When the Economy Hands You Lemons, Consider Dividend ETFs

We now have 3 consecutive months of job losses, with March chiming in as the worst showing in 5 years.

Does hope spring eternal? Or are we going to see yet another slide into the abyss?

Perhaps investors are beginning to see that the Fed/Congress/Treasury Department are committed to muting the effects of this recession. Or perhaps investors recognize that the little cited Dow Jones Transportation Average holds a key to the direction of the U.S. economy.

The iShares Dow Jones Transportation Fund (IYT) has gains for 1-day, 5-days, 3-months, 6-months and 1 year. What's more, if the sector performance facts don't encourage, you might want to check the fact that IYT has risen above its 200-day moving average.

The chart is quite telling. Our stock markets first felt the wrath of the credit crisis pain and the need for Fed intervention back in August of 2007. That's when IYT fell below its long-term trend. It now appears to have made a convincing move above its long-term trend... in the eye of the recessionary storm.

And that's NOT uncommon! Stocks roughly average 23% in price appreciation from the mid-point of an actual recession. If IYT s the forward-looking indicator that it has been throughout history, the mid-point of the recession might actually be March 31. (Could it be that the near 400 point jump on April 1 was actually the start of something new?)

So let's say Bernanke's Fed is correct in its assessment. We may see nega-growth in Q1 and Q2, but the Fed expects recovery to begin occurring in the 2nd half. if that were to come to fruition, you'd have the March 31 mid-point. More importantly, you'd better begin preparing your BUY list.

Yet before anyone gets ahead of him or herself... is it possible that the "bad times" could get worse? They sure could. It's not like the Fed was ahead of the curve back in 2007... they responded late to the credit crunch and the trend towards recession.

And let's take the devil's advocate position a step further. If subprime/real estate could take down financials, and financials/real estate could take down the U.S. economy, couldn't the U.S. economy drag on developed and international markets that had been growing furiously? Maybe.

It follows that there needs to be a simple plan for balanced investors to manage the uncertainty; that is, you need to participate, but you may need to go a safer route to victory.

What's the route? Dividends. You have to think about the companies that have been properly "vetted" with more than 5 years of dividend growth alongside the highest yields.

In the U.S. right now, the 100 highest paying dividend stocks are collectively paying 4%+. That's better than CDs, money markets or most bond alternatives. If you think that the stock market will be higher or even flat over the next year, then the Dow Jones Select Dividend Index (DVY) may be for you.

Keep in mind just how "battle-tested" DVY is. These 100 companies pulled from the Dow Jones U.S. Total Market Index have increased their dividends in each of the last 5 years without cutting or decreasing a single payment. AND... their collective yield is greater than the rate of inflation.

There's another gem in the dividend jewelry box... but not that many investors have shown interest one way or the other. The investment? The SPDR S&P International Dividend ETF (DWX).

I have written about this relatively new offering at great length.

Using the same logic as I have with DVY, it's impossible to ignore the 2% quarterly dividend income stream that the SPDR S&P International Dividend Fund (DWX) is producing. Foreign stocks could fizzle and go flat over the next year, and you'd still earn 8%. Or they might gain 20% off their current spot... and you'd pick up a healthy income stream to augment your total profit.

It's the exceptionally low volume than makes this a difficult investment for investors to get a better buy price or a better sell price. Yet that may improve with a bit of time and a bit of desire on the part of the investing public.

Comments

[eclane:]

Since Oct 2007, total return on spy was about -11.5% while DVY total return was -15.5% (both according to Stockcharts.com). I think we need a different answer.

2008 Apr 06 08:58 AM

[SteveTheHawk:]

The dividend ETF's seem to have a common thread of being heavily invested in financials. In regards to DWX it's about a quarter of their holdings. Their next largest holding is consumer discretionary. Neither category appeals much to me right now. A decent dividend doesn't mean much when the underlying stock is unacceptably risky.

2008 Apr 06 10:09 AM

[Seaferer20:]

It's hard to convince clients of the wisdom of dividends when their NAVs continue to plummet and the overall portfolio value is decreasing despite the dividend payment. That's why a valuable rule of thumb is that one should have 3 years of anticipated portfolio cash needs, i.e., income, in cash/short-term bonds. It relieves the pain a bit knowing that one needn't sell at a loss to put the next loaf of bread on the table.

2008 Apr 06 10:23 AM

[opinionated:]

Personally, I find all these comments especially helpful.

2008 Apr 06 11:24 AM

[StateofConf...:]

For dividends, I use ADVDX mutual fund. The div. is much higher and they invest in a variety of companies which they can rotate. They also meet requirements for 15% max tax. So far I have not found anything better, except for a few individual stocks like FRO and PWE.

2008 Apr 06 11:03 PM

[Marol:]

ADVDX: NAV plunging over a year.

I have posted this question before, but so far no answer.

What is the point of dividends? I am told that the value of a stock drops immediately afterwards, the same amount as the dividend that was paid. So I don't see the benefit. Someone please explain -- and thanks!

2008 Apr 07 04:07 AM

[goatfarmer:]

Marol, I'll have a crack at explaining why I am now interested in dividends, since it's a good question and the answer is not obvious.

First, I am retired and want an income stream. If I can get an average 2.5% dividend income on my portfolio, I can live reasonably on that. So, provided that the dividends don't all go down together, I'll be able to live of the divs and not touch the stocks, with the hope that eventually the stocks will provide capital growth.

Secondly, I have now been 'in the markets' for about 13 years. I can look back and see what would have happened if I had invested in stable dividend-growing companies, such as KO and GE and JNJ, a little over ten years ago. I'd now be getting a yield of around 10% on my initial investment while still having the option of capital growth. The magic of compounding is a good reason to buy and hold strong dividend-growing companies

Of course the counter argument is that money is money, whether dividends or capital appreciation. I could simply declare a 2.5% dividend from portfolio every year and live off that. Why sacrafice growth to dividends? True. But in this wild and wonderful world, where markets are volatile, the prospect of a modest, reasonably secure, yield is attractive. And many of the dividend companies that I am following have a good growth record, albeit not stellar. I'll be happy with modest stable growth.

Also, if all other things are equal, why not invest in the companies that pay dividends? I am persuaded by the argument that what matters in a balanced portfolio is asset allocation among sectors rather than stock picking. If I can stock my sector shelves with dividend goodies, why not get the extra returns?

I used to be a trader speculating wildly. I used to poo poo dividends as being for grannies. After reviewing my performance over ten years, I realized that I fell into the 'normal' category for traders who haven't been wiped out: average 3% per annum. I have since refocussed my attention on more modest goals, with the hope of greater returns. The modest return of a dividend portfolio fits the bill - or part of it.

2008 Apr 07 09:11 AM

[locke:]

In theory there is no difference between dividend payers and non payers. In practice, there is. Dividend payers did better historically. One idea for the reason is that having to make dividend payments reminds management who really owns the company, thereby altering their behavior for the better.

2008 Apr 07 02:27 PM

[Tom B:]

Gee. No, GE.

2008 Apr 07 02:28 PM

[David Jackson:]

Gary, count me in the dividend sceptic camp:

Why Dividend Paying Stocks Are a Mistake
seekingalpha.com/artic...

2008 Apr 07 03:27 PM

[User 171371:]

David, in the last 15 years I haver never bought anything that has not paid a divy.My time line is 2 to 9 years and it has worked for me.

I own ADVDX(5% of portfolio) and collect a large divy monthly, yes my principal is down but if you believe in the markets I shall have it all back and more.

2008 Apr 07 06:47 PM

[d_teller:]

For over 30 years my family has invested (in mainly sheltered accounts) in mutual funds and stocks that pay dividends.

Some long-term holdings, such as Southern (SO) and HealthCareProperties (HCP) and Nationwide Health (NHP) are even now priced much above where they were purchased. Others, such as (HRP and "Richly valued Reits") were sold last May, and replaced with CEFs that pay good dividends (e.g., FAX and AOD/AGD = relatives of ADVDX) even if they're in sheltered accounts. Other securities, such as (PCU) and (SID) were partially sold, when their portfolio position exceeded 5%, last Fall, and the proceeds were used to buy (ACAS) when its price was <$33, or (O) when its price dropped in the November mini-panic.

The goal is to have one's "minimum required distributions" mostly covered by the dividend stream, so as not to be forced into sales when a security drops in value, but it's still one you'd like to hold.

Last year, in October, (PTR) and (ACH) were also sold for two reasons: their prices went parabolic, but more importantly, they indicated that their dividend payouts would decrease, as they were devoting (via Central Bank of China directions) an increasing income stream to their own internal infrastructural requirements.

The portfolio's structure is considerably overweighted to "foreign", (non U.S. securities and funds), and has been for more than 25 years, when it became obvious that U.S. securities had a high P/E and low dividend payout.

For a younger person, below 40 years, I think GROWTH is a good risk bet...but as one contemplates retirement, and particularly when there is no more "new" money to invest, one needs a few years worth of cash (even if it is depreciating) and an emphasis on steady dividends to sleep well at nights.

Not all the dividend-paying securities were "good buys"...some like (AHM) and, more recently (TMA),went "goodbye", but, overall, this is a slow growth (meaning MRD's don't zoom) and steady cash flow portfolio.

Right now, I'll probably sell (BLXJF) & (OTT), and reinvest in (WIN) & (FRP). When (ATPWF) share prices drops a bit more, I'll probably add more...these all yield above 10%, and have for some time..but it's not a "buy & forget" portfolio.

2008 Apr 07 08:32 PM

[goatfarmer:]

On the subject of dividend ETFs, it may be worth noting that an ETF will often pay less dividends than would a holding of the top 10 stocks in the ETF. The value of the ETF is in diversification. But one wonders whether the additional marginal diversification in holding the ETF over, say, the top ten holdings, is worth the diminution of dividends.

2008 Apr 08 01:44 AM

[No Moss:]

I encourage everyone to look at a five year chart of Intel and notice the month of April. Nuff said.

2008 Apr 08 10:40 PM

[No Moss:]

Oops, sorry, wrong thread on that Intel posting. Need my coffee. Let me add that I owned ADVDX and found that the generous dividend had a hard time keeping up with the drop in NAV. There's no such thing as a free lunch.

2008 Apr 08 10:42 PM

[joenobody02:]

The 1 year return of RMB (i.e. CNY) is 11+%. You dont do anything and at almost no risk. Just exchange your sinking USD for the Chinese yuan and put it in an interest bearing 1 year saving deposit account.

2008 Apr 09 04:52 AM

[Patrick M:]

Another reason not to buy dividend ETFs is that the expense ratio comes straight out of the dividends you receive, and dividend ETFs tend to have higher expense ratios than simpler index ETFs.


On Apr 08 01:44 AM goatfarmer wrote:

> On the subject of dividend ETFs, it may be worth noting that an ETF
> will often pay less dividends than would a holding of the top 10
> stocks in the ETF. The value of the ETF is in diversification. But
> one wonders whether the additional marginal diversification in holding
> the ETF over, say, the top ten holdings, is worth the diminution
> of dividends.

2008 Apr 09 08:12 AM