Friday, June 8, 2018

Throwing the baby out with the bathwater in 2018

Today a lot of investors are pessimistic and afraid of rising interest rates. Yet the economy is doing fine, and earnings are on a tear. In fact, the rising earnings have caused stock valuations to improve. Also, you should realize that interest rates are rising because the economy is doing well. There is a lot of investor fear for another 2008. But 2008 was the worst downturn in nearly a hundred years and not likely to repeat. Most of the fear is due to the ‘recency’ of the 2008 crash. It is the last major crash and although the markets experienced corrections in 2010 and 2011, these corrections were in fact in excess of 20% from their preceding market peak and could be considered bear markets. Canada’s TSX fell in over 20% in the 2016 oil-price cash.

It maybe a 9 year or so bull market in the U.S. but globally that count is questionable. This bull market may not have been as long lasting as many investors think. The point I am trying to make is that we could look at the current market in a more contrarian manner. If you exclude the FAANG stocks, many U.S. stocks have not really fared that well and that is in spit of the massive share buybacks that companies have done over recent years instead of paying dividends.  Stock buybacks are better from an after-tax perspective than dividends and it increases demand in a market with less outstanding shares, i.e. it supports higher valuations (higher P/E or dividend yields or price/book ratios).
Dividend paying stocks were very popular just a few years ago but now they are underperforming in an already shaky 2018 market. Really, dividends are not like interest rates. After all, profits of companies in a strong economy are likely to improve. Those profits are paid out, in part, as dividends and thus these dividends are likely to increase as well. This is an important difference between dividends and interest rates. Your dividends have an implied inflation protection unlike interest paying fixed income investments. Also, on an after-tax basis, Canadian dividends are advantaged over interest.  As a rule of thumb, I would suggest that dividends equal 1.5x interest rates. If your have 3% dividend yield, then that equals interest rates of 1.5x3%=4.5% interest rates.  Thus, getting one-year-GIC-rates of 1.5% is a lot less attractive than a dividend yield of 3% or higher. Don’t write those dividend-paying-stocks off. A price turn around or stabilizing prices for dividend paying stocks may result in a very attractive buying opportunity.

We may have a depressed market and great buying opportunities for dividend-paying-stocks with earnings growth. When you combine this with severely depressed prices in commodity stocks we see a quite different picture than a raging nine-year bull market in an investment climate that seems to worry about everything from Italian governments to shaky economies in Turkey and Argentina and of course ‘trade wars’.  That is more like ‘climbing-a-wall-of-worry’ than a raging euphoric market bubble. Time to become a bit contrarian?  I think so – building cash is still high on my list but if you have sufficient cash to sit through a shallow downturn then it may prove smart NOT to increase your cash holdings any further and consider investing in commodity stocks and in dividend growers especially in the U.S. Be weary though of Tech stocks.

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