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Dry Bones and Liquidity Traps

|Includes:ADP, Aetna, Inc. (AET), PG, SLB, VZ

 I saw a great many bones on the floor of the valley, bones that were very dry. He asked me, "Son of man, can these bones live?”  I said, "O Sovereign Lord, you alone know."

Ezekiel 37: 2-3


After the biggest credit bubble in modern history, the U.S. economy looks more and more like a valley of dry bones. This metaphor is especially apt after New York’s hottest summer on record, a summer when economic vitality dried up and blew away.  


How can the economy remain dry when monetary policy is gushing with stimulus? Perhaps America is in a liquidity trap. This occurs when interest rates approach zero, monetary policy is impotent, and the Fed is merely “pushing on a string.”


The specter of a liquidity trap haunts economists, who are all too familiar with Japan’s zombie economy during the 1990s. This was Japan’s “lost decade,” so the possibility of a liquidity trap vexes policymakers on both sides of the political aisle.


Where, then, can investors find yield during an economic drought? Surely not at the bank, where short-term rates are negative after inflation. And surely not in exotic derivatives, since these were weapons of mass destruction during the real-estate bubble.

For conservative investors seeking to improve the yield of their portfolio, I believe that dividend stocks in defensive industries are a good place to start. This includes utilities, pharmaceuticals, and consumer staples. After screening by dividend yield and industry sector, I analyze balance sheets and cash flows to assess a firm’s prospects for sustained and rising dividends. Screening for dividend yield is one tool among many, though it does have a certain appeal in the age of Bernie Madoff: You can’t fake dividend payments.


Next, I suggest that investors consider companies that have a strong track record for diversity. Candidates include Verizon, Aetna, ADP, P&G, and other corporations on the "DiversityInc Top 50 Companies for Diversity”. This list is compiled each year by DiversityInc, which does an in-depth evaluation of firms based on statistical measures of demographic data. These data range from supplier diversity to the composition of the boards of directors. An emphasis on diversity is one way that my firm, Right Blend Investing, helps clients “invest in their beliefs.”      


Div2: Dividends and Diversity

The result of this screening and analysis is a portfolio that offers both dividends and diversity. In future articles I will describe additions and deletions to this list, as well as my investment perspective on the entire portfolio.


Dividends also impose capital discipline, especially when firms are flush with cash. Management is less likely to make dilutive acquisitions, and dividends are more of a commitment than stock buybacks. Hence, dividends are a sign of management’s expectations, and research has shown that dividend signals generate alpha (excess risk-adjusted returns).


Diversity as a Screening Tool

There is also evidence that progressive policies about employer diversity also generate alpha. Unfortunately, though, statistics cannot differentiate between cause and effect. Proponents may argue that diversity contributes to success, while critics may argue that it is merely coincident with success.


Diversity certainly helps some companies succeed. I am bullish on Schlumberger, which has diversity in its DNA. Since the company’s inception it has recruited employees locally and promoted them globally, which is one reason I am a long-term holder.


Critics, however, will say that successful companies choose diversity after they become successful. For them, diversity is a luxury that firms can only afford in high-margin businesses.


Personally, I believe that diversity is like research and development: It requires upfront investment that generates returns over time. Firms that do not invest in diversity are just like firms that do not invest in R&D. These choices will eventually hurt profits, so both dividends and diversity provide valuable signals about a company’s underlying health. This makes the Div2 Portfolio an attractive alternative for yield-hungry investors, especially in dry economic times.


“Can these bones live?” Only the Lord knows. But dividends and diversity are surely signs of life. 

Disclosure: Long SLB
Stocks: AET, SLB, VZ, ADP, PG