Dividend Growth Investors Don't Care About Bear Markets: Should They?

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Includes: ARCC, CTL, ED, EPR, GEO, GOV, MAIN, MO, O, OHI, RAI, RMR, SO, STON, SUI, T, VGR, VZ, WPC
by: George Schneider

Summary

You know that a bear market is on the horizon, right?

How far away is the horizon?

When, not if, is the appropriate question.

Dividend growth investors don't care about these questions. Should they?

Dividend Growth investors don't care about these questions. Should they?

Year to date, the Fill-The-Gap Portfolio, a dividend growth and income portfolio I've been managing publicly and transparently on Seeking Alpha for eighteen months, has effectively returned 8.5 times the return on both the Dow Jones Industrial Average and the S&P 500 Index or in other words, it has handily trumped these indexes by 750%.

I'm a dividend growth and income investor and I don't care much about those summary questions stated above, or concerns about when the next bear market will be upon us. I'll tell you why.

With major market indexes again within striking distance of new highs, some market participants have taken a bear market scenario off the table. Only a week ago, with Britain's decision to leave the EU leaving global markets in shambles, investors worldwide thought they were again coming face to face with the next bear market.

A few days later, most global markets had recovered their losses while some actually closed higher than the pre-Brexit vote, including Britain's FTSE index.

Now that markets have regained their footing, the conversation about bear markets has subsided and investors are preparing for a new assault on market highs.

Should they be thinking this way? After all, this bull market is very long in the tooth, surpassing seven years in duration. Bulls don't run forever. All good things come to an end. We all know that bulls are eventually followed by Bears.

It's only a matter of when it arrives, not if it arrives.

Should we care?

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There are many different varieties of investors. Generally, they'll fall into three main categories and each will have their own needs and goals. You'll usually find some overlap between the groups since there are not many total purists among us.

Capital Gain Investors

Within this group, you'll find some hit and run investors, interested in quick, in and out, short-term capital gains. Get rich quick investors would feel comfortable in this category.

They might be day traders, or those who focus their attention on the next big thing and try to ride the coattails of a company that's at the forefront of a new drug or technology. Tesla comes to mind.

More patient investors who seek long-term capital gains would also reside here. They tend to be more analytical in their assessment of possible candidates for inclusion in their portfolios and allow for a longer time frame for their capital gains to develop and reward them.

Income Investors

Within this group, you'll generally find very conservative investors who like to invest in the asset class that is closest to a sure thing. For many, that would mean investing in FDIC insured guaranteed CDs or U.S. Government bonds of various maturities. Slightly more risk-accepting investors might buy government agency bonds which carry "implied" U.S. government backing.

A step further up the risk scale you'll encounter the dividend growth investors. Their aim is to put together a collection of dividend-paying stocks with good histories of increasing those dividends on a regular basis.

Total Return Investors

Total return investors would like to have their cake, and eat it, too. They'll generally make their assessments as to suitability for their portfolios based on both factors. They seek a combination of capital gain and dividend income to get them to their goal.

Does A Bond Investor Fear A Bear Market?

Normally, a bear market is accompanied by recession which is characterized by contracting growth in the economy. At such times, interest rates usually decrease. I know, it's hard to believe that rates could go lower than they already are (the 10-year Treasury touched a new low of 1.37% on Tuesday), but lower they will go in recession. Perhaps, rates will finally rise in the next year or so, giving Treasury room to lower them once again when recession hits.

In this case, as rates go lower, the prices of bonds that investors already own will trend higher (bond prices move inversely to interest rates). If those investors plan on liquidating their bonds for spending money in retirement, that will be a propitious development for them.

If they are not yet near retirement and have to roll over maturing bonds into new ones, they'll be out of luck. With rates contracting along with the next recession, those investors needing to roll over maturing bonds will have to accept still lower interest payments when they buy new bonds. Of course, lower interest rates will mean lower income. If they are then near retirement, they'll be in a tough position, having to live on less income than they might have supposed.

What About CD Investors?

Investors in federally insured CDs generally have nothing to fear as regards loss of capital. They simply need to make sure they don't go above the maximum insured amounts at any one institution, and that they don't make a withdrawal of principal before CD maturity which would occasion a penalty payment.

What this investor does have to fear is the very real degradation of his purchasing power. Even if he receives as much as 2% on a very long-dated CD, when inflation is subtracted (most observers agree it is higher than 2%), his real return will be negative.

Negative interest rates are beginning to sweep the globe as more and more governments issue bonds that investors are buying with the promise of getting back less in principal than what they invested.

Switzerland just issued a 50-year bond with negative rates. This astonishing development is standing long-held interest rate relationships on their heads. Nobody knows where this will ultimately lead. Suffice it to say, the CD investor today is losing purchasing power with every passing day.

He will not lose principal in the next recession, but loss of purchasing power is almost guaranteed.

Do Total Return Investors Have Anything To Fear?

Depending upon how close to retirement a total return investor finds himself, a recession with a falling stock market could present a great challenge. Because this investor is dependent upon two outcomes, price and dividends, one or the other leg, or both could be on tenuous grounds.

If his retirement is within a year or so of the next bear market, he may find himself woefully underfunded for that portion of his assets that he counted upon to liquidate for spending money. Some of his dividends might also be threatened, and reduced or entirely eliminated by sudden recession-weakened companies, no longer in a position to pay out dividends.

Both sides of this spear could stick him with losses to the capital he was counting on and loss of income.

Some investors wisely prepare to defend against this double whammy by keeping two years or more of spending money in cash. This allows the investors to maintain his life style while he waits for the markets to right themselves and capital to be restored to the portfolio.

How Will The Dividend Growth Investor Fare Against The Bear?

There is a subset of dividend growth investors that I believe will do fine, thank you, when the next bear comes for a visit. This is the group that has lived on less than their earned income all of their lives and invested the remainder to prepare for their retirements.

This is a group that has already saved enough principal so that their investments in dividend stocks produce more than enough income for retirement spending, no matter the economic environment or stock market condition then existing.

Those investors who equal-weight their portfolio so that each component produces essentially equal amounts of income will experience no real threat to their living standard if one, or even a few companies reduce, or even eliminate the dividend for a time while the economy is weak.

If an investor is careful to choose and partner with high quality income generators with long histories of paying and increasing dividends, the threat to bear market income will be greatly minimized.

Those investors who have lived their entire lives on less than their earnings know how to deal with this type of scenario. They are battle-tested even before the battle has begun. They know how to draw in their horns, adjust their spending to the new regime and survive it all.

In addition, dividend growth investors do not have to just sit and take dividend reductions for granted. They can choose to be active in portfolio management and move their unproductive investments to more reliable dividend payers and restore their income streams in short order.

Make Friends With The Bear

This is how I'll make friends with the bear.

Bear Markets Are Not A Threat, But An Opportunity

Seen through this lens, the over-achieving saver-dividend growth investor, always living below his means, is in a position to view the cheaper prices that accompany a bear market not as a threat, but as a golden opportunity.

Because such investors always have money left over after paying expenses, cheaper prices that look like spoiled, rotten bananas to other shoppers take on the appearance of radiant gems in the rough to them.

Instead of paying $43.35 today for AT&T (NYSE:T), he might buy it in the next bear market for just $21.72 a share, the price that was available in the depths of the financial crisis. This is how I built my portfolio with accidental high yielders during the financial crisis of 2007-2009.

AT&T is the type of company a dividend growth investor can count on to be reliable, just as it has been for many decades, to continue paying a growing dividend.

Instead of having to accept a 4.42% yield brought about by the current $1.92 annual dividend, he may be in the position of collecting today's $1.92 dividend on a $21.72 share price, thereby obtaining a much enhanced yield of 8.84% on his new, bear market investment. And, with growth of that dividend throughout the following years, his yield on original cost will continue to soar.

Buying in this manner in a few bear markets that are sure to occur over the span of the average investor's lifetime has the enviable effect of giving investors lifetime income many times what could be accomplished by investors who simply buy and hold, and never reinvest dividends along the way.

Portfolio Value - Not An Issue

Investors in this enviable position, either having saved sufficient assets, or in the process of doing so, find themselves not glued to total portfolio value. The only time such investors are interested in price at all is when they are considering purchasing a stock. They understand that if they can buy a stock at fair value or below, that starting price will be the driving force behind income production. That starting price will determine his outlay and his starting yield on his investment and the amount of beginning income he can count on.

After that point, this type of investor stays totally focused on his most important metric, growth of his annual income.

Viewing Success In Stages

I believe in the concept of one dividend at a time. I also believe it important to see our rewards in a simple, straightforward manner, one which reinforces our proclivity to invest, and then reinvest our dividend in order to compound our income.

In an effort to stay connected to our portfolio dividend income and the successful stages of growth of that income, I'll enter our positions in both the public Fill-The-Gap Portfolio and subscriber portfolio into the Dividend Growth and Income Spreadsheet. It keeps me focused on my bottom line of producing income. When dividends are raised, I'll enter that into the assigned column. My algorithms then compute for me my new income on each portfolio constituent, the new income when a raise occurs, the yields, the increased percent of income and total portfolio income. This focus helps keep me on track toward my goal of building and growing income.

Dividend Growth And Income Spreadsheet

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Reducing Risk By Weighting Positions To Equal Income Production

AT&T was introduced as an example to consider. Of course, it is not my intention to suggest that investors should overweight their portfolios in any one stock, asset class or sector. It is my belief that if we carry a good mixture of high-yield, slow growing dividend companies, with a healthy dose of low-yielding, high growing dividend companies, and an equally good amount of middle yielding, mid-growth dividend companies, we can achieve a portfolio that enhances our overall income while at the same time reducing risk.

In keeping with my foundational principle of reducing risk to portfolio income, we could examine various scenarios pertaining to T with the Watch List Real Time Tracker and discover how many shares of each to buy to produce equal amounts of income, which is our continuing goal.

The closer we hew to this principle, the more we de-risk the portfolio for any possible dividend cut in the future. The diversity of sectors and the number of constituents imparts some level of risk mitigation. Should one or two components reduce their dividend at any point in the future, our income would temporarily decline by perhaps 5% or so, depending upon the severity of the cut.

When stocks fall to better-timed entry points, we buy shares in order to grow portfolio income. In order to gain some of these better-timed entry prices that enable me to receive higher yield and income, I use the Watch List Real Time Tracker to alert me. As a stock comes within 3% of my target price, the alert turns green (this alert distance is customizable). The order can then be placed.

The Watch List Tracker makes it extremely easy to manipulate share counts in column C in order to find the proper mix that will give us equal amounts of income, as shown in the percentage breakdown in column O. Our target value totals in column G inform us, before we place a trade, how much each position in this name will cost us, and what the total for all positions will come to.

In addition, individual dividend rates, current yields and targeted yields we'd receive if our target prices are hit are clearly shown for each position as well as the group.

Although the yield points may vary quite a bit, column O shows us that each purchase made at those different levels would be responsible for an equal percentage of portfolio income.

Scrolling to the right, our tickers are locked in place for us for easy reference. Here we are able to discover in column R whether a stock is trading above or below its 52-week high.

Column T shows us the current P/E ratio and we can compare it to other peers in its industry group and the S&P 500 as well to see if it is trading unreasonably high in relationship to the broad market or if it is trading at or below fair value.

In column V, we discover when a stock last paid a dividend. If we are current owners, we can see from column U when the next ex-dividend date will be.

If we are interested in capturing the next dividend, we must make a purchase before that date to qualify for the next upcoming dividend.

Watch List Real Time Tracker

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Real Time Portfolio Tracker

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The Fill-The-Gap Portfolio At A Glance

I began writing a series of articles on December 24, 2014, to demonstrate the real-life construction and management of a portfolio dedicated to growing income to close a yawning gap that so many millions of seniors and near-retirees face today between their Social Security benefit and retirement expenses.

The beginning article was entitled "This Is Not Your Father's Retirement Plan." This project began with $411,600 in capital that was deployed in such a way that each of the portfolio constituents yielded approximately equal amounts of yearly income.

The FTG Portfolio Constituents

Constructed beginning on 12/24/14, this portfolio now consists of 19 companies, including AT&T, Inc. (NYSE:T), Altria Group, Inc. (NYSE:MO), Consolidated Edison, Inc. (NYSE:ED), Verizon Communications (NYSE:VZ), CenturyLink Inc. (NYSE:CTL), Main Street Capital (NYSE:MAIN), Ares Capital (NASDAQ:ARCC), Reynolds American, Inc. (NYSE:RAI), Vector Group Ltd. (NYSE:VGR), EPR Properties (NYSE:EPR), Realty Income Corporation (NYSE:O), Sun Communities Inc. (NYSE:SUI), Omega Healthcare Investors (NYSE:OHI), StoneMor Partners L.P. (NYSE:STON), W.P. Carey, Inc. (NYSE:WPC), Government Properties Income Trust (NYSE:GOV), The GEO Group (NYSE:GEO), The RMR Group (NASDAQ:RMR), and Southern Company (NYSE:SO).

Because we bought all of these equities at cheaper prices since the inception of the portfolio, the yield on cost that we have achieved is 6.63%.

FTG Portfolio Close, July 5, 2016

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FTG Recap

Currently, the FTG is producing $27,305 in annual income, which is $165.00 greater than last month. When added to the average couple's Social Security benefit of $28,800, we have, in only 18 months' time, significantly exceeded our goal of filling the gap between SS income and a comfortable $50,000 retirement. In fact, our total income between these two sources is now $56,105, which, again, is $165.00 more than last month's income. This is due to the dividend increases we received last month and our reinvestment of dividends into our new position in Southern Company shares and the new dividend income attendant to this purchase. We are now in hailing distance of our dividend income exceeding Social Security benefit income.

We have experienced no cuts, no freezes and no elimination of dividends in 16 months of portfolio management. On the contrary, we have enjoyed a regular stream of dividend increases, more than enough to keep us comfortably ahead of inflation.

With its beginning value of $411,600 and the addition of a $6,500 IRA contribution for 2015 and a $6,500 IRA contribution for 2016, total asset contributions come to $424,600. The portfolio has grown $113,341 to a value of $537,941. This represents capital appreciation of 26.69% in just 18 months.

$537,941- $424,600 = $ 113,341 capital appreciation

$113,341/$424,600 = 26.69% percentage gain

This year alone, the FTG has grown $84,270 in value, or 18.58%, while the Dow is up only 2.39% and the S&P 500 is up just 2.18%. Accordingly, the Fill-The-Gap Portfolio has effectively returned 8.5 times the return on both the Dow Jones Industrial Average and the S&P 500 Index or in other words, it has handily trumped these indexes by 750%.

The S&P declined .68% on Tuesday as the market began to go into worry mode over Brexit and its consequences once again. In sharp contrast, the FTG Portfolio rose .62%.

RODAT Subscriber Portfolio Recap

Our charter subscribers who began with us November 1, 2015 have seen their portfolio grow $60,515 in capital value for a gain of 15.45% in just 8 months. This year alone, subscribers have enjoyed $54,192 in capital growth, or a 13.62% gain, while annual dividend income has already grown to $25,265 with our newest purchase on Tuesday. This was a result of my analysis surrounding an enormous increase in gun checks just announced by the FBI and discussed in "What Can A World Chess Championship Tournament Teach Us About Gun Sales?."

MY FTG Mirror Calculator

After doing their own due diligence, subscribers wishing to proportionately emulate FTG Portfolio trades for their own portfolios use the "My FTG Mirror Calculator" or the "My RODAT Mirror Calculator" to simplify their task.

With the touch of a button, readers know exactly how many shares to buy if they wish to mirror the FTG Portfolio. In real time, it indicates the current price of the stock, the current dividend and yield, how much the purchase will cost, and how much dividend income the new purchase will produce annually. All of these metrics are updated on a real-time basis all day long.

My FTG Mirror Calculator

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Author's note: Should you be interested in reading any of my other articles detailing various strategies to enhance your returns on a dividend growth portfolio, you will find them here.

As always, I look forward to your comments, discussion, and questions.

We are currently offering a FREE two-week trial of my subscription service. To learn more about this premium service, please click this link:

Retirement: One Dividend At A Time

Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.

Disclosure: I am/we are long AINV, ARCC, CTL, ED, EPR, DUK, GEO, GOV, MAIN, MO, O, OHI, RAI, RMR, RGR, WEC, SO, STON, SUI, CTL, T, VZ, VGR, WPC.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.