustrate the magical power of dividend compounding at a 6% CAGR, here is a chart of the S&P 500 dividend stream over the 21-year period of 1993 – 2014:
The trend of increasing dividends doesn’t appear to be slowing either. Here is a table showing the number of S&P 500 companies increasing their dividend payouts:
| COUNT OF DIVIDEND ACTIONS YEAR-TO-DATE | INCREASING THEIR DIVIDEND |
| 2014 YTD | 292 |
| 2013 | 366 |
| 2012 | 333 |
| 2011 | 320 |
| 2010 | 243 |
| 2009 | 151 |
Source: Standard and Poor’s
As I mentioned before, while dividends have more than tripled over the last twenty years, stock prices have gone up even more – appreciating about 4.5x’s (see chart below):
With aging demographics increasing retirement income needs, it comes as no surprise to me that the percentage of S&P 500 companies paying dividends has increased from 71% (351 companies) in 2001 to 84% (423 companies) at the end of Q3 – 2014. Interestingly, all 30 members of the Dow Jones Industrial Average currently pay a dividend. If you broaden out the perspective to all S&P Dow Jones Indices, you will discover the strength of dividends is particularly evident over the last 12 months. During this period, dividends increased by a whopping +27%, or $55 billion.
This trend in increasing dividends can also be seen through the lens of the dividend payout ratio. It is true that over longer timeframes the dividend payout ratio has been coming down (see Dividend Floodgates Widen) because of share buyback tax efficiency. Nevertheless, more recently the dividend payout ratio has drifted upwards to a range of about 32% of profits since 2011 (see chart below):
Source: FactSet
There’s no disputing the benefit of rising stock dividends. Baby Boomers, retirees, and other long-term investors are increasingly reaping the rewards of these dividend gifts that keep on giving.
Other Investing Caffeine articles on dividends:
Dividends: From Sapling to Abundant Fruit Tree
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs) including SPY, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
Investing Caffeine 
