Posts tagged ‘Treasuries’
Sleeping and Napping Through Bubbles
We have lived through many investment bubbles in our history, and unfortunately, most investors sleep through the early wealth-creating inflation stages. Typically, the average investor wakes up later to a hot idea once every man, woman, and child have identified the clear trend…right as the bubble is about burst. Sadly, the masses do a great job of identifying financial bubbles at the end of a cycle, but have a tougher time realizing the catastrophic consequences of exiting a tired winner. Or as strategist Jim Stack states, “Bubbles, for the most part, are invisible to those trapped inside the bubble.” The challenge of recognizing bubbles explains why they are more easily classified as bubbles after a colossal collapse occurs. For those speculators chasing a precise exit point on a bubblicious investment, they may be better served by waiting for the prick of the bubble, then take a decade long nap before revisiting the fallen angel investment idea.
Even for the minority of pundits and investors who are able to accurately identify these financial bubbles in advance, a much smaller number of these professionals are actually able to pinpoint when the bubble will burst. Take for example Alan Greenspan, the ex-Federal Reserve Chairman from 1987 to 2006. He managed to correctly identify the technology bubble in late-1996 when he delivered his infamous “irrational exuberance” speech, which questioned the high valuation of the frothy, tech-driven stock market. The only problem with Greenspan’s speech was his timing was massively off. Stated differently, Greenspan was three years premature in calling out the pricking of the bubble, as the NASDAQ index subsequently proceeded to more than triple from early 1997 to early 2000 (the index exploded from about 1,300 to over 5,000).
One of the reasons bubbles are so difficult to time during their later stages is because the deflation period occurs so quickly. As renowned value investor Howard Marks fittingly notes, “The air always goes out a lot faster than it went in.”
Bubbles, Bubbles, Everywhere
Financial bubbles do not occur every day, but thanks to the psychological forces of investor greed and fear, bubbles do occur more often than one might think. As a matter of fact, famed investor Jeremy Grantham claims to have identified 28 bubbles in various global markets since 1920. Definitions vary, but Webster’s Dictionary defines a financial bubble as the following:
A state of booming economic activity (as in a stock market) that often ends in a sudden collapse.
Although there is no numerical definition of what defines a bubble or collapse, the financial crisis of 2008 – 2009, which was fueled by a housing and real estate bubble, is the freshest example in most people minds. However, bubbles go back much further in time – here are a few memorable ones:
Dutch Tulip-Mania: Fear and greed have been ubiquitous since the dawn of mankind, and those emotions even translate over to the buying and selling of tulips. Believe it or not, some 400 years ago in the 1630s, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation-adjusted basis). This bubble ended like all bubbles, as you can see from the chart below.
Source: The Stock Market Crash.net
British Railroad Mania: In the mid-1840s, hundreds of companies applied to build railways in Britain. Like all bubbles, speculators entered the arena, and the majority of companies went under or got gobbled up by larger railway companies.
Roaring 20s: Here in the U.S., the Roaring 1920s eventually led to the great Wall Street Crash of 1929, which finally led to a nearly -90% plunge in the Dow Jones Industrial stock index over a relatively short timeframe. Leverage and speculation were contributors to this bust, which resulted in the Great Depression.
Nifty Fifty: The so-called Nifty Fifty stocks were a concentrated set of glamor stocks or “Blue Chips” that investors and traders piled into. The group of stocks included household names like Avon (AVP), McDonald’s (MCD), Polaroid, Xerox (XRX), IBM and Disney (DIS). At the time, the Nifty Fifty were considered “one-decision” stocks that investors could buy and hold forever. Regrettably, numerous of these hefty priced stocks (many above a 50 P/E) came crashing down about 90% during the 1973-74 period.
Japan’s Nikkei: The Japanese Nikkei 225 index traded at an eye popping Price-Earnings (P/E) ratio of about 60x right before the eventual collapse. The value of the Nikkei index increased over 450% in the eight years leading up to the peak in 1989 (from 6,850 in October 1982 to a peak of 38,957 in December 1989).
Source: Thechartstore.com
The Tech Bubble: We all know how the technology bubble of the late 1990s ended, and it wasn’t pretty. PE ratios above 100 for tech stocks was the norm (see table below), as compared to an overall PE of the S&P 500 index today of about 14x.
Source: Wall Street Journal – March 14, 2000
The Next Bubble
What is/are the next investment bubble(s)? Nobody knows for sure, but readers of Investing Caffeine know that long-term bonds are one fertile area. Given the generational low in yields and rates, and the 35-year bull run in bond prices, it can be difficult to justify heavy allocations of inflation losing bonds for long time-horizon investors. Commercial real estate and Silicon Valley unicorns could be other potential over-heated areas. However, as we discussed earlier, identifying and timing bubble bursts is extremely challenging. Nevertheless, the great thing about long-term investing is that probabilities and valuations ultimately do matter, and therefore a diversified portfolio skewed away from extreme valuations and speculative sectors will pay handsome dividends over the long-run.
Many traders continue to daydream as they chase performance through speculative investment bubbles, looking to squeeze the last ounce of an easily identifiable trend. As the lead investment manager at Sidoxia Capital Management, I spend less time sucking the last puff out of a cigarette, and spend more time opportunistically devoting resources to valuation-sensitive growth trends. As demonstrated with historical examples, following the popular trend du jour eventually leads to financial ruin and nightmares. Avoiding bubbles and pursuing fairly priced growth prospects is the way to achieve investment prosperity…and provide sweet dreams.
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), MCD, DIS and are short TLT, but at the time of publishing SCM had no direct positions in AVP, XRX, IBM,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.
Bernanke: Santa Claus or Grinch?
I’ve written plenty about my thoughts on the Fed (see Fed Fatigue) and all the blathering from the media talking heads. Debates about the timing and probability of a Fed “taper” decision came to a crescendo in the recent week. As is often the case, the exact opposite of what the pundits expected actually happened. It was not a huge surprise the Federal Reserve initiated a $10 billion tapering of its $85 billion monthly bond buying program, but going into this week’s announcement, the betting money was putting their dollars on the status quo.
With the holiday season upon us, investors must determine whether the tapered QE1/QE2/QE3 gifts delivered by Bernanke are a cause for concern. So the key question is, will this Santa Claus rally prance into 2014, or will the Grinch use the taper as an excuse to steal this multi-year bull market gift away?
Regardless of your viewpoint, what we did learn from this week’s Fed announcement is that this initial move by the Fed will be a baby step, reducing mortgage-backed and Treasury security purchases by a measly $5 billion each. I say that tongue in cheek because the total global bond market has been estimated at about $80,000,000,000,000 (that’s $80 trillion).
As I’ve pointed out in the past, the Fed gets way too much credit (blame) for their impact on interest rates (see Interest Rates: Perception vs Reality). Interest rates even before this announcement were as high/higher than when QE1 was instituted. What’s more, if the Fed has such artificial influence over interest rates, then why do Austria, Belgium, Canada, Denmark, Finland, France, Germany, Japan, Netherlands, Sweden, and Switzerland all have lower 10-year yields than the U.S.? Maybe their central banks are just more powerful than our Fed? Unlikely.
Dow 128,000 in 2053
Readers of Investing Caffeine know I have followed the lead of investing greats like Warren Buffett and Peter Lynch, who believe trying to time the markets is a waste of your time. In a recent Lynch interview, earlier this month, Charlie Rose asked for Lynch’s opinion regarding the stock market, given the current record high levels. Here’s what he had to say:
“I think the market is fairly priced on what is happening right now. You have to say to yourself, is five years from now, 10 years from now, corporate profits are growing about 7 or 8% a year. That means they double, including dividends, about every 10 years, quadruple every 20, go up 8-fold every 40. That’s the kind of numbers you are interested in. The 10-year bond today is a little over 2%. So I think the stock market is the best place to be for the next 10, 20, 30 years. The next two years? No idea. I’ve never known what the next two years are going to bring.”
READ MORE ABOUT PETER LYNCH HERE
Guessing is Fun but Fruitless
I freely admit it. I’m a stock-a-holic and member of S.A. (Stock-a-holic’s Anonymous). I enjoy debating the future direction of the economy and financial markets, not only because it is fun, but also because without these topics my blog would likely go extinct. The reality of the situation is that my hobby of thinking and writing about the financial markets has no direct impact on my investment decisions for me or my clients.
There is no question that stocks go down during recessions, and an average investor will likely live through at least another half-dozen recessions in their lifetime. Unfortunately, speculators have learned firsthand about the dangers of trading based on economic and/or political headlines during volatile cycles. That doesn’t mean everyone should buy and do nothing. If done properly, it can be quite advantageous to periodically rebalance your portfolio through the use of various valuation and macro metrics as a means to objectively protect/enhance your portfolio’s performance. For example, cutting exposure to cyclical and debt-laden companies going into an economic downturn is probably wise. Reducing long-term Treasury positions during a period of near-record low interest rates (see Confessions of a Bond Hater) as the economy strengthens is also likely a shrewd move.
As we have seen over the last five years, the net result of investor portfolio shuffling has been a lot of pain. The acts of panic-selling caused damaging losses for numerous reasons, including a combination of agonizing transactions costs; increased inflation-decaying cash positions; burdensome taxes; and a mass migration into low-yielding bonds. After major indexes have virtually tripled from the 2009 lows, many investors are now left with the gut-wrenching decision of whether to get back into stocks as the markets reach new highs.
As the bulls continue to point to the scores of gifts still lying under the Christmas tree, the bears are left hoping that new Fed Grinch Yellen will come and steal all the presents, trees, and food from the planned 2014 economic feast. There are still six trading days left in the year, so Santa Bernanke cannot finish wrapping up his +30% S&P 500 total return gift quite yet. Nevertheless, ever since the initial taper announcement, stocks have moved higher and Bernanke has equity investors singing “Joy to the World!”
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.
Time to Trade in the Investment Tricycle
This article is an excerpt from a previously released Sidoxia Capital Management’s complementary newsletter (May 1, 2013). Subscribe on the right side of the page for an entire monthly update.
As the stock market continues to set new, all-time record highs and the Dow Jones Industrial index nears another historic milestone (15,000 level), investors remain cautiously skeptical of the rebound – like a nervous toddler choosing to ride a tricycle instead of a bicycle. Investors have been moving slowly, but stock prices have not – the Dow has risen +13% in 2013 alone. What’s more, over the last four years the S&P 500 index (which represents large companies) has climbed +140%; the S&P 400 (mid-sized companies) +195%; and the S&P 600 (small-sized companies) +200%.
The gains have been staggering, but like the experience of riding a bicycle, the bumps, scrapes, and bruises suffered during the 2008-2009 financial crash have caused investors to abandon their investment bikes for a perceived safer vehicle…a tricycle. What do I mean by that? Well, over the last six years, investors have pulled out more than -$521,000,000,000 from stock funds and piled those proceeds into bonds (Calafia Beach Pundit chart below). For retirees and billionaires this strategy may make sense in certain instances. But for millions of others, interest rate risk, inflation risk, and the risk of outliving your money can be more hazardous to financial well-being, than the artificially perceived safety expected from bonds. The fact of the matter is investing inefficiently in cash, money markets, CDs, and low-yielding fixed income securities can be riskier in the long-run than a globally diversified portfolio invested across a broad set of asset classes (including equities). The latter should be the strategy of choice, unless of course you are someone who yearns to work at Wal-Mart (WMT) as a greeter in your 80s!
Investor Training Wheels
I don’t want to irresponsibly flog everyone, because investing attitudes have begun to change a little in 2013, as investors have added $66 billion to stock funds (data from ICI). Effectively, some investors have gone from riding their tricycle to hopping on a bike with training wheels. With this change in mindset, surely people have commenced selling bonds to buy stocks, right? Wrong! Investors have actually bought more bonds (+$69 billion) than stocks in the first three months of the year, which helps explain why interest rates on the 10-year Treasury are only yielding a paltry 1.67% (near last year’s record summer low) – remember, bond buying causes interest rates to go down. If you really want to do research, you could ask your parents when rates were ever this low, but some readers’ parents may not even had been born yet. The previous record low in interest rates, according to Bloomberg, at 1.95% was achieved in 1941.
Over the last five years the news has been atrocious, and as we have proven, investing based off of current headlines is a horrible investment strategy. As we’ve seen firsthand, there can be very long, multi-year periods when stock performance has absolutely no correlation with the positive or negative nature of news reports. To better make my point, I ask you, what types of headlines have you been reading over the last four years? I can answer the question for you with a few examples. For starters, we’ve endured financial collapses in Iceland, Ireland, Dubai, Greece, and now Cyprus. At home domestically, we’ve experienced a “flash crash” that temporarily evaporated about $1 trillion dollars in value (and 1,000 Dow points) within a few minutes due to high frequency algorithmic traders. How about unemployment data? We’ve witnessed the slowest, jobless U.S. recovery in a generation (since World War II), and European countries have it much worse than we do (e.g., Spain just registered a 27% unemployment rate). What about political gridlock and brinksmanship? We’ve seen debt ceiling stand-offs lead to a historic loss of our country’s AAA debt status; a partisan presidential election; a deafening fiscal cliff debate; and now mindless sequestration. Nevertheless, large cap stocks and small cap stocks have more than doubled and tripled, respectively.
Fear sells advertising, and sounds smarter than “everything is rosy,” but the fact remains, things are not as bad as many bears claim. Corporations are earning record profits, and hold trillions in cash (e.g., Apple Inc.’s recent announcement of more than $50 billion in share repurchase and $11 billion in annual dividend payments are proof). Moreover, central banks around the globe are doing whatever it takes to stimulate growth – most recently the Bank of Japan promised to inject $1.4 trillion into its economy by the end of 2014, in order to kick-start expansion. Lastly, the U.S. employment picture continues to improve, albeit slowly (7.6% unemployment in March), allowing consumers to pay down debt, buy more homes, and spend money to spur economic growth.
Dangers of Being Informed
Hopefully this clarifies how useless and futile newspaper headlines are when it comes to effective investing. As Mark Twain astutely noted, “If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.” It’s perfectly fine to remain in tune with current events, but shuffling around your life’s savings based on this information is a foolish plan.
If the concerns and worries du jour have you nervously riding a tricycle, just realize that you may not reach your investment destination with this mode of transportation. I understand that it is not all hearts and flowers in the financial markets, and there are plenty of legitimate risks to consider. However, excessive exposure in low-rate asset classes may be riskier than many realize. If you’re still riding your investment tricycle, you’re probably better off by grabbing a helmet and pads (i.e., globally diversified portfolio) and jumping on a bike – you are more likely to reach your financial destination.
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), WMT and AAPL, 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.
Bond-Choking Central Banks Expand Investment Menu
Central banks around the globe are choking on low-yielding bonds, and as result are now expanding their investment menu beyond Treasuries into equities. Expansionary monetary policies purchasing short-term, low-rate bonds means that central banks have been gobbling up securities on their balance sheets that are earning next to nothing. To counteract the bond-induced indigestion of the central banks, many of them are considering increasing their equity purchasing strategies. How can you blame them? With the 10-year U.S. Treasury notes yielding 1.66%; 10-year German bonds eking out 1.21%; and 10-year Japanese Government Bonds (JGBs) paying a paltry 0.59%, it’s no wonder central banks are looking for better alternatives.
More specifically, the Bank of Japan (BOJ) is planning to pump $1.4 trillion into its economy over the next two years to encourage some inflation through open-ended asset purchases. Earlier this month, the BOJ said it has a goal of more than doubling equity related exchange traded funds (ETFs) by the end of 2014. According to Business Insider, the BOJ is currently holding $14.1 billion in equity ETFs with an objective to reach $35.3 billion in 2014.
I can only imagine how stock market bears feel about this developing trend when they have already blamed central banks’ quantitative easing initiatives as the artificial support mechanism for stock prices (see also The Central Bank Dog Ate my Homework).
While expanded equity purchases could break the backs of bond bulls and stock naysayers, some smart people agree that this strategy makes sense. Take Jim O’Neill, the chairman of Goldman Sachs Asset Management, who is retiring next week. Here’s what he has to say about expanded central bank stock purchases:
“Frankly, it makes a huge amount of sense in a world of floating exchange rates and such incredible opportunity, why should central banks keep so much money in very short term, liquid things when they’re not going to ever need it? To help their future returns for their citizens, why would they not invest in equity?”
How big is this shift towards equities? The Royal Bank of Scotland conducted a survey of 60 central banks that have about $6.7 trillion in reserves. There were 13% of the central banks already invested in equities, and almost 25% of them said they are or will be invested in equities within the next five years.
While I may agree that stocks generally are a more attractive asset class than bubblicious bonds right now, I may draw the line once the Fed starts buying houses, gasoline, and groceries for all Americans. Until then, dividend yields remain higher than Treasury yields, and the earnings yields (earnings/price) on stocks will remain more attractive than bond yields. Once stocks gain more in price and/or bonds sell off significantly, it will be a more appropriate time to reassess the investment opportunity set. A further stock rise or bond selloff are both possible scenarios, but until then, central banks will continue to look to place its money where it is treated best.
The central bank menu has been largely limited to low-yielding, overpriced government bonds, but the appetite for new menu items has heightened. Stocks may be an enticing new option for central banks, but let’s hope they delay buying houses, gasoline, and groceries.
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.
Sleeping Through Bubbles and Decade Long Naps
We have lived through many investment bubbles in our history, and unfortunately most investors sleep through the early wealth-creating inflation stages. Typically, the average investor wakes up later to a hot idea once every man, woman, and child has identified the clear trend…right as the bubble is about burst. Sadly, the masses do a great job of identifying financial bubbles at the end of a cycle, but have a tougher time realizing the catastrophic consequences of exiting a tired winner. Or as strategist Jim Stack states, “Bubbles, for the most part, are invisible to those trapped inside the bubble.” The challenge of recognizing bubbles explains why they are more easily classified as bubbles after a colossal collapse occurs. For those speculators chasing a precise exit point on a bubblicious investment, they may be better served by waiting for the prick of the bubble, then take a decade long nap before revisiting the fallen angel investment idea.
Even for the minority of pundits and investors who are able to accurately identify these financial bubbles in advance, a much smaller number of these professionals are actually able to pinpoint when the bubble will burst. Take for example Alan Greenspan, the ex-Federal Reserve Chairman from 1987 to 2006. He managed to correctly identify the technology bubble in late-1996 when he delivered his infamous “irrational exuberance” speech, which questioned the high valuation of the frothy, tech-driven stock market. The only problem with Greenspan’s speech was his timing was massively off. Stated differently, Greenspan was three years premature in calling out the pricking of the bubble, as the NASDAQ index subsequently proceeded to more than triple from early 1997 to early 2000 (the index exploded from about 1,300 to over 5,000).
One of the reasons bubbles are so difficult to time during their later stages is because the deflation period occurs so quickly. As renowned value investor Howard Marks fittingly notes, “The air always goes out a lot faster than it went in.”
Bubbles, Bubbles, Everywhere
Financial bubbles do not occur every day, but thanks to the psychological forces of investor greed and fear, bubbles do occur more often than one might think. As a matter of fact, famed investor Jeremy Grantham claims to have identified 28 bubbles in various global markets since 1920. Definitions vary, but Webster’s Dictionary defines a financial bubble as the following:
A state of booming economic activity (as in a stock market) that often ends in a sudden collapse.
Although there is no numerical definition of what defines a bubble or collapse, the financial crisis of 2008 – 2009, which was fueled by a housing and real estate bubble, is the freshest example in most people minds. However, bubbles go back much further in time – here are a few memorable ones:
Dutch Tulip-Mania: Fear and greed have been ubiquitous since the dawn of mankind, and those emotions even translate over to the buying and selling of tulips. Believe it or not, some 400 years ago in the 1630s, individual Dutch tulip bulbs were selling for the same prices as homes ($61,700 on an inflation adjusted basis). This bubble ended like all bubbles, as you can see from the chart below.
Source: The Stock Market Crash.net
British Railroad Mania: In the mid-1840s, hundreds of companies applied to build railways in Britain. Like all bubbles, speculators entered the arena, and the majority of companies went under or got gobbled up by larger railway companies.
Roaring 20s: Here in the U.S., the Roaring 1920s eventually led to the great Wall Street Crash of 1929, which finally led to a nearly -90% plunge in the Dow Jones Industrial stock index over a relatively short timeframe. Leverage and speculation were contributors to this bust, which resulted in the Great Depression.
Nifty Fifty: The so-called Nifty Fifty stocks were a concentrated set of glamour stocks or “Blue Chips” that investors and traders piled into. The group of stocks included household names like Avon (AVP), McDonald’s (MCD), Polaroid, Xerox (XRX), IBM and Disney (DIS). At the time, the Nifty Fifty were considered “one-decision” stocks that investors could buy and hold forever. Regrettably, numerous of these hefty priced stocks (many above a 50 P/E) came crashing down about 90% during the1973-74 period.
Japan’s Nikkei: The Japanese Nikkei 225 index traded at an eye popping Price-Earnings (P/E) ratio of about 60x right before the eventual collapse. The value of the Nikkei index increased over 450% in the eight years leading up to the peak in 1989 (from 6,850 in October 1982 to a peak of 38,957 in December 1989).
Source: Thechartstore.com
The Tech Bubble: We all know how the technology bubble of the late 1990s ended, and it wasn’t pretty. PE ratios above 100 for tech stocks was the norm (see table below), as compared to an overall PE of the S&P 500 index today of about 14x.
Source: Wall Street Journal – March 14, 2000
The Next Bubble
What is/are the next investment bubble(s)? Nobody knows for sure, but readers of Investing Caffeine know that long-term bonds are one fertile area. Given the generational low in yields and rates, and the near doubling of long-term Treasury prices over the last twelve years, it can be difficult to justify heavy allocations of inflation losing bonds for long time-horizon investors. Gold, another asset class that has increased massively in price (over 6-fold rise since about 2000) and attracted swaths of speculators, is another target area. However, as we discussed earlier, timing bubble bursts is extremely challenging. Nevertheless, the great thing about long-term investing is that probabilities and valuations ultimately do matter, and therefore a diversified portfolio skewed away from extreme valuations and speculative sectors will pay handsome dividends over the long-run.
Many traders continue to daydream as they chase performance through speculative investment bubbles, looking to squeeze the last ounce of an easily identifiable trend. As the lead investment manager at Sidoxia Capital Management, I spend less time sucking the last puff out of a cigarette, and spend more time opportunistically devoting resources to less popular growth trends. As demonstrated with historical examples, following the trend du jour eventually leads to financial ruin and nightmares. Avoiding bubbles and pursuing fairly priced growth prospects is the way to achieve investment prosperity…and provide sweet dreams.
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 are short TLT, but at the time of publishing SCM had no direct positions in AVP, MCD, XRX, IBM, DIS, 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.
Dividend Floodgates Widen
The recently reported lackluster, monthly employment report made stockholders grumpy (as measured by the recent -168 point decline in the Dow Jones Industrial index) and bondholders ecstatic (as measured by the surge in the 10-year Treasury note price and plunge in yield to a meager 1.88% annual rate). Stocks on the other hand are yielding a much more attractive rate of approximately 7.70% based on 2012 earnings estimates (see chart below) and are also offering a dividend yield of about 2.25%.
S&P 500 earnings yields trouncing bond yields despite historical correlation.
In my view, either stock prices go higher and drive equity yields lower; bonds sell off and Treasury yields spike higher; or a combination of the two. Either way, there are not many compelling reasons to pile into Treasuries, although I fully understand some Treasuries are needed in many investors’ portfolios for income, diversification, and risk tolerance reasons.
Not only are equity earnings yields beating Treasury yields, but so are dividend yields. It has been a generation, or more than 50 years, since the last time stock dividends were yielding more than 10-year Treasuries (see chart below). If you invested in stocks back when dividend yields outpaced bond yields, and held onto your shares, you did pretty well in stocks (the Dow Jones Industrial index traded around 600 in 1960 and over 13,000 today).
Source: The Financial Times
The Dynamic Dividend Payers
The problem with bond payments (coupons), in most cases, is that they are static. I have never heard of a bond issuer sending a notice to a bond holder stating they wanted to increase the size of interest payments to their investors. On the flip side, stocks can and do increase payments to investors all the time. In fact here is a list of some of the longest paying dividend dynamos that have incredible dividend hike streaks:
• Procter & Gamble (PG – 55 consecutive years)
• Emerson Electric (EMR – 54 years)
• 3M Company (MMM – 53 years)
• The Coca-Cola Company (KO – 49 years)
• Johnson & Johnson (JNJ – 49 years)
• Colgate-Palmolive Company (CL – 48 years)
• Target Corporation (TGT – 43 years)
• PepsiCo Inc. (PEP – 39 years)
• Wal-Mart Stores Inc. (WMT – 38 years)
• McDonald’s Corporation (MCD – 35 years)
This is obviously a small number of the long-term consecutive dividend hikers, but on a shorter term basis, more and more players are joining the dividend paying team. So far, in 2012 alone through April, there have been 152 companies in the S&P 500 index that have raised their dividend (a +11% increase over the same period a year ago). Of those 152 companies that increased the dividend this year, the average boost was more than +23%. Some notable names that have had significant dividend increases in 2012 include the following companies:
• Macy’s Inc. (M: +100% dividend increase)
• Mastercard Inc. (MA: +100%)
• Wells Fargo & Company (WFC: +83%)
• Comcast Corp. (CMCSA: +44%)
• Cisco Systems Inc. (CSCO: +33%)
• Goldman Sachs Group Inc. (GS: +31%)
• Freeport McMoran (FCX: +25%)
• Harley Davidson Inc. (HOG: +24%)
• Exxon Mobil Corp. (XOM: +21%)
• JP Morgan Chase & Co. (JPM: +20%)
Lots of Dividend Headroom
The nervous mood of investors is not much different from the temperament of uneasy business executives, so companies have been slow to hire; unhurried to acquire; and deliberate with their expansion plans. Rather than aggressively spend, corporations have chosen to cut costs, hoard cash, grow earnings, buy back shares, and pay out ever increasing dividends from the trillions in cash piling up.
When a company on average is earning an 8% yield on their stock price, there is plenty of headroom to increase the dividend. As a matter of fact, a company paying a 2% yield could increase its dividend by 10% for about 15 consecutive years and still pay a quadrupling dividend with NO earnings growth. Simply put, there is a lot of room for companies to increase dividends further despite the floodgate of dividend increases we have experienced over the last few years. If you look at the chart below, the dividend yield is the lowest it has been in more than a century (1900).
Source: The Financial Times
Perhaps we will experience another “Summer Swoon” this year, but for those selective and patient investors that sniff out high-quality, dividend paying stocks, you will be getting “paid to wait” while the dividend floodgates continue to widen.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including Treasury bond ETFs), CMCSA and WMT, but at the time of publishing SCM had no direct position in PG, EMR, MMM, KO, JNJ, CL, TGT, PEP, MCD, M, MA, WFC, CSCO, GS, FCX, HOG, XOM, JPM, 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.
2011: Beating Batter into Flat Pancake
As it turns out, 2011 can be characterized as the year of the pancake…the flat pancake. While the Dow Jones Industrial Average (Dow) rose about 6% this year (its third consecutive annual gain), the S&P 500 ended the year flat at 1257.6 (-0.003%), the smallest yearly move in more than four decades. Along the way in 2011, there was plenty of violent beating and whipping of the lumpy pancake batter before the flat cake was cooked for the year. With respect to the financial markets, the 2011 lumps came in the form of various unsavory events:
* Never-Ending Eurozone Financial Saga: After Ireland and Portugal sought bailouts, Greece added its negligent financial storyline to the financial soap opera. Whether European government leaders can manage out-of-control deficits and debt loads will determine if Greece and other peripheral countries will topple larger countries like Italy and Spain.
* Credit Rating Downgrade: Standard & Poor’s, the highest profile credit rating agency, downgraded the U.S.’s long-term debt rating to AA+ from AAA due to high debt levels and Congressional legislators inability to hammer out a deficit-reduction plan during the debt ceiling negotiations.
* Japanese Earthquake and Tsunami: Japan and the global economy were rocked by a magnitude 9.0 earthquake and tsunami on March 11, 2011, which resulted in 15,844 people dead and 3,451 people missing. The ripple effects are still being felt through large industries like the automobile and electronics industries.
* Arab Spring Protests: Protesters throughout the Middle East and North Africa provided additional uncertainty to the global political map as demonstrators demanded regime change and more political freedoms. In the long-run, removing oppressive leaders like Hosni Mubarak (Egypt’s leader for 30 years), Muammar Gadaffi (Libya’s leader for 42 years), and Zine al-Abidine Ben Ali (Tunisia’s president for 23 years) should be beneficial for global stability, but in the short-run, how the new leadership vacuum will be filled remains ambiguous.
* Occupy Movement Voices Disapproval: The Occupy Wall Street movement began on September 17, 2011 in Liberty Square in Manhattan’s Financial District, and spread to over 100 cities in the U.S. There has not been a cohesive articulated agenda, but a common thread underlying all the Occupy movements is a sense that 99% of the population is being treated unfairly due to a flawed corrupt system controlled by Wall Street that is feeding the richest 1%.
All these lumps experienced in 2011 were not settling to investors’ stomachs. As a result individuals continued the trend of piling into bonds, in hopes of soothing their investment tummies. Long-term Treasury prices spiked upwards in 2011 (+29% as measured by TLT Treasury ETF) and soaring 10-year Treasury note prices pushed yields (1.87%) below yields on S&P 500 equities (2.1%). Despite a more than 3,400 point increase in the Dow (+39%) since the end of 2008, investors have still poured $774 billion into bonds versus $33 billion yanked from equities, according to EPFR Global. Over-weighting bonds makes sense for some, including retirees on fixed budgets, but many investors should brace for an inevitable reversal in bond prices. Eventually, the sweet taste of safety achieved from bond appreciation will turn to heartburn, once interest rates reverse their 30 year trend of declines.
Syrupy Factors Help Sweeten Pancakes
Although the aforementioned factors lead to historically high volatility and flat flavors in 2011, there are also some countering sweet reasons that make equities look more palatable for 2012. Here are some of the factors:
* Record Corporate Profits: Even with the constant barrage of fear, uncertainty, and doubt distributed via the media channels, corporations posted record profits in 2011, with an estimated increase of +16% over last year (and another forecasted +10% rise in 2012 – Source: S&P).
* Historic Levels of Cash: Record profits mean record cash, and all those riches have been piling up on non-financial corporate balance sheets at historic levels. At the beginning of Q4 the figure stood at $2.12 trillion. Companies have generally been stingy, but as the recovery progresses, they have increasingly been spending on technology, equipment, international expansion, and even the beginnings of hiring.
* Interest Rates at 60 Year Lows: Interest rates are at record lows and home affordability has never been better with 30-year fixed rate mortgages hovering below 4%. Housing may not come screaming back, but the foundation for a recovery is being laid.
* Improving Economic Variables: Whether you’re looking at broader economic activity (Gross Domestic Product up for nine consecutive quarters); employment growth (declining unemployment rate and 21 consecutive months of private job creation), or consumer spending (consumer confidence approaching multi-year highs), all major signs are currently pointing to an improving outlook.
* Near Record Exports: While the U.S. dollar has made some recent gains against foreign currencies because of the financial crisis in Europe, the relative value of the dollar remains historically low versus the major global currencies. The longer-term depreciation of the dollar has buoyed exports of U.S. goods to near record levels despite the global uncertainty.
* Unprecedented Central Bank Support Globally: Ben Bernanke and the U.S. Federal Reserve is committed to keeping exceptionally low levels of lending interest rates at least through mid-2013, while also implementing “Operation Twist” and potential further quantitative easing (QE3). Translation: Ben Bernanke is going to do everything in his power to keep interest rates low in order to stimulate economic growth. The European Central Bank (ECB) has pulled out its lending fire trucks too, with an unparalleled three-year lending program to extinguish liquidity fires in the European banking sector.
* Improving Mergers & Acquisitions Environment: We may not be back to the 2006 buyout “hay-days,” but U.S. mergers and acquisitions activity increased +24% in 2011. What’s more, high profile potential IPOs like an estimated $100 billion Facebook offering may help kick-start the new equity issuance market in 2012.
* Tasty Fat Dividends: Rarely have S&P 500 dividend yields (currently 2.1%) outpaced the interest rates earned on 10-year Treasury note yields, but now happens to be one of those times. Typically S&P 500 stock dividends have averaged about 40% of the yield on 10-year Treasury notes, and now it is 112%. In Q3 of 2011, dividend increases rose +17% and expectations are for nearly a +11% increase in 2012, said Howard Silverblatt, senior index analyst at S&P.
Any way you cut it (or beat the batter), 2011 was a volatile year. And despite all the fear, uncertainty, and doubt, profits continue to grow and sovereign nations are being forced to deal with their fiscal problems. Unforeseen risks always exist, but if Europe can contain its financial crisis and the U.S. recovery can continue into this new election year, then opportunities in the 2012 attractively priced equity markets should sweeten the flat equity pancake we ate in 2011.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including a short position in TLT, 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.
Playing Whack-A-Mole with the Pros
Source: Flickr
Deciphering the ups and the downs of the financial markets is a lot like playing a game of Whack-A-Mole. First the market is up 300 points, then down 300 points. Next Greece and Europe are going down the drain, and then Germany and the ECB (European Central Bank) are here to save the day. The daily data points are a rapid moving target, and if history continues to serve as a guide (see History Often Rhymes with the Future), the bobbing consensus views of pundits will continue to get hammered by investors’ mallets.
Let’s take a look at recent history to see who has been the “whack-er” and whom has been the “whack-ee.” Whether it was the gloom and doom consensus view in the early 1980s (reference BusinessWeek’s 1979 front page “The Death of Equities”) or the euphoric championing of tech stocks in the 1990s (see Money magazine’s March 2000 cover, “The Hottest Market Ever”), the consensus view was wrong then, and is likely wrong again today.
Here are some of the fresher consensus views that have popped up and then gotten beaten down:
End of QE2 – The Consensus: If you rewind the clock back to June 2011 when the Federal Reserve’s $600 billion QE2 (Quantitative Easing Part II) monetary stimulus program was coming to an end, a majority of pundits expected bond prices to tank in the absence of the Fed’s Ben Bernanke’s checkbook support. Before the end of QE2, Reuters financial service surveyed 64 professionals, and a substantial majority predicted bond prices would tank and interest rates would catapult upwards. Actual Result: The pundits were wrong and rates did not go up, they in fact went down. As a result, bond prices screamed higher – bond values increased significantly as 10-year Treasury yields fell from 3.16% to a low of 1.72% last week.
Debt Ceiling Debate – The Consensus: Just one month later, Democrats and Republicans were playing a game of political “chicken” in the process of raising the debt ceiling to over $16 trillion. Bill Gross, bond guru and CEO of fixed income giant PIMCO, was one of the many pros who earlier this year sold Treasuries in droves because fears of bond vigilantes shredding prices of U.S. Treasury bonds .
Here was the prevalent thought process at the time: Profligate spending by irresponsible bureaucrats in Washington if not curtailed dramatically would cascade into a disaster, which would lead to higher default risk, cancerous inflation, and exploding interest rates ala Greece. Actual Result: Once again, the pundits were proved wrong in the deciphering of their cloudy crystal balls. Interest rates did not rise, they actually fell. As a result, bond prices screamed higher and 10-year Treasury yields dived from 2.74% to the recent low of 1.72%.
S&P Credit Downgrade – The Consensus: The S&P credit rating agency warned Washington that a failure to come to meaningful consensus on deficit and debt reduction would result in bitter consequences. Despite a $2 trillion error made by S&P, the agency kept its word and downgraded the U.S.’s long-term debt rating to AA+ from AAA. Research from JP Morgan (JPM) cautioned investors of the imminent punishment to be placed on $4 trillion in Treasury collateral, which could lead to a seizing in credit markets. Actual Result: Rather than becoming the ugly stepchild, U.S. Treasuries became a global safe-haven for investors around the world to pile into. Not only did bond prices steadily climb (and yields decline), but the value of our currency as measured by the Dollar Index (DXY) has risen significantly since then.
Dollar Index (DXY) Source: Bloomberg
What is next? Nobody knows for certain. In the meantime, grab some cotton candy, popcorn, and a rubber mallet. There is never a shortage of confident mole-like experts popping up on TV, newspapers, blogs, and radio. So when the deafening noise about the inevitable collapse of Europe and the global economy comes roaring in, make sure you are the one holding the mallet and not the mole getting whacked on the head.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in JPM, MHP, 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.
Skiing Portfolios Down Bunny Slopes
Oh Nelly, take it easy…don’t get too crazy on that bunny slope. With fall officially kicking off and the crisp smell of leaves in the air, the new season also marks the beginning of the ski season. In many respects, investing is a lot like skiing. Unfortunately, many investors are financially skiing their investment portfolios down a bunny slope by stuffing their money in low yielding CDs, money market accounts, and Treasury securities. The bunny slope certainly feels safe and secure, but many investors are actually doing more long-term harm than good and could be potentially jeopardizing their retirements.
Let’s take a gander at the cautious returns offered up from the financial bunny slope products:
Source: Bankrate.com
That CD earning 1.21% should cover a fraction of your medical insurance premium hike, or if you accumulate the interest from your money market account for a few years, perhaps it will cover the family seeing a new 3-D movie. If you also extend the maturity on that CD a little, maybe it can cover an order of chicken fingers at Applebees (APPB)?!
We all know, for much of the non-retiree population, the probability that entitlement programs like Social Security and Medicare will be wiped out or severely cut is very high. Not to mention, life expectancies for non-retirees are increasing dramatically – some life insurance actuarial tables are registering well above 100 years old. These trends indicate the criticalness of investing efficiently for a large swath of the population, especially non-retirees.
Let’s Face It, One Size Does Not Fit All
Bodie Miller & Grandpa
As I have pointed out in the past, when it comes to investing (or skiing), one size does not fit all (see article). Just as it does not make sense to have Bode Miller (32 year old Olympic gold medalist) ski down a beginner’s bunny slope, it also does not make sense to take a 75-year old grandpa helicopter skiing off a cornice. The same principles apply to investment portfolios. The risk one takes should be commensurate with an individual’s age, objectives, and constraints.
Often the average investor is unaware of the risks they are taking because of the counterintuitive nature of the financial market dangers. In the late 1990s, technology stocks felt safe (risk was high). In the mid-2000s, real estate felt like a sure bet (risk was high), and in 2010, Treasury bonds and gold are currently being touted as sure bets and safe havens (read Bubblicious Bonds and Shiny Metal Shopping). You guess how the next story ends?
Unquestionably, coasting down the bunny slopes with CDs, money market accounts, and Treasuries is prudent strategy if you are a retiree holding a massive nest egg able to meet all your expenses. However, if you are younger non-retiree and do not want to retire on mac & cheese or work at Wal-Mart as a greeter into your 80s, then I suggest you venture away from the bunny slope and select a more suitable intermediate path to financial success.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, and WMT, but at the time of publishing SCM had no direct position in APPB, 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.
Treasury Bubble Hasn’t Burst….Yet
10-Year Treasury Chart (5-14-09)
Clusterstlock’s Joe Weisenthal’s takes a historical look on 10-year Treasury yields going back to 1962. As you can see, the yield is still below 1962 levels, despite the massive inflationary steps the Federal Reserve and Treasury have taken over the last 18 months (6-26-09 yield was 3.51%). These trends can also be put into perspective by reading Vincent Fernando’s post at http://www.researchreloaded.com. Take a peek.
Ways to take advantage of this trend include purchases of TBT (UltraShort 20+ Year Treasury ProShares) or short TLT (iShares Barclays 20+ Year Treasury Bond)*.
Reverse View of Historical 10-Year Treasury Yield
*Disclosure: Sidoxia Capital Management clients and/or Slome Sidoxia Fund may have a short position in TLT.
Investing Caffeine 
