Alpha Power Investing Newsletter

February 13, 2012

The War Against Savers

In recent weeks, the War Against Savers has intensified. The Federal Reserve has announced that it intends to keep short-term interest rates near zero into 2014. The longer this goes on, the more investors expect it to continue and will step up their efforts to find meaningful yields in riskier investments.

The math on short-term CDs is easy and brutal: 1% yield plus 2% inflation plus taxes equal a return somewhere south of -1% real. If you're a saver, the government is picking your pocket big-time.

The War Against Savers is a deliberate attempt by the Fed to force money into the stock market and/or consumption. The Fed cares not one whit that much of this money is a source of retirement income.

So here we are, at the end of a 30-year bull market in bonds, facing negative real returns in the safest investments and virtually no chance that longer-term bonds will profit from falling long-term rates in the future. Indeed, it's a good bet that the long-term direction of rates and inflation is up - we just don't know when it will kick into gear.

Against this backdrop, Wall Street has been beating the drums for dividend-paying stocks that routinely increase dividends. What are we suppose to make of this? Here is a graph of the S&P 500 dividend yield since 1880:

There are basically only three ways that the yield on a stock can go up: 1) the dividend is increased while the price stays the same; 2) the price of the stock falls; 3) some combination of the above.

A glance at the chart above shows what happened in 2008-09, when a sharp drop in the market caused the S&P 500 yield to spike up to 3%. The stock market advance since then has dropped the market yield to 1.97%.

Today's investors are buying dividends at nearly the lowest yield in history, hoping that stocks remain stable over the next several years. The problem is that the historical mean yield is double the current yield. If history teaches us anything in the investment game, it is that things revert to the mean and in most cases overshoot the mean.

In order for the market yield to return to the mean yield without a market decline, stocks would have to stay at today's level for 15 years while dividends compounded at 5% annually. Of course, today's dividend investor could hope for an increase in the market over the next decade, which would put dividends and capital gains in his/her pocket over time. The problem with that hope is that the market is currently in the top deciles of long-term valuation and, once again, the mean-reverting tendency of financial data threatens.

The chart below shows the current Shiller PE ratio* of the S&P 500 compared to its long, long, long-term history.

As you can see, the current PE is about where it was in the mid-60's, the late-20's, and the early 1910's. Each of these valuation points marked the beginning of a long-term slide in stock prices which pushed the market through the mean (16.42) and eventually into the lowest quartile (under 10.00). Faced with this possibility, no one should expect dividend growth to compensate for the loss of value which may be in the cards over the next decade.

Conservative investors who hope to use the stock market as a substitute for bonds need to realize that stocks are not cheap by historical standards. This means that the stock market is more susceptible to shocks from bad news and Fed policy changes. Fulltime exposure to the stock market under these conditions is rank speculation. The stock market has never stayed at these high valuations for long and there's no reason to suppose that it will continue to do so after the Fed decides to alter its zero-rate policy.

Risk-averse investors should check out the ALPHA Bonds Strategy. It's a unique combination of conservative, intermediate fixed-income management and a low-risk equity strategy with 32 years of supporting data. For more information about this strategy, go to the Programs and Performance section of our website at www.alphaim.net and click on the link for the ALPHA Bonds Strategy to read the brochure.

Sincerely,
Jerry Minton, Ph.D.
President
1-877-229-9400, Ext. 11

Past performance is not a guarantee of future performance.

 
© 2011 Alpha Investment Management, Inc.
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