It's been almost a month since my post about "selling a winner" and "going out to dinner" - the timing of which turns out to have been quite, well, timely….
Last week the market caught wind of Fed/Bernanke tapering (reducing the pace at which the Federal Reserve buys mortgage-backed bonds). As a result, we've seen a significant correction in the newest form of "next-best-thing-to-bonds-in-terms-of-risk" assets: Dividend-paying stocks.
But I thought dividend-paying stocks were supposed to be less volatile than those that don't pay "as good" a dividend? Or certainly less volatile than those that pay no dividend at all, right? What happened? What happened to my steady eddy utilities - think Duke Energy (DUK) or Consolidated Edison (ED)? Both are down more than 10% from recent highs. How about my consistent cash cow telecom stocks? The bellwether itself, Verizon Wireless (VZ) is down 8% from its recent high. And the universe of master limited partnerships (best represented by AMJ), down 6%. All four of these names pay a dividend greater than 4% and, with the 10-year Treasury falling from 4% five years ago to below 2%, were looking pretty darn tasty in relative terms.
That is, until the 10-year Treasury spiked back above 2.00% last week….
You see, a 10-year Treasury Note moving from 1.60% to 2.10% doesn't seem like a huge move at first glance. It just seems like rates were obscenely low and now they are still obscenely low, just to a slightly less obscene degree. Well, a little math (and a quick look at the chart above) tells me that interest rates today are more than 30% higher than they were a month ago.
But what about the not-so-subtle advantages of interest rates having been so low in the first place? These companies have been able to reduce their cost of capital by retiring older, higher interest debt and issuing new bonds, preferred stock, and convertible securities at more favorable rates. This allows them to reinvest in their businesses cheaply, buy back additional shares, or even boost their dividends and distributions to shareholders.
So what does this mean for my dividend-paying stocks?
It means my 4%-paying stocks are going to be slightly less attractive when compared to the risk-free T-Note. But let's keep things in perspective - it's going to be a while before I prefer to own a 10-year piece of government paper over equity in a company (or group of companies) with pricing power to compete against inflation. If the dividend payers listed above had neither the ability nor willingness to improve their dividends/distributions per share over time, then owning their shares in a rising interest-rate environment is not particularly appealing.
Keep in mind, despite this recent move, interest rates are still well below historical norms. Below is a chart of the 10-year Treasury rate over the last five years. Keep calm and continue refinancing….
Everything is relative (in the bond market, too)
My take is the recent sell-off in these assets is overdone and based on the false premise that interest rates will continue to spike higher. If I'm wrong and we see the 10-year headed towards 2.50 or even 3.00% by year's end, then yes, there could be a bit more pain ahead in these assets. The trouble with that argument is you're not just fighting Ben Bernanke, who has publicly stated that his primary objective in easing is to see solid improvements in the labor market (specifically, an unemployment rate of 6.5%). You are also fighting retirees, endowments, pension funds, foreign governments, and mutual funds who may be infinitely more interested in securing 3% on their fixed income portfolios than they are at 2%. Any increased appetite for our government's debt puts downward pressure on the interest rates we must pay to attract investment. Everything is relative….
All dividend stocks are not created equal
(click to enlarge)When used to describe a stock, the word 'dividend' has become synonymous with 'desirable' this year. But paying a dividend alone is neither good nor bad. If your craving for dividends is insatiable, may I suggest that you focus on those companies/industries/sectors that look to increase their per share distributions over time. Take the MLPs, for instance - we are able to isolate those companies within the MLP universe that have consistently maintained and/or grown their quarterly distributions over the past 15-20 years. The other good news is that we have seen several rising rate environments over that period of time, so we have a pretty good idea of what we can expect in similar conditions going forward.
Technically, Apple (AAPL) is a dividend-paying stock today, and just last month it was able to borrow $17B at an average cost of less than 2%. Its stock pays a higher dividend (2.70%) than its bonds. It would have been an arbitrage opportunity to borrow money from investors and use the proceeds to buy its own stock back!
The last 18 months in hindsight….
In November of 2011 the yield on the S&P500 eclipsed that of the 10-Year Treasury, right around 2.10%. Starting then, over a 10-year time period an investor would have earned more interest/dividends/yield by investing in an index of stocks than buying our government's debt. Completely unheard of. It means that if you were putting a chunk of money to work in November 2011, it made zero sense mathematically to buy bonds. But some people did. They are the ones you can hear defending themselves in the papers and on television today by saying they "weren't wrong, they were just early." You be the judge….
So what's the better story here? Is it the fact that interest rates have jumped by 0.50% from their most recent bottom? Or is it the beneath-the-surface, yet-to-be-fully-recognized benefits of corporate refinancing, restructuring, and investing? I think it's the latter, and will be addressing the subject in more detail later this year….