December 2002
On Thursday, November 7, 2002, the Federal Reserve made a
bold statement about the U.S. economy by cutting the federal
funds interest rate an additional 0.50% to a 40 year low of
1.25%. Many investors are confused about how to invest in
this low interest rate environment.
Investors are wondering if the rate cut means the economy
is still in too much trouble to jump back into the stock market.
I believe an important part of gauging future trends rests
in being able to remember the past. As such, I feel that it
is important to take a step back before I advise someone how
to invest in this market atmosphere. Look what happened just
a few years ago when the Dot.com technology investing mania
dominated the financial markets. Investors who survived that
market are now much more attentive to the risks associated
with investing, especially in growth stocks. I believe this
will prevent them from investing their money solely into the
growth sector and encourage them to diversify and search out
lower risk investment alternatives. That is why total return
investing and dividend investing, I believe, will begin to
see inflows. Many people ask me, “So what if total return
investing and dividend investing is back into vogue. Why should
I invest my money that way?”
For one, dividend investing historically has less volatility
than the overall market. The lower volatility will be greatly
appreciated after the whipsaw markets of the late 1990’s
and early 2000’s. And it may seem a bit counterintuitive,
but companies that pay the highest dividends are also likely
to grow the fastest according to Mark Hulbert in his November
20, 2002, article in the New York Times titled “In a
Twist, High Dividends Are Now a Predictor of Growth”.
With consumer confidence wavering, I believe that dividends
signal a commitment to shareholders that a company has enough
cash flow to sustain its operations. While it does not guarantee
that there are not accounting issues within the company, if
management is paying its shareholders a dividend, it is one
less item on their financials that they can mess with. Let’s
look at what happened to General Electric (GE) last month.
They took a $1.4 Billion write down on their reinsurance unit,
which cut their 2002 Earnings Forecast. At the same time,
they raised their dividend per share by $0.01 (approximately
6% increase), and this caused the stock to have an 8% up day.
This showed that though they had a minor set back, they reinforced
their commitment to their shareholders by increasing their
dividend.
I feel that dividend paying stocks will be the leaders out
of this recent down turn. If growth companies want to participate,
I think that they will have to start paying dividends to help
boost their stock prices. A great number of these companies
are sitting on a good deal of cash and do not have as many
investment opportunities to put money to work and make an
acceptable rate of return. Cisco (CSCO) shareholders just
turned down a dividend in favor of more share buy backs. Microsoft
(MSFT) has approximately $40 Billion in cash as of September
30, 2002, and their stock is down over 13% since December
31, 2001. Just like Cisco, they will have to consider the
possibility of offering a dividend to get their stock price
back up.
With interest rates at such low levels, it suggests to me
that money market mutual funds are going to have to start
closing. Before the Federal Reserve Board’s latest action,
many money market funds were not able to charge for managing
money in order to give some positive rate of return to the
investors. With rates lower, how can they keep the fund open
when they are loosing money? This means there will be a good
deal of money that will need to be invested somewhere else.
Additionally, there is a risk when looking to invest in bonds
with rates so low. Bond prices could drop significantly when
rates do go higher causing a loss in investment principal.
Bonds are not as safe as money market funds. Here are the
yields as of December 9, 2002:
2-year government security yield 1.87%
5-year government security yield 3.07%
10-year government security yield 4.06%
30-year government security yield 4.95%
Dogs of the Dow yield is 4.16%
This shows that you can get approximately a 10-year government
security rate of return by investing in the ten Dogs of the
Dow stocks, and you are situated to benefit from stock market
gains should the market turns around.
Finally, the recent success of the Republicans in the House
and Senate Elections can help the case for dividend investing.
With the Republicans running the agenda in Congress, there
have been rumors of eliminating the double taxation on corporate
dividends. This will also help to make total return investing
more attractive to investors. When will this prediction come to fruition? I do not know,
but I do believe the upside potential significantly outweighs
the possibility of stock prices going lower over the long
term. As always, I believe that if you buy quality companies
you will make money over time.
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