Are Dividend Investors Becoming Irrationally Exuberant?

by: Adam Aloisi


In 1996, then Fed chief Alan Greenspan cautioned against "irrational exuberance" in equity markets.

The macroeconomic backdrop is notably different today compared to 20 years ago.

Be tuned to risk mitigation, position governance, and prudent asset allocation.

A strategy session with current economic thoughts and equity ideas.

It's not exactly earth-shattering news to make mention of lofty dividend stock valuations. Indeed, collective equity multiples across the board have rested above historical norms for virtually the entire post-financial crisis span.

And with major market indices all advancing double digits - 20% for the Nasdaq - during the first seven months of 2017, mild nosebleed conditions persist.

The Best Of Times, The Worst Of Times

While it may be fair to opine that stocks are performing "well" on a collective basis, a bipolar market has clearly developed. Tech sector euphoria, the "Amazon (NASDAQ:AMZN) effect," and traditional retail despair have led to valuation discrepancies not seen since the much frothier Y2K bubble.

In 1996, Fed chief Alan Greenspan forewarned that "irrational exuberance" might be putting equity markets in a general state of peril. For three years investors ignored Greenspan's caution, until markets corrected with a very quick and painful dose of reality - and then a longer-term hangover.

Today, things are different. Interest rates are the lowest they've ever been. Income investors have and continue to pay premiums to own quality stocks with higher yields and the potential for growth. To an extent this is clearly rational, as, tangibly speaking, income stocks become more desirable when bonds and risk-free yield coupons plummet.

There is clearly a volatile, growth-speculative backdrop to today's market, but it should be characterized as much more rational and perhaps discriminate than 20 years ago. Back then, start-up IPOs, stock splits, and an unsophisticated chase dominated markets. At least today, investors seem keyed into profitable ventures rather than fly-by-night "dot bombs."

Assessing The Potholes

Despite the relative loft of today's market, the sailing has clearly not been smooth in all cases. Dividend investors with a primarily total return bent need to think long and hard before putting money to work in this market. Here's a small sampling of some popular dividend stocks and their peak-to-trough price destruction over the past several years.

Stock Decline
Kinder Morgan (NYSE:KMI) 70%
Target (NYSE:TGT) 45%
Simon Property Group (NYSE:SPG) 35%
Washington Prime Group (NYSE:WPG) 66%
B&G Foods (NYSE:BGS) 37%
Kroger (NYSE:KR) 52%

And just this past week, two of the most widely held and favored dividend growth stocks, Altria (NYSE:MO) and Starbucks (NASDAQ:SBUX) - the veritable nicotine/caffeine combo - both tanked.

While the knee-jerk reaction on the part of most dividend investors might be to add on the dip - and that may prove indeed the right thing to do - I'd opine that these are still far from screaming values or no-brainer buys. What ultimately will happen to Altria's earnings on the FDA talk is really pie-in-the-sky stuff right now, although it appears nothing should materially change over the short term.

And despite the sell-off, MO still sells at about a 20X multiple. That's still pretty steep for a company growing in the upper single digits. Although, that's better than paying a slightly larger multiple for, say, Procter & Gamble (NYSE:PG), which has been barely moving the bottom line needle at all.

The real lesson here is that investors need to be tuned to the possibility of periodic black swan events such as these and be prepared to deal with them through proper portfolio positioning and thoughtful position tweaking.

Be On Guard

Realistically, beyond the proverbial crystal ball, there is very little a long-term dividend or dividend growth investor can do to protect themselves from industry or company atrocities or broad market corrections. Ample diversification, position size governance, covered call or cash-secured put selling, and a cash raise might be viewed as some cardinal ways to defensively manage in today's market.

You can try to time with bold allocative moves, but frankly, at least in my view, as the market becomes increasingly complex, the more difficult it has become to predict broad equity movement. You're more likely to get caught with your pants down than create alpha with erratic or knee-jerk timing moves.

In terms of Altria and position governance, it's notably much easier to deal with the consequence of the recent sell-off if the stock is not a huge component of one's portfolio. The bigger the position, the larger the conundrum one might be currently faced with. I'm not sure I'd want to be the SA author who has stated that their entire retirement portfolio is in Altria.

The company clearly isn't going belly-up, but its forward health is now shrouded somewhat in smoke. While my own inclination is to add to my position, I haven't done so as of yet. Should I?

Strategy Session

I haven't written much lately, partially because of time constraints, but also because I'm seeing a dearth of table-pounding dividend investment opportunities. I've made very few portfolio adjustments over the past few months, content to mostly watch things from the grandstands. There's frankly not much to say and no compelling reason to do more than hold positions or minor portfolio clean-up, in my view.

While the market may not be imminently vulnerable, my view continues to be that subcutaneous issues, unless corrected, will lead to serious economic problems down the line. The two main concerns are how healthcare will be portioned by our dysfunctional misfits in Washington and how states and municipalities will contend with pension underfunding.

On a macroeconomic/interest rate level, the 10-year Treasury, barring a black swan event, will probably bob around in the current 2.25-2.5% range for the foreseeable future. I'd continue to stick with dividend equity benefiting from low rates, although again, much of the goodness is already baked into REITs, finance companies, and other leveraged entities, so I wouldn't be in a rush to bolster positions - that is, unless you are convinced that valuation multiples will continue to expand and bond yields push back to 2016 post-Brexit levels.

I don't see that happening, and if it should, it would be indicative that the economy is not holding its own. Thus, this is not the time to be aggressive. Dividend growth on a wholesale level is slowing, payout rates are rising, risks are escalating, while potential rewards are diminishing.

In terms of specific equities, the selling in A-mall REITs is overdone. Nibble on Macerich Co. (NYSE:MAC), Simon Property Group, and Taubman Centers (NYSE:TCO) with their 4.5-5% yields. A more speculative play on the overdone Amazon effect would be Washington Prime Group. Twenty years ago, the imminent death of the mall was predicted by tech speculators. They were wrong then, and while the pressure is mounting on brick-and-mortar retail, they are wrong now, too.

I'd probably also look at food for some value. Differentiated and leveraged B&G Foods currently trades with a 5% yield, and 3.5%-yielding General Mills (NYSE:GIS), while slow growing, looks comparably reasonable. Faster-growing, lower-yielding alternatives would be Hormel Foods Corp. (NYSE:HRL) and Pinnacle Foods (NYSE:PF).

Elsewhere, consider Whirlpool (NYSE:WHR) for its mountains of free cash flow and reasonable valuation, as well as IBM, which looks as good as it has in almost two years.

On the momentum side, leisure is still a desirable theme. Cruise carrier Royal Caribbean Cruises (NYSE:RCL) had another monster quarter, and the stock continues to rally. Trading only with a mid-teens multiple and growing almost as fast, this stock continues to be underestimated. While early season weather has hamstrung amusement park operators Cedar Fair (NYSE:FUN) and Six Flags Entertainment Corp. (NYSE:SIX), the longer-term prospects for both are bright - their yields are 5 and 4.5 percent, respectively.

One of my favorite stocks 18 months ago, Boeing (NYSE:BA), has now doubled. However, if you didn't buy it then, I'm not sure why you would do so now. The stock is representative of the current market oddity, in my view. Way too much pessimism in 2016 and way too much optimism baked in today. I'd consider covered calls if you own it now, or even a trim/sell.

Instead, to play the aircraft growth/strength theme, buy aircraft lessees Aircastle Ltd. (NYSE:AYR) for a yield play or Air Lease Corp. (NYSE:AL) for a growth play.


While current dividend equity valuations are clearly not as ridiculously frothy as some were during the tech-inspired growth boom of the late '90s, it would be unwise to forget the shades of bubbles past.

Remember, markets rose for nearly three years following Alan Greenspan's historic "irrational exuberance" comment. If you don't think things can get more expensive before they get cheaper, think again.

Don't be drugged into a false stupor, however. If things look too good to be true, they usually are. Though it can take a while, reality always wins out.

Disclosure: I am/we are long AL, AYR, BA, BGS, FUN, MO, PF, RCL, SIX, WHR, WPG.

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.