Value turn coming? June 1, 2017

Year-to-date through May 31st, the S&P 500 Growth Index is up 13.0%, while the S&P 500 Value Index is up just 1.8%.  This eye-popping 11.2% ytd spread might normally draw more attention, but the market seems to be saying ‘same ol, same ol’ – as it simply extends a trend dating back to 2007. We should pay attention though.  Years and years of Federal Reserve ‘ZIRP’ policy and rounds of Quantitative Easing helped goose the ‘growthier’ side of the market over value consistently and emphatically.  This trend is long in the tooth by historical standards, and with the Fed now beginning a path to higher rates and a contraction of its balance sheet, the tipping point may soon be at hand. Below, a chart representing the last two decades of value vs. growth, showing the value component nearing its turn-of-the-century (tech bubble), out of favor extreme.

Blog Chart 1

In addition the market is becoming narrow in its view of what’s ‘working’ – as the chart below via Bespoke Investment Group illustrates.   Year-to-date returns for the S&P 500 through middle of last week show that just 5 stocks – or 1% of the index listings – have accounted for a remarkable 42% of 2017 returns.  Several of those stocks are big weightings in the growth indices highlighted above…

Blog Chart 2

dataSource:  FactSet

Fed can’t see forest for trees… September 21, 2016

The Federal Reserve decided today it once again will not raise interest rates. Nine years after the start of the financial crisis, eight years since ZIRP (Zero Interest Rate Policy) was enacted with a near zero 25 basis point federal funds target rate – we’ve seen just one quarter of a point increase and remain entrenched in unprecedented monetary policy waters. This, despite the fact that the unemployment rate is currently at 4.9%, materially better than its 30 and 50 year averages, and Leading Economic Indicators (LEI) have been in expansion for seven years.  In their statement today the Fed said in part: “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”  If not now, when? The Federal Reserve continues to act with imprudence, focused on minutiae instead of the long term sustainability of their policy decisions, and worse yet, a case can be made they have become beholden to markets and possibly politics.  The Fed simply can no longer see the forest for the trees, and this reality needs to be factored into everyone’s investment strategies.

Brexit… June 27, 2016

Last Thursday British voters decided to end their 43-year relationship with the European Union, surprising markets that had priced in as virtual certainty the continuation of that relationship. In addition to a surge in downside volatility across global markets, British Prime Minister David Cameron (who had campaigned to remain in the EU) said he would soon step aside.   Without question this decision is a momentous one, and may have long term implications for the health of the EU, but in the end is likely to be more of a political than economic event.

From an economic perspective this outcome could certainly act as a tax on the global trade system, like throwing sand in the gears of a machine and acting to slow growth, as a period of uncertainty and contract re-negotiation with trade partners commences. It does not appear by itself to have the ability to ‘systemically’ undermine the financial system, however.  What it probably points to is a political ‘tipping point’ about globalization, and is a snapshot of one country’s dissatisfaction with policies relating to immigration, regulation and trade.  We will hear much more of this across the globe and here at home for years to come.

In our view, the main impact looking out the next few years will be that one component of total return, price to earnings multiples (P/E’s), will become a headwind instead of the nice tailwind they’ve been for the last 6 to 7 years.  When this bull market started, P/E’s were near 10, today they are near 17.  A 70% increase in the multiple that investors have been willing to pay for stocks’ earnings has been fuel for above average returns, and we should not expect this P/E expansion to continue.   The ‘Brexit’ event has to some degree undermined confidence, and created a period of uncertainty that should lead to a lower average P/E level for the market.  If this should happen, that leaves two other components that contribute to total return, earnings and dividends.  As mentioned above, global growth could slow a bit, inhibiting the effectiveness of earnings contribution to returns. That leaves dividends. Dividends are by far the most predictable of the three, and also the only component that never ‘detracts’ from portfolio returns. The dividend component will likely make an outsized contribution relative to total return in the years ahead, in addition to paying investors periodically for their patience, as the markets sort out uncertainty of events like ‘Brexit’. As usual, durable and growing payouts from high quality companies will remain the focus of our strategies at Martin Capital Partners.

Dividends are the engine… February 29, 2016

For those of you who know our philosophy, you know we believe that quality, durable and growing dividend income is the engine of long term investment returns.  When reviewing the production of returns through history we have often cited a study done by the Brandes Institute, originally published in 2004, titled “Examining the Income Component of Total returns”, and recently updated. The link to the updated piece, “Income as the Source of Long Term Returns”, is below.   It may surprise many investors to know that over a legitimate investment time frame, it’s not capital appreciation that makes the most impact, it’s the income produced through dividends.  The income component makes a meaningful impact as early as five years (over a 40% contribution), reaches equality with capital appreciation around a 10 year horizon, and then becomes increasingly dominant as horizons extend further.   Given our belief that appreciation for stocks over the next five years and beyond will not be driven by ‘Fed Induced’ price to earnings multiple expansion like it has the last five, the focus on income production from equities may be all the more important.

Income as the Source of Long Term Returns

Still failing the test of common sense… September 18, 2015

Citing “recent global economic and financial developments” the Federal Open Market Committee kept its zero interest rate policy in place yesterday – not acting to raise rates, and leaving without change emergency policy that’s been in effect since December, 2008.

We would argue this decision not to act continues to fail the test of common sense.   To that point, the Leading Economic Indicators Index (LEI), a basket of 10 components including items such as building permits, average weekly hours and interest rate spreads that tend to foreshadow changes in the overall economy, have been in a positive trend since 2009.   This is the longest time frame – by three full years – that the Fed has chosen not to be active with a rate increase given these generally positive (though maybe not robust) indicators, in almost half of a century.

We could make an additional case that the Fed is being influenced by news and events outside of mandated purview – but that’s an argument we’ve made before (October 2014 Quarterly Point of View) and won’t expound on here.  Just looking at the case of the LEI however, this continued stance does not pass the test of common sense…

The World-Wide Undermining of Free Markets… August 20, 2015

The op-ed below by Romain Hatchuel, The World-Wide Undermining of Free Markets, published in last week’s Wall Street Journal is worth reading.  It echoes themes we discussed in our latest Quarterly Point of View, Undermined Incentive for Responsibility. The consequences of moral hazard risk are hard to quantify, but that does not make them any less real.  I have condensed the piece focusing on major points made, but here is the link to the entire opinion: http://www.wsj.com/articles/the-world-wide-undermining-of-free-markets-1439249677

The World-Wide Undermining of Free Markets

August 10, 2015

Chinese authorities have gotten creative in their efforts to control the fall in the Shanghai and Shenzhen stock markets, which recently experienced their steepest one-day plunge in more than eight years. Prohibiting large shareholders and executives from selling their stocks, as announced last month, was a bold step, as was providing central-bank money to brokerage firms for equity purchases. Shutting down a large part of the markets was perhaps the most brazen move, as regulators allowed more than half of all listed companies to suspend trading in their shares.

It’s little surprise that Communist China would tamper with its own stock markets. Of more concern: Since the 2008 financial crisis, free-market principles in most developed markets, including the U.S. and Europe, have come under attack by governments and central banks bent on buoying asset prices and easing the pain of often necessary market discipline.

Since 2008 the Federal Reserve, the European Central Bank, the People’s Bank of China, the Bank of Japan and the Bank of England have all cut their interest rates drastically. While these lower rates have supported consumption, they have primarily benefited financial assets, which have rallied for six years with only rare corrections…. Governments increased public spending through fiscal stimulus plans, while central banks implemented aggressive quantitative-easing programs, which translated into colossal purchases of financial assets. Since 2008 the combined balance sheets of the world’s five leading central banks have increased by a staggering $9 trillion.

July’s near “Grexit” from the eurozone has revived the debate of austerity versus supposedly growth-friendly policies. Austerity-bashers have found in this latest episode of the Greek crisis new reasons to criticize the so-called troika of international creditors—the European Commission, the International Monetary Fund and the European Central Bank—and Germany in particular for its stance against providing more bailout funds to Greece without meaningful concessions.  Greece is depicted as an innocent victim of the eurozone’s economic and fiscal tyranny. So a country that has borrowed astronomical amounts of money, stubbornly resisted crucial reforms, repeatedly missed its budget-deficit targets, and likely manipulated its fiscal numbers is called a victim? A country that is now in the process of being bailed out for the third time in five years, a victim? Meanwhile, the coldhearted “austerians” aren’t only accused of being substantively wrong, but also of pursuing hidden or purely ideological agendas, such as slashing social programs or making the rich richer.

More people need to question the antiausterity camp’s real motives, which clearly stem from a distrust of markets. This is especially obvious when their attacks on fiscal discipline ignore the progress made by countries where austerity measures have been successfully implemented, such as the United Kingdom, Ireland or Portugal.

Do these fiscal doves care that much about unemployed Spaniards or Greek pensioners? Perhaps, but their ultimate goal, it seems, is to ensure that extraordinary postcrisis measures become permanent policy. Those who oppose this merely want a gradual return to normal fiscal and monetary policies. Austerity is just another word for free market, and the harsh debate around it is actually about whether the economy should operate freely again, or continue to drift toward a state-driven model.

Unprecedented monetary easing, high public spending, repressive regulation and automatic debt forgiveness, while arguably useful in the midst of a severe crisis, cannot be sustainable remedies in the long term—that is unless one believes the world should do away with free-market principles altogether. Those who continue to advocate such measures, more than seven years after the global financial crisis blew up, should at least admit that what they really want is a profound and permanent change in the system.

Maybe they know something I don’t, but it is fair to ask whether these extreme interventionist policies have become part of the problem rather than the solution, and if we shouldn’t instead revert to what remains the most successful economic system ever tried—the free market.

As far as the U.S. and its slow but steady drift away from market fundamentals is concerned, the Federal Reserve’s future interest-rate decisions and the coming presidential election will provide important clues as to where the nation, and its still unsteady economy, is headed.

Mr. Hatchuel is managing partner of Square Advisors LLC, a New York-based asset-management firm.

Failing the test of common sense? April 16, 2015

Today’s Op-Ed section of the Wall Street Journal contained a piece by Christian Broda and Stanley Druckenmiller addressing the Federal Reserve’s stance on rates, saying it fails the test of history and common sense.  We would agree.  Below are excerpts from their opinion piece highlighting points similar to what we discussed in our letter last October, Impolitic Fed http://www.martincp.com/wp-content/themes/2014OctoberQuarterlyPointofView.pdf

The Fed’s Faulty 1937 Excuse

By Christian Broda and Stanley Druckenmiller

Policy makers and financial pundits insist that the risk of the Federal Reserve raising rates too early exceeds that of moving too late. The Fed appears to agree. In recent years, the Fed has repeatedly moved its goal posts, seemingly to avoid raising the federal-funds rate from near zero.

But is the prevailing consensus correct if emergency economic conditions are long past?

Comparisons with 1937 or with Japan in the 1990s are commonly used as examples of mistakes to avoid. Both occasions were preceded by a severe financial crisis, and years later monetary policy was prematurely tightened.

The differences between the current policy conjuncture and these historical analogues are striking, however. Eight years after the 1929 crash, consumer prices in the U.S. had fallen by a cumulative 18% and unemployment remained above 14%. And in Japan today prices are still down relative to their pre-banking crisis levels.

In contrast, since 2007, prices in the U.S. rose by an accumulated 16%, and the Fed’s favorite annual inflation measure has never been below 1%. Current unemployment is at 5.5%, the same rate prevailing in the boom years of 1996 and 2004. The U.S. is currently far from being mired in deflation and low growth as was the case in the late 1930s or in Japan in the 1990s. Therefore the initial conditions for considering the conduct of future monetary policy are radically different…

…Near-zero rates during and in the years after 2008 no doubt helped end the so-called Great Recession. But the U.S. economy is no longer under emergency conditions or facing the perils of 1937. Why then does it require emergency monetary policy? While inflation targeting gave no warning of what was to come in 2008, why is inflation moving from 1.5% to 2% a necessary condition for raising rates from the current emergency levels? Even models that the Fed used to justify quantitative easing (QE) in recent years are today pointing to rates well above 1%. Why now use new, untested theories to justify zero?

….QE has ushered in a new sense of power by central banks. Yet monetary policy has limitations. It is mostly well-suited to filling in temporary shortfalls in demand. Except for exceptional conditions, it borrows growth from the future.

The Fed seems all-too-convinced that this is a trade-off worth making. With unemployment at 10%, history was likely on their side. At a 5.5% unemployment rate, it fails the test of history and common sense. May the risk-reward of too early versus too late prevailing in policy circles be backward?

Mr. Broda is a managing director at Duquesne Capital Management. Mr. Druckenmiller was the founder of Duquesne Capital and is the CEO of the Duquesne Family Office.

http://www.wsj.com/articles/the-feds-faulty-1937-excuse-1429138981?KEYWORDS=druckenmiller

Apple…February 11, 2015

On January 27th Apple Inc. (AAPL) reported a blowout quarter, selling a mind boggling 9 iPhones per second during every 24 hour period over the entire prior three months. Those amazing results helped lead Apple to produce the single greatest quarter ever reported by any public company as it tallied total profits of $18 billion. The company’s recent market value also exceeded $700 billion, a level never before reached by any company. These results mean they now sit on $178 billion in cash and marketable securities, equal to almost $31 per share. Apple has been using this cash to return capital to shareholders through dividend payments and share repurchases.

Though Apple had paid a dividend early in its corporate life it suspended it in 1995 while the company struggled mightily. As their unbelievable renaissance has continued over the last decade, they began paying a dividend again in 2012 and subsequently raised it 25% since that time. Virtually overnight they have become the 2nd biggest dividend payer in the world on an absolute basis.

We began buying the stock in our strategy in mid 2013 after the 2nd dividend raise was announced as we felt the valuation of the stock and it’s strong fundamentals, combined with a developing dividend culture backed by a fortress balance sheet was just too compelling to ignore. Since that time the stock has doubled in price and investors have enjoyed growing cash dividend payments in addition. Given continued strong fundamentals and massive cash balances, we believe dividend payments will continue to rise and expect Apple at some point in the near future to become the single biggest dividend payer in the world.

The point of this tidbit is to update some thoughts on the company, in addition to highlighting the need for dividend focused investors to be disciplined, but not dogmatic. In other words, it is highly important to have an approach that sets disciplined boundaries for the kinds of companies sought to be included in a portfolio, but it also highlights the risks of being to formulaic or dogmatic as to who can potentially be added. Most dividend strategies look for either the highest yield available (where inadvertent risks lay in wait), or require a certain number of years of payment (or payment growth) to be produced before a position can be established. This has led most dividend investors to be out of Apple. A flexible approach, allowing for a thoughtful understanding of a company’s quality, balance sheet strength and changing attitude and culture towards dividend payments may be a wiser path. We think Apple has been a good example of that approach.

trick or treat?…October 31,2014

If anyone doubted we are in the age of the central banker, today’s action by the Bank of Japan will leave no more room to wonder.   Worried about the pace of economic growth and deflation, the BoJ expanded its yearly asset purchases (similar to U.S. ‘QE’) by tens of trillion yen and will triple the pace of buying stock and property funds. Stocks around the world rose in response. Bloomberg: Kuroda Jolts Markets. Whether it’s the Bank of Japan, the European Central Bank or the U.S. Federal Reserve, no one doubts that central banks are large and in charge, no one doubts central banks influence on asset prices and no one doubts that all economic data is interpreted through the lens of central bank policy.  And because ultimately all success and failure of markets comes down to fundamentals; real earnings, cash flows and distributed dividends by corporations that make up ‘markets’, this view of central bank omnipotence is not healthy.  Ultimately this singular, one sided focus will create unwanted volatility and unwarranted risk.  Since the world is focused on this macro ‘central bank’ view, now is the time to make sure portfolios are situated to stand future tests.  These central banks apparently do not understand the ‘moral hazard’ risk they are playing with, and as they build the view of their omnipotence, whether deliberate or inadvertent, they may be setting markets up for a volatile future, when inevitably, that omnipotence will come into question. Quarterly Point of View: Impolitic Fed

Fed: costs now exceed benefits?…July 30, 2014

In our view the potential costs have crossed the potential benefits.  There is a high probability that the Federal Reserve is so confident in its ‘abilities’ that it has become complacent to the long run potential risks, and is staying too accommodative, too long.

The Federal Reserve has a ‘dual’ mandate to promote the goals of maximum employment and stable prices. The ‘maximum employment’ goal is difficult to define – but the unemployment rate as illustrated by the household survey has dropped to 6.1% – well below peak unemployment during the crisis of 10.1% and ahead of the Feds recent forecast by six months (Chart below shows US Unemployment, source: multpl.com, U.S. Bureau of Labor and Statistics).  Though not a desired level, it most certainly falls in the normal category when looking back over the last half century.  Additionally, wages are beginning to lift at the same time that consumer prices are rising to the 2% medium term inflation target the Fed had set as a goal, more quickly than anticipated.

U.S. Unemployment Rate (January 1950 – June 2014):

In today’s Federal Open Market Committee statement, the Fed said it will continue to cut the level of asset purchases to $25 billion a month of mortgage backed and Treasury securities, slowing the rate of growth, but still increasing the size of the Feds balance sheet.  They also stated: “The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

The Fed has to ask itself; What is more ‘out-of-norm’ – the economy, or our policy to address the economy?  I think the answer now is without a doubt, the Fed’s policy…  If that is in fact true, then any benefits the economy might see by a continually hyper accommodative monetary policy are not commensurate with the risks that a prolonged out-of-the-norm policy will have on creating long run, unintended risks.

Adjusted Monetary Base as proxy for Fed Balance Sheet Assets:

Thomas Friedman: Why Putin Doesn’t Respect Us…March 5, 2014

Thomas Friedman published this column in yesterday’s New York Times.  Not everything in it we agree with, but most we do.  It’s worth the three minutes of reading time.

Just as we’ve turned the coverage of politics into sports, we’re doing the same with geopolitics. There is much nonsense being written about how Vladimir Putin showed how he is “tougher” than Barack Obama and how Obama now needs to demonstrate his manhood. This is how great powers get drawn into the politics of small tribes and end up in great wars that end badly for everyone. We vastly exaggerate Putin’s strength — so does he — and we vastly underestimate our own strength, and ability to weaken him through nonmilitary means.

Let’s start with Putin. Any man who actually believes, as Putin has said, that the breakup of the Soviet Union was “the greatest geopolitical catastrophe” of the 20th century is caught up in a dangerous fantasy that can’t end well for him or his people. The Soviet Union died because Communism could not provide rising standards of living, and its collapse actually unleashed boundless human energy all across Eastern Europe and Russia. A wise Putin would have redesigned Russia so its vast human talent could take advantage of all that energy. He would be fighting today to get Russia into the European Union, not to keep Ukraine out. But that is not who Putin is and never will be. He is guilty of the soft bigotry of low expectations toward his people and prefers to turn Russia into a mafia-run petro-state — all the better to steal from.

So Putin is now fighting human nature among his own young people and his neighbors — who both want more E.U. and less Putinism. To put it in market terms, Putin is long oil and short history. He has made himself steadily richer and Russia steadily more reliant on natural resources rather than its human ones. History will not be kind to him — especially if energy prices ever collapse.

So spare me the Putin-body-slammed-Obama prattle. This isn’t All-Star Wrestling. The fact that Putin has seized Crimea, a Russian-speaking zone of Ukraine, once part of Russia, where many of the citizens prefer to be part of Russia and where Russia has a major naval base, is not like taking Poland. I support economic and diplomatic sanctions to punish Russia for its violation of international norms and making clear that harsher sanctions, even military aid for Kiev, would ensue should Putin try to bite off more of Ukraine. But we need to remember that that little corner of the world is always going to mean more, much more, to Putin than to us, and we should refrain from making threats on which we’re not going to deliver.

What disturbs me about Crimea is the larger trend it fits into, that Putinism used to just be a threat to Russia but is now becoming a threat to global stability. I opposed expanding NATO toward Russia after the Cold War, when Russia was at its most democratic and least threatening. It remains one of the dumbest things we’ve ever done and, of course, laid the groundwork for Putin’s rise.

For a long time, Putin has exploited the humiliation and anti-Western attitudes NATO expansion triggered to gain popularity, but this seems to have become so fundamental to his domestic politics that it has locked him into a zero-sum relationship with the West that makes it hard to see how we collaborate with him in more serious trouble spots, like Syria or Iran. President Bashar al-Assad of Syria is engaged in monstrous, genocidal behavior that also threatens the stability of the Middle East. But Putin stands by him. At least half the people of Ukraine long to be part of Europe, but he treated that understandable desire as a NATO plot and quickly resorted to force.

I don’t want to go to war with Putin, but it is time we expose his real weakness and our real strength. That, though, requires a long-term strategy — not just fulminating on “Meet the Press.” It requires going after the twin pillars of his regime: oil and gas. Just as the oil glut of the 1980s, partly engineered by the Saudis, brought down global oil prices to a level that helped collapse Soviet Communism, we could do the same today to Putinism by putting the right long-term policies in place. That is by investing in the facilities to liquefy and export our natural gas bounty (provided it is extracted at the highest environmental standards) and making Europe, which gets 30 percent of its gas from Russia, more dependent on us instead. I’d also raise our gasoline tax, put in place a carbon tax and a national renewable energy portfolio standard — all of which would also help lower the global oil price (and make us stronger, with cleaner air, less oil dependence and more innovation).

You want to frighten Putin? Just announce those steps. But you know the story, the tough guys in Washington who want to take on Putin would rather ask 1 percent of Americans — the military and their families — to make the ultimate sacrifice than have all of us make a small sacrifice in the form of tiny energy price increases. Those tough guys who thump their chests in Congress but run for the hills if you ask them to vote for a 10-cent increase in the gasoline tax that would actually boost our leverage, they’ll never rise to this challenge. We’ll do anything to expose Putin’s weakness; anything that isn’t hard. And you wonder why Putin holds us in contempt?

Thomas L Friedman  3/4/14

tune out the noise… November 20, 2013

As investors we are constantly bombarded by noise disguised as news, or even worse, investment advice.  To be a successful investor over a long duration it is imperative to tune out the noise and stay disciplined.   This photo taken of my television one year ago today is a prime example why…

It shows Bill Gross of PIMCO, a highly acclaimed and undoubtedly savvy money manager based on his successful track record, appearing on Bloomberg Television.  As the caption explains – he told investors to sell dividend paying stocks in the 3-4% yielding range.  It is quite possible many investors actually acted on this information – selling these types of stocks – based on the fact the suggestion was coming from a noted investment ‘guru’.  But acting on these kinds of sound bites becomes dangerous, even when coming from ‘legitimate’ sources.  Screening for all stocks within the S&P500 that yielded between 3% and 4% at the end of last November when this picture was taken, and running their performance through yesterday’s market close, shows the average return of the 74 stocks fitting his category returning a very powerful +34.1%!

This quote from Warren Buffett, in Berkshire Hathaway’s 1987 Annual Report (emphasis mine) came immediately to mind…

“… an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super contagious emotions that swirl about the marketplace.”

rising rates and dividend stock performance… August 27, 2013

Interest rates were bound to rise eventually – but the timing of such things always seem to jolt investors when they materialize.  On May 1st the 10 year U.S. Treasury Note hit its low yield of the year at 1.61% – only to rise 81% – hitting a recent peak of 2.92% on the 22nd of August.  Bond prices of course move inversely to yield, so this back up in rates has taken a toll on the average bond investor’s portfolio.  The stock market’s impact has been much more muted to this point, but it got us thinking again about the relationship between stocks – specifically dividend paying stocks – and the rest of the stock market should interest rates continue to climb.  The common belief is above-average yielding stocks will suffer in rising rate trends, but historical results tell us otherwise.

Looking at the last half century of data ending in 2010, we analyzed stock market returns in periods when interest rates trended higher.  This is a simple and straight forward evaluation – but we agree with Peter Lynch who once said “never invest in any idea you can’t illustrate with a crayon” – and believe the same stands true for parameters in research.  Over the last 50 years we defined any rising rate trend as two consecutive years when the yield on the 10 year U.S. Treasury Note increased.  Any serious investor should have funds invested for at least this amount of time so it’s certainly not too long an evaluation frame, and it’s also short enough to get multiple samples.  There were 13 episodes of rising rate trends under this definition, more than half in the inflationary period between 1974 and 1982.  Breaking down the stock market into two buckets, high dividend payers were defined as the top 30% of the S&P500 stocks in dividend yield terms in each calendar year, and then compared to the S&P500 as a whole. The total return for holding 10 year U.S. Treasury Notes during those periods was also examined. Below are the results.

Over half of a century, rising interest rate trends were not a reason to avoid high dividend paying stocks versus the ‘average’ stock.  In fact, the opposite is true.  The real truth is that the power of income generation from equities through higher than average, growing dividends, is paramount – despite the perceived headwind of rising rates.

Sources:  Martin Capital Partners, LLC, Federal Reserve Bank of St. Louis, Fama & French.

‘reaching for yield’… June 4, 2013

“More money has been lost reaching for yield than at the point of a gun.” Raymond DeVoe

With interest rates remaining near half century lows as central banks of the world continue their quantitative easing/bond buying, it seems ‘reaching for yield’ wherever it can be found, is in full swing. Some of the poorest countries in the world have issued debt in 2013, with remarkable success. Honduras, Paraguay and Rwanda, with collective GDP of approximately $49 billion – slightly less than the annual revenue of Intel Corporation (INTC) – have sold ten year notes with yields ranging from 4.625% to 7.5% in the last 5 months, according to Reuters. Paraguay, a landlocked South American country with no record of repaying foreign investors its debt and an inflation rate triple that of the United States, auctioned $500 million of junk rated sovereign bonds in January at an interest rate of 4.625%. The issue had demand 12 times the amount for sale. Rwanda, the African nation only now starting to exit decades of ethnic tension, issued its first international debt sale in late April. The euro-denominated bonds were priced to yield 6.625%, or just over a half of a percent higher than the average yield of comparable length U.S. high yield paper. The $400 million offering had $3.5 billion worth of orders.

Our investment focus is not international bond investing, but a question can be fairly raised – ‘are investors getting compensated at those interest rates for the associated risks?’ We might argue the answer is no. Whether a bond investor or stock investor, looking for coupon payments or dividends, it is paramount to look beyond the yield ‘temptation’. Rather, a focus on the quality of the issuer producing the income and a keen discernment of the long term durability of that income is of chief importance.

look beyond the ‘in favor’ sectors… May 10, 2013

Four companies comprise the ‘household products’ industry within the S&P 500 Index. They are long standing, high quality enterprises whose products we use every day. The four companies are Procter & Gamble, Clorox, Kimberly – Clark and Colgate-Palmolive. Understandably, investors have recently been seeking reliable companies paying consistent dividends, and franchises such as the four in the household products industry fit that bill. But as often becomes the case, the markets desire for too much of one thing can leave better value elsewhere. Take a basket of four ‘old’ technology companies for example and let’s compare a few items briefly. Using Microsoft, Intel, Texas Instruments and Cisco Systems as a comparative basket of stocks, it is interesting to see that investors may be able to get significantly better values, while still get what they are looking for on the dividend front.

P/E P/Cash Flow Div Yield 5 Yr Div Growth Net Debt to Capital
Household Products 19.1 16.2 2.80% 9% 63%
Old Technology 13.1 9.7 3.20% 15% 17%

Yes, this is simply a ‘snap-shot’ of these stocks and there are many items to consider.  But a few things here are clear – earnings and cash flows can be purchased significantly cheaper in the old tech basket than the household products group currently – over 30% cheaper –  and nothing is given up in the form of current income.  In fact, the old tech group pays almost 15% more current income, in addition to growing that dividend income at a faster pace the last five years.  Finally, there are many ways to measure ‘quality’, but one measure is most certainly debt, and on that metric as well the old tech basket laps the currently very popular household products.

a cow for milk, a hen for eggs, and stocks for dividends… February 26, 2013

Last week was a good one on the dividend growth front.  Three of our portfolio holdings announced handsome increases in their payouts.  What’s striking to us about the dividend payout increases is that they all represent accelerations of growth rates, and all come from very mature, stable and conservative companies.  When we think about the interest rate and economic environment, and then consider that these franchises have decided to give us as share-owners annual raises of this amount, it’s a reminder of the essence of long term investing.

Company Recent dividend increase 5 year dividend growth rate Dividends paid since
Texas Instruments (TXN) 33%* 15% 1962
Wal-Mart (WMT) 18% 14% 1973
Coca-Cola (KO) 10% 8% 1893
* this takes TXN’s 12 month total increase to 65%

“Earnings are only a means to an end, and the means should not be mistaken for the end. Therefore we must say that a stock derives its value from its dividends, not its earnings.  In short, a stock is worth only what you can get out of it.  Even so spoke the old farmer to his son:  A cow for her milk, a hen for her eggs, and a stock, by heck for her dividends. An orchard for fruit, bees for their honey, and stocks, besides for their dividends…” John Burr Williams, The Theory of Investment Value, 1938

show us the money… February 8, 2013

Shareholder activism is nothing new.  Large investors, using their equity stakes in companies, have for years put public pressure on managements to change corporate policy, utilize cost cutting, divest assets, restructure operations and so on.  The main goal of course is to increase shareholder value, one way or another.

The latest high profile activist in the news is hedge fund manager David Einhorn, whose firm Greenlight Capital owns a stake in Apple exceeding $600 million.  What does he want? He wants Apple to quit hoarding cash on its balance sheet, which stands currently at $137 billion and accounts for over 30% of the public company’s market value, and start using it for the benefit of share-owners.

Balance sheets of U.S corporations have rarely been in this good of condition; non-financial companies hold more cash relative to total assets than at any point in over a half a century.  In an extremely low interest rate environment and with a massive force of baby boomers starting to retire and needing income wherever they can find it, the writing is on the wall for heads of these companies who have the cash and aren’t distributing it in reasonable sums.

Though Mr. Einhorn’s proposal in this particular case would have the company issue a form of security paying preferred dividends, this activism is evidence of what has certainly started, and will likely become a significant trend – investors saying ‘give us our cash’.

some good news… January 4, 2013

Somewhat buried beneath the surface of the highly imperfect fiscal cliff package voted on this week was some good news for dividend investors. Dividend tax rates for individuals making less than $400,000 per year and households earning less than $450,000 remain at 15%, while those making over those amounts will be taxed at 20%. Even considering the higher 20% number, there are some significant positives to take.  First of all, this rate is now permanent (meaning not set to expire), making it likely to be in effect for some time and at a significantly lower level than many believed would be adopted.   Secondly, this rate is low by historical standards, as dividend taxes have been higher than 20% in 42 of the last 51 years, and for those that pay 15% this remains the single lowest rate dividends have been taxed in at least a half century.  Finally, this tax rate is equivalent with the capital gains tax and the level playing field between the two should have positive ramifications for dividend investors as corporate management decides how to allocate cash flows.  For many years before 2003 capital gains had preferential treatment to dividends but that temporarily ended with the Bush tax cuts that were set to expire on New Years Eve.  Wisely this level playing field was made a permanent feature.

– The above tax rates exclude a new 3.8% surtax on investment income as a result of ObamaCare subsidies for private health insurance and expansion of Medicaid. This looks to impact individuals making more than $200,000 a year or couples with $250,000 or more, and applies to all forms of income from investments, apparently even including profits from a home sale.

U.S. runs out of cash on Monday… December 27, 2012

As the fiscal cliff looms, another component to the debate takes center stage. Treasury Secretary Timothy Geithner said yesterday in a letter to Majority Leader Harry Reid that the U.S will reach its debt limit on December 31st and will have to take extraordinary measures or ‘would otherwise default on its legal obligations’.

The debt ceiling currently stands at $16.394 trillion.

We thought now would be a good time to re-post the link to a 3 minute satirical short film called Debt Limit – A Guide to American Federal Debt Made Easy, we originally highlighted in our blog this past February.  Putting our national debt into perspective, the video examines how it would apply pro-rata to just one family.   In its own way the point is highlighted that we have tough choices to make, but unfortunately these decisions continue to be put off.  It is worth the 3 minutes.  Additionally, The Treasury Secretary’s letter is copied below.

http://debtlimitusa.org/

December 26, 2012
The Honorable Harry Reid
Majority Leader
United States Senate
Washington, DC 20510

Dear Mr. Leader:

I am writing to inform you that the statutory debt limit will be reached on December 31, 2012, and to notify you that the Treasury Department will shortly begin taking certain extraordinary measures authorized by law to temporarily postpone the date that the United States would otherwise default on its legal obligations.

These extraordinary measures, which are explained in detail in an appendix​ to this letter, can create approximately $200 billion in headroom under the debt limit. Under normal circumstances, that amount of headroom would last approximately two months. However, given the significant uncertainty that now exists with regard to unresolved tax and spending policies for 2013, it is not possible to predict the effective duration of these measures. At this time, the extent to which the upcoming tax filing season will be delayed as a result of these unresolved policy questions is also uncertain. If left unresolved, the expiring tax provisions and automatic spending cuts, as well as the attendant delays in filing of tax returns, would have the effect of adding some additional time to the duration of the extraordinary measures. Treasury will provide more guidance regarding the expected duration of these measures when the policy outlook becomes clearer.

Sincerely,

Timothy F. Geithner

Fear the fiscal cliff? maybe for a trader, but not an investor… November 28, 2012

Typing ‘fiscal cliff’ in Google search currently returns 630 million references!  Nationally (and internationally) it is clear our attention is focused intently on lawmakers in Washington D.C. and what they will do with pending automatic tax increases and spending cuts due to take effect at the start of the new year.

As investors we need to prepare for the likelihood of a debate that will be all too public and filled with rancor, likely resulting in a fair amount of volatile price action for stocks.  As news is incrementally digested over the course of the next month or so, there will be days filled with gloom and despair and other days that may offer some hope.  In either case, we need to focus on what matters – and outside of an outrageously unexpected result, it ultimately won’t matter much over an investment time horizon what does get decided in Washington.  It might to a trader, but not to an investor.

We are not trying to convey a tax increase as a positive development, but it’s extremely important to keep it in perspective. Dividends have accounted for a huge part of the stock market’s total return for many, many decades. In addition, dividend paying stocks have a long record of outperforming non-payers, and have done so even in periods of oppressive tax regimes. The table below illustrates the performance disparity between dividend growers, constant dividend payers, non-payers and cutters over the period from 1972 to June of 2011.

Stocks by Dividend Segment Annualized Return Cumulative Return
Dividend Growers 9.66% 3722%
Constant Dividend Payers 7.44% 1599%
Non-Dividend Payers 1.83% 105%
Dividend Cutters -0.56% -20%
Returns from 1/31/1972 through 6/30/2011
Source: Ned Davis Research Group

Initially, one might think that periods of very high dividend tax rates (particularly relative to capital gains) would cause investors to gravitate away from dividend paying stocks – but that is not what has happened. In the time frame cited above, dividend tax rates exceeded 38.5% exactly two thirds of the time, with an astounding top rate of 70% levied for a full 10 years of the analysis period! What’s more, the average difference between the rate on dividends and capital gains was vast, with capital gains spending 82% of the time at a maximum rate of 28% or under – but often significantly below that. Investors who are worried that a rise in dividend taxes will be commensurately larger than capital gains taxes – and therefore seek to avoid significant dividend payers – may end up being thoroughly surprised by the eventual performance outcome.

Morningstar looked at 100 years of tax rates on dividends compared to capital gains and termed the spread between the two the ‘dividend tax penalty’. In an environment where a large spread exists, we might conclude that corporate management would opt not to pay out a high portion of earnings (referred to as the payout ratio), but this has not been the historical case. In decades where the ‘penalty’ was highest – in the range around 60% – the three year average payout ratio hovered well above half of all profits being distributed through dividends. Compare this to the last nine years, when the penalty has been 0% (no difference between capital gains and dividend taxes) and yet payout ratios have resided near the historical nadir of roughly 35%. In other words there has been no correlation between a high ‘dividend tax penalty’, and the inclination of management to reduce commitments to dividends through lower payout ratios.  Just recently Goldman Sachs issued a report estimating dividend growth for the S&P500 to be 11% in 2013, even after assuming a dividend tax increase into the 25% range. If dividend taxes rise further that may tilt some return of cash to shareholders via share buybacks, but would still result in additional growth of dividend income over current levels.

Also, most American investors hold a significant portion of their stocks in tax deferred accounts such as Individual Retirement Accounts, both Traditional and Roth, and 401(k) accounts. Frequent reports estimate the percentage of stock holdings in all forms of these tax deferred portfolios to be greater than 60% to 65% of all equity ownership. Given that no tax is paid on investment income earned while inside of these accounts, a change in dividend tax rates has no direct impact.

We clearly don’t prefer to see tax increases on investment income, but even if tax burdens do rise, dividends will continue to supply substantial, durable and growing streams of income. We would rather capture a dollar up front, taxed at prevailing rates, than receive the promise of capital gains we may never get the opportunity to pay taxes on. Bonds, already taxed at ordinary income rates, cannot provide growth of income, and at today’s rates they hardly even provide interest. Stocks that do not pay dividends provide neither income nor predictable capital gains. With the added support of demographic trends and the absence of material income from bonds, we believe investors will continue to seek consistent dividend payers.

It is worth repeating the characteristics we seek in the companies we want our clients to own, terming it QDG: Quality, Durability and Growth. Generally businesses fail or are at risk due to some combination of intense competition, low returns on capital and unmanageable debt levels.  Additionally complacency and/or arrogance manifest’s itself in insufficient attention to the balance sheet when times are good – in turn putting the enterprise at risk when times aren’t so good.  As these are the characteristics often associated with failure, we look to turn that around and focus on Quality franchises with very strong competitive positions (often global leaders in their industries), with consistently high returns on capital, favorable gearing ratios (debt to capital levels) and other important marks of balance sheet attention.  Identifying the Durability and Growth of dividend income are key steps in finding those companies that not only survive the turbulent times but thrive in the next phase.  We look for a history of dividend payment through market cycles, an identifiable, established and committed dividend culture or one that is making a rapid and decisive conversion to an attractive dividend payer.  Strong cash flow and prospects for earnings growth to support payout growth is crucial.  We would rather accept a lower yield that consistently grows, than stretch for a higher yield we believe may not be sustainable.  Ultimately we believe a portfolio of quality companies with durable and growing dividend payments – where we’re treated as an owner, sharing in the profits consistently on a cash basis – has the opportunity to produce attractive risk-adjusted returns.

Below are a few examples of current portfolio holdings and the extraordinary length of time they have paid uninterrupted dividends to their shareholders.  These companies have survived and prospered while sharing their wealth with investors for over a century and through umpteen changes in the tax codes:

  • Bank of Nova Scotia: 180 years
  • Coca Cola:  119 years
  • General Electric:  113 years
  • Pfizer:  111 years
  • Norfolk Southern:  111 years
  • Public Service Enterprise Group:  105 years
  • Chevron:  100 years

The successful application of our dividend growth strategy has never solely been a function of low tax rates, as the intrinsic advantages of durable dividends have allowed shareowners to prosper through a wide variety of tax environments. We don’t see any reason why that should change.

Dividend growth continued in Q3… October 11, 2012

Dividend payments for U.S. domestic- listed common stocks rose to a record $398 billion in aggregate for the third quarter according to Standard and Poor’s.  Out of roughly 10,000 listed issues there were 439 dividend enhancements, a 25% gain over the same point in 2011.  Fifty three companies cut payments.  There is a bona fide opportunity for dividend growth to continue, as the payout ratio (dividend payments as a percent of earnings) is running in the low 30% range, versus a long term historical average of greater than 50%.  Some notable dividend increases in the third quarter included:

Cisco Systems + 75%

Norfolk Southern + 6%  (in addition to a 9% increase they made in March equaling 16% year over year)

Texas Instruments + 24%

McDonalds + 10%

Medtronic + 7%

Microsoft + 15%

Sources: Standard and Poor’s, Barrons, Martin Capital Partners

Investors have been paying up for ‘defense’… August 3, 2012

Investors have been paying up for ‘defense’.  This is reflected in many ways, probably the most obvious being the demand for US Treasury notes.  With the current yield on a 10 year note at 1.57%, the implied negative real rate of return is fairly clear evidence of the payment for defense and the flight to safety (or perceived safety).   There’s also some evidence within the equity markets of this mentality as well.  Take the utility sector for instance, which according to Thomson Reuters Baseline has traded at an average P/E discount to the SP500 of 20% over the last two decades, but now hovers at a 10% premium to the market – it’s peak relative valuation over that span.  Risk averse investors are seeking as much certainty as possible, and these generally stable businesses with nice dividends have attracted a lot of attention.  This attention however has resulted in valuation levels that do not appear as attractive as they have at other periods, and yields have shrunk as a result.  Though a good case can be made that high quality businesses with stable and high dividends deserve a certain level of premium, investors need to consider other factors, such as growth of that yield when determining the appropriate price to pay for a stock.

Below is a chart of the P/E ratios for a few of the top holdings in the Utilities Select Sector SPDR (XLU).  The market as a whole trades under 15x earnings, so these multiples illustrate the current premium for ‘defense’.  The issue for investors who may have large allocations to this sector is that from current levels, the defense may not end up being as hardy as hoped.

SO PE Ratio Chart

returns are not a straight line… June 4, 2012

The stock market as measured by the S&P 500 fell officially into ‘correction’ territory intraday today before rallying, giving back 10% from the highs in April of this year.  A bad jobs report last week and non-stop news of Europe’s attempts to deleverage without killing any hopes of growth are the current heavy weights.  The drumbeat of negative headlines will likely start raising angst among investors who may wonder what to do now.   As we often recite – stick with quality franchises that produce durable and growing streams of cash dividends and try not to let the headlines cause you stress.   Why? In the three decades since 1980 the average intra-year drop investors have experienced, according to Standard and Poor’s, is just shy of 15%, and yet calendar year returns were positive 78% of the time.  Additionally, in the last three years the average drop has been 21%, but by year end median returns were well into positive double digits.  No one knows of course what the rest of the year will hold, but by focusing on quality and income and not allowing fearful headlines to alter a sound investment strategy, investors can increase their chances of long term success.

the Apple effect… April 25, 2012

Apple is en fuego.   The company blew out their latest quarterly report, issued last night, and analysts on average see the company making $45.50 per share in earnings for fiscal 2012.  Five years ago Apple earned $3.93 per share. That’s over 1,000% earnings growth in 5 short years, or 63% compounded annual growth.  Utterly remarkable.  What is also remarkable is the extent to which Apple’s stock is having an impact on the direction of stock indices.  Take the Nasdaq 100 for instance, which includes 100 of the largest domestic and international non-financial securities listed on The Nasdaq Stock Market.  Because it’s a market capitalization weighted index (like most) Apple now makes up 19% of the index due to its current value.  Today alone the stock accounted for just shy of 60% of the Index’s 2.68% return!  Analyzed on a year to date basis, without Apple’s contribution, the index would need to lop off almost 40% of its return.   Investors need to be very aware of the distortions this can create when using indices for comparisons sake, and though it may have been beneficial recently to ‘index investors’, without the ability to control the level of exposure, unknown risks are created, only to become apparent later.   In other words, those that live by the sword may end up dying by the sword.

The ‘tax’ overhang… March 6, 2012

President Obama recently submitted his 2013 budget proposal, containing a host of tax increases, including those for dividends.  Given that dividends are already taxed at the corporate level – of which anyone receiving those dividends is already a pro-rata corporate owner – the ‘double taxation’ on those profits is philosophically troubling.  This double taxation though has been the case for many years and many a Presidential administration, albeit in varying degrees, and is likely to remain…  The proposal itself however, and previous coverage about its potential, may have contributed to the relatively slow start for dividend payers in 2012.   Much debate – and an election –  in 2012 will go a long way in determining if the proposals are even enacted, but we believe the ‘tax discussion’ will mean more in short term perception, than long term reality.   After very strong relative performance for dividend stocks in 2011 the ‘taxation’ excuse may be used often this year as a reason to avoid dividend focused strategies.  We acknowledge this perception could have an influence – but we would view any under-performance as a chance for investors to get involved in quality, dividend growing stocks, as the ultimate reality likely will differ from the perception that drives short term prices.  Below is a chart updated in 2010 outlining the last four decades of dividend tax regimes.  As is evident, even in periods of extremely oppressive policy, dividend paying stocks have maintained a performance advantage versus non-payers.  We believe this is likely to continue when evaluated over a full market cycle.

Debt Limit… February 8, 2012

The link below is to a 3 minute satirical short film called Debt Limit – A Guide to American Federal Debt Made Easy.   Putting our national debt into perspective, the video examines how it would apply pro-rata to just one family.   In its own way the point is highlighted that we have tough choices to make, and the sooner the better.  It is worth the 3 minutes.

http://debtlimitusa.org/

‘Ahead of the Tape’ today… January 11, 2012

Today’s ‘Ahead of the Tape’ from the Wall Street Journal by Kelly Evans cited some interesting data points on dividends – we have attached a portion:

… The total return for dividend stocks has topped nonpaying stocks every year since 2000 except for 2003 and 2009, according to S&P. And the gains that dividend-focused investors might have missed in those years are partly offset by their shallower losses during steep market selloffs. Given where we are in the current market cycle, with the strong rebound year of 2009 past, it would be highly unusual for dividend-payers to lag behind the market this year. Investors should also keep the power of compounding in mind: $10,000 invested in nondividend-paying stocks in 1979 would be worth about $250,000 as of 2010. The same amount put into dividend-paying stocks—and continually reinvested—would have returned $413,600, notes S&P’s Howard Silverblatt.  On top of this, companies are likely to ratchet up their payouts this year, continuing a trend from 2011. Corporate cash levels are near all-time highs, after all, and as BofA Merrill Lynch points out, the S&P 500’s current payout ratio is hovering at all-time lows…

Happy New Year! December 30, 2011

As we reflect on a prosperous 2011 for our dividend growth stocks, we want to express heartfelt thanksgiving to our wonderful clients and financial partners. We are humbled and excited to wake up each morning and serve those that have entrusted us with their capital.  It is a sincere privilege. Happy New Year!

a growing income stream… December 15, 2011

The markets continue to struggle finding direction with all eyes on the Euro Zone, but if we peek past those headlines  some very positive things continue to develop on the dividend growth front.  Within the past three months alone, just shy of 30% of our Core Dividend portfolio holdings have given our clients pay raises.   The extent of these raises vary, but they are all in the right direction – up.   Over half of the payout increases exceeded 15%, with two companies posting stellar bumps of 25% or more.  The smallest increase amounted to just 1%, but even that doesn’t appear too stingy when we get to add it to an already very generous dividend yield of 5.5%.   The beautiful thing is that dividends are tangible, paid in cash and go straight into investors wallets.  It is hard to overestimate the impact this kind of growth has over time.  With the 10 year US Treasury Note yielding just 1.91% as of today’s close – with no opportunity for income growth –  high quality stocks with reliable and growing dividends appear all the more attractive.

the face of things to come… December 5, 2011

Italy’s new government unveiled austerity measures today in an attempt to begin dealing with serious debt issues that plague the country.  The bond market in Italy, which is one of the world’s largest, has been in turmoil recently amid rising borrowing costs as investors flee – becoming a threat to Italy and the Euro as a whole.  That bond market saw some relief today with hopes high it will last more than temporarily.  To Italy’s credit they now are upfront about the issues they face and the need to deal with them.  “Italians are to blame for our public debt, and we risk compromising everything we’ve accomplished in the last 60 years”, Prime Minister Mario Monti told a news conference.  He also stated he will not accept a salary as premier and economy minister.  In announcing pension overhauls which were part of the plan Labor Minister Elsa Fornero broke down in tears, saying the changes were necessary to avoid “collective impoverishment”.  The pain of this reality is reflected in the photo of her below courtesy of AP/Wall Street Journal.   Unfortunately this is the reality the world faces and is symbolic of the many future steps needed by the world’s developed nations.

the super-committee, anything but… November 22, 2011

We are witnessing an unbelievable lack of leadership in our nation’s Capitol these days.  On Monday the congressional ‘super-committee’ in charge of deficit cutting simply quit, evidently concluding failure was easier to swallow than compromise.  As a result an automatic $1.2 trillion in spending cuts are on schedule to begin in 2013 over the next 10 years, roughly half targeted for the Pentagon but also including education and health care.  Members of both parties appear worried about the impact of the automatic cuts, but ‘so what’ seems to be the refrain.  The super-committee and Congress as a whole appear immune to intense public disapproval of their performance and are willing to gamble that the continued failure to adequately address our nation’s problems won’t have a meaningful impact.  Here’s to throwing out every member of Congress on either side more concerned about their own position than willing to work for the good of the country.

A thought on the MF Global mess… November 4, 2011

By Brian S. Wesbury, First Trust

The $41 billion bankruptcy of MF Global, led by CEO Jon Corzine, is obviously front page headline news these days.  It has been, and will continue to be, a circus-like atmosphere.  Rumors and innuendo will mix with facts and emotion as pundits and investors attempt to divine a meaning or message.

There are many who want to make this about Wall Street and Capitalism.  They will say, “the subprime crisis, Bernie Madoff, the flash crash, market volatility, and now MF Global all show how out of control, or crooked, or un-regulated Wall Street and capitalism really is.  It’s like the Wild, Wild West.  We need more government control and transparency.”

But, while there are many things to learn from MF Global, the idea that “capitalism failed” is not one of them.  There is, of course, the lesson that serving customers and earning money the hard way is the best way to create wealth…making proprietary bets to try and “strike it rich” is not.  The idea that someone understands the market better than the market itself is an age old business problem, created and supported by blind ego.

This problem – ego – has taken down companies before and it will take down companies again.  It’s not special to Wall Street, it happens in everyday life.  It’s human.  It happens on Main Street, it happens at home with the kids, it happens on the sports field.  It’s life.

Capitalism deals with this fact of life very well.  Winners (those who operate with integrity and wisdom and read the needs of customers well) accumulate more assets.  Losers (those who try to cut corners, cheat people or misunderstand customers) have assets taken away from them.  There are always exceptions to the rule, but as time marches on, assets flow toward those who use them best.

Jon Corzine made bets on government… This is understandable in a way.  Jon Corzine has been in government, not the private sector, for the past decade.  He was a US Senator from, and Governor of, New Jersey.  Moreover, his former employer (Goldman Sachs) and probably many of the hedge fund types who traded and cleared through MF Global often base trading strategies on policy moves by the Fed, the US Treasury, the ECB, and other sovereign governments.  This is a widespread practice these days.  Macro-trading, based on government policy moves has become the go-to spot for trillions of dollars of capital.

This can be a dangerous strategy as MF Global, and many others, have found.  Investors who want to build wealth over time would be better served by trusting in capitalism and buying assets that are attached to thriving businesses that serve customers well and make profits the old fashioned way.  Capitalism works.

The above piece is an excerpt condensed from economist Brian Wesbury’s blog regarding the recent bankruptcy of MF Global. The full post can be found here: http://www.ftportfolios.com/retail/blogs/Economics/index.aspx

“take the money and run”… November 1, 2011

Today as the market prepared to open and stock index futures were pointing to a lower open on continued Greek shenanigans, the financial news network CNBC was playing background music as they panned the floor of the New York Stock Exchange heading to a commercial break.  The tune was Steve Miller’s popular song from the ‘70’s ‘Take the Money and Run’.  At another time we might discuss at a deeper level the merits of the news network’s subliminal messaging, but in short order it is yet another example of the continued short cycle, trading mentality of our stock market culture today.  As we have discussed in previous blog posts as well as our most recent quarterly Point of View, titled Motion Sickness located under our resources tab, this short cycle view of investing can be very dangerous to most investors’ financial health.   Along these lines we recently ran across a very short but salient video by Bill Ackman, a successful hedge fund manager.  We believe this two minute introduction video to a longer lecture encapsulates some key thoughts about the psychology of investing that may be worth revisiting again.
http://www.investmentpostcards.com/2011/11/01/bill-ackman-on-the-psychology-of-investing/

Also, if your interested below is a link to hear The Steve Miller Band’s song from 1975  : )

http://www.youtube.com/watch?v=-WCFUGCOLLU

market dividend trends are positive… October 28, 2011

Positive dividend news continues for the market in 2011.  Through the end of the third quarter payout declarations, in the form of increases, reinstatement’s and extras rose 17% from the same period in 2010 according to Standard and Poor’s Indices, while only 23 of the 7,000 companies that report their data to S&P cut or omitted disbursements.  Year to date through September the number of companies with positive declarations increased 26% to 1,304 from 1,033 while decreases and passed payouts fell 37% in that time.   On an absolute basis corporations added just shy of $40 billion to dividends in the past three quarters which is 50% above the total added for all of 2010.   For only the 2nd time in almost 50 years these payout boosts helped the S&P500 dividend yield exceed that of the 10 year US Treasury Note yield during the quarter, which had simultaneously seen it’s coupon drop to generational lows.

occupiers effect? October 24, 2011

MCP’s Reid Weaver earned his Chartered Financial Analyst designation in 2011, the most respected and recognized investment credential in the world.   As a CFA charterholder he gets access for our firm to some interesting data, and we wanted to pass along a piece below from the CFA Institute that was very interesting to us.

source: CFA Institute 2011

Given that the poll reflected above surveyed CFA charterholders – who are anything but ‘outsiders’ to Wall Street –  the idea that almost half of the respondents at least somewhat support the global protests goes to show the deep sense of angst about the economy and those in decision making power.  Though the demands and mission of the ‘occupiers’ are anything but clear, what does seem clear to us is that in some way, shape or form it will not be business as usual the next 10 years on Wall Street.  What configuration this takes is hard to discern, as those that appear to support the idea of the protests seemingly have vastly different end goals.  Though the protests themselves may dissipate shortly, what they represent underneath the surface should not necessarily be dismissed out of hand from an investment perspective.

U.S. companies healthy, but hoarding… September 28, 2011

U.S. corporations have a higher share of cash on their balance sheets than at any point in almost a half century, the Federal Reserve reported on September 16th.   Businesses appear to be building up buffers rather than hiring or investing in new plants.  Non-financial companies held more than $2 trillion in cash and other liquid assets as of the end of June, up more than $88 billion from the end of the first quarter of this year.  Cash accounted for 7.1% of all company assets (everything from hard assets to investments) which is the highest level in 48 years.  The figures released by the Federal Reserve do not take into account the additional and substantial cash reserves held at many U.S. companies’ foreign subsidiaries – which would be taxed if repatriated to the United States.  These figures are continued evidence of the healthy financial position of Corporate America.  Ultimately this has positive implications for the U.S. economy, but in the immediate term, it is confirmation that the Fed’s intended consequence of low interest rates – to spur riskier pursuits like investment and hiring – is not yet playing out.

showing us the $… September 22, 2011

In July we posted to the blog a short piece, ‘show us the $, Mr. Softy’ (copied below) on Microsoft (MSFT) – discussing the mind boggling cash flow numbers they had just reported and their level of commitment to the dividend.  Though they clearly have the ability to do much more – which in part is why we think a good reward for risk scenario exists – they did announce Tuesday a 25% jump in the dividend. Since they first started paying a dividend 8 years ago, outside of a $3.00 ‘special dividend’ payment in 2004 this is their largest percentage increase, exceeding last years 23% bump.  At today’s price MSFT now sports a yield of 3.2%, or 85% above the current 10 year US Treasury.  This commitment is a good sign and we believe will be an important factor in the total return for this stock (and for others that do the same) into the future.  Additionally, Texas Instruments (TXN) last week boosted their payout 30%, a huge leap from the 8% increase they gave us last year.  Amazingly, both of these companies have zero net debt and these cash payout enhancements are further tangible demonstrations of the balance sheet strength of many top tier technology companies.  In the short run the market doesn’t care about these things, it would rather worry about ‘Operation Twist’, Greece and whether or not we are officially in a recession – all items that easily hold our attention.  But as Ben Graham used to say, if ultimately the market is a ‘weighing machine’, we believe it will end up weighing the cash.

July 22, 2011: Microsoft (MSFT) recently reported earnings for their fiscal year end June 30th and the report highlights the capability they have to grow into a significant dividend payer.  The measure that is most astonishing in our mind was reported free cash flow  – this figure exceeded $24.7 billion for the year.  To put this number into perspective, it means 74.6%  of all the companies in the S&P500 have a smaller total market value than the free cash flow just generated by MSFT over the last 12 months!   With less than $12 billion in long term borrowings and total cash on the balance sheet of approximately $53 billion, the opportunity to continue to pay investors a higher cash dividend is clearly present.  Their current dividend commitment to investors is under $6 billion per year – this can and should increase.  We’ll be watching.

first non-convertible debt since 1987… September 19, 2011

Some news out of Intel (INTC) last week caught our attention.  The company issued $5 billion of 5, 10 and 30 year bonds in its first sale of non-convertible debt in 24 years. The 5 year note yielded 1.95%, the 10 year note 3.3% and the 30 year bonds 4.8%. Intel does not need to borrow the money; they reported having $4.64 billion in cash and only $2.09 billion of long term debt in their latest quarterly filing.  They also produced an astounding $17.1 billion in cash flow over the trailing four quarters.  But if investors are willing to gobble up the notes, why wouldn’t they borrow at those rates?

This news hints at several things to us, but primarily it’s evidence of the continued discrepancy in our mind between the valuation of many high quality stocks versus the valuation of bonds.  Intel’s common stock on the day they floated the debt deal yielded 4% (almost a percent higher than the 10 year fixed note they issued and double the rate on the same maturity issued by the US Treasury), it traded at 9 times forward earnings, produced an internal cash flow yield in relation to it’s enterprise value of almost 17% and sported a return on equity over 25%.  Very importantly the dividend is not fixed. Intel has been growing it at 14% over the last 5 years and likely will continue to grow it into the future given its cash flow prowess and statements issued by company officials.  But in this market where fear appears the overriding emotion, many flock to the bonds and not the high quality stocks of companies that issue them.  If an investor buys and holds the 10 year note, the best return they can make is the 3.3% coupon – and that does not factor in inflation.   While acknowledging a higher level of risk than the bond holder, give us 10 years with a high quality company rapidly growing a durable dividend while purchased at this valuation and we believe the return has potential far beyond the bond holder’s coupon, while potentially hedging us to some degree against inflation and compensating us for the added risk.

By the way the company stated they will use the borrowings to repurchase stock, which normally we aren’t big fans of companies doing, but in Intel’s case it appears wise based in part on the valuation metrics cited above.

from the active to the patient… September 13, 2011

“The stock market serves as a relocation center at which money is moved from the active to the patient.”  Warren Buffett

The New York Times Sunday ran an article on stock market volatility. “The last few years have been the most volatile for all of recorded history,” said Andrew Lo, professor of finance at the M.I.T. Sloan School of Management. For evidence, he says that 10 of the biggest 20 daily upswings and 11 of the largest 20 daily drops since the beginning of 1980 to the end of last month have occurred in just the last three years”. The article goes on to say that high-frequency traders… ‘now account for up to 60 percent of daily turnover’ and probably help account for the large increase in the last several years over prior decades of what they term ‘extreme volatility’ – see the bottom of their chart below in reference to moves of 4% or higher:

Sometimes it seems the math ‘wizards’ on Wall Street, with their high frequency and program trading are lengthening the odds against the average investor – and that may be true when analyzed in extremely short time frames. But this volatility may actually be a gift in disguise for investors with any reasonable time frame beyond the next quarter’s report. The quantitative and computing brainpower continues to focus on ever shortening time horizons – not on identifying sustainable competitive advantages, long run earnings power or the lasting value of large and growing streams of dividend income. As Wall Street focuses ever more intently on short term movements, we believe this will ultimately create more opportunity for those investors whose time horizon reaches beyond a month, a day or an hour. The more these financial ‘wizards’ concentrate on the next few seconds, the less likely they are to identify the long term values that we diligently seek.



commodity market message… September 6, 2011

The following is an interesting piece from Scott Grannis’  Calafia Beach Pundit blog,  about a potentially reassuring message from the commodity markets:

“This chart compares Bloomberg’s Constant Maturity Commodity Index (white line) to the S&P 500 Index (orange line). From last November through April, these two indices were almost perfectly correlated, suggesting that both were reacting to the same economic growth fundamentals. The correlation broke down over the past month or two, however, as equities were overcome by fears that a collapse of the Eurozone banking system could have serious repercussions for the global economy. Commodities initially shared in the onset of panic, but have since bounced back, and today are trading a little above their average for the year to date.

The action in the commodity markets suggests that the economic growth fundamentals have deteriorated much less than the behavior of the equity markets would suggest, and that the fundamentals have actually improved in recent weeks. This is an important development, of course, since growth can trump lots of problems. The Eurozone is far from conquering its sovereign debt problems, but commodity markets suggest that there is at least some concrete hope for a solution.”  Scott Grannis,  Economist

beginning of a long demographic influence on dividends? August 31, 2011

From the Wall Street Journal this past weekend – a small and fairly anecdotal piece of data – but interesting nonetheless. According to Jason Trennert of Strategas Research Partners, over the last 14 months, the 25 companies that paid the most dividends as a percentage of their market value beat the S&P 500 by 8.9 percentage points, while the 25 companies that increased cash on their balance sheets the most, lagged by a wide 8.4 percentage points.  Despite a small data sample and the time frame appearing somewhat random – though it does coincide with the pullback lows of June, 2010 – an intriguing underlying story seems to be developing.  That story is that investors are searching for yield and growth of yield – and appear to be losing patience with those corporate boards that would rather hoard cash than prudently distribute a share of profits in the form of dividends.

As we wrote in our January, 2011 Quarterly Point of View, for the next 19 years there will be approximately 10,000  people a day celebrating their 65th birthday in this country – the age most notably linked to retirement. With the 10 year US Treasury Note yielding barely above 2% and money market funds paying virtually nothing – investors are seeking income in other places, and that includes dividend paying stocks.  If the data we just cited is any indication, the future bodes well for those companies that pay durable and growing dividends, and corporate boards that don’t consider it important may find an entire demographic punishing them.

what does the philly fed index mean to us? August 24, 2011

It is important to take economic reports with a grain of salt and not make investment decisions based on one number, no matter how bad or good that number may be – or how important the report is considered.  The Business Outlook Survey, more commonly known as the Philadelphia Fed Index, is a monthly survey of manufacturers in the Third Federal Reserve District.  Participants indicate the direction of change in overall business activity and in the various measures of activity at their plants. The survey has been conducted each month since May 1968 and last week it reported an August data reading of -30.7, which in perspective is the worst level since March of 2009.   On the surface it appeared to confirm the inevitability of a double-dip – but beyond the headlines there is another story.  Jason Goepfert of SentimenTrader.com has looked at every reading of the index since 1968, and subsequent stock market performance:  There have been 20 historical readings worse than -30 prior to last weeks report and 6 months later the SP500 had advanced 80% of the time, with a median return of 14.1%.  When performance is evaluated one year from the reading the market had risen 95% of the time with a median advance of 22.9%.  This is not a prediction of future returns – we have economic headwinds to overcome – but this analysis illustrates that taking economic reports at face value, and their perceived impact on the stock market, can be precarious if not hazardous.

mr. market… August 18, 2011

At times of extreme volatility, as we are currently experiencing, we need to attempt to view the stock market in a different context.  The comments below are pulled from Warren Buffett’s Berkshire Hathaway annual report in 1987.  He refers to Benjamin Graham, considered by many to be the father of value investing, and his story on how to view the market.  I think it is helpful in framing investment decisions…

“Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkable accommodating fellow named Mr. Market who is your partner in private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you. But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up someday in a particularly foolish mood, you are free to either ignore him or take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, ’If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.’ ”

— Warren Buffett

market volatility comments August 8, 2011

These are times that test us all as investors.  Quick and steep declines are painful to watch – and always seem to be created by events that are so different from anything in the past that they deceive us into believing they will create a permanent, unrecoverable condition.   Even though history repeatedly proves this to be untrue, it often seems emotionally unsatisfactory to provide statistics to make us feel better.  So I’d like to include a few quotes that when thought about deeply are profoundly true, and which great investors do apply.

In his 1987 annual report for Berkshire Hathaway, Warren Buffett said (my emphasis in bold);  

“…In my opinion investment success will not be produced by arcane formulas, computer programs, or signals flashed by the price behavior of stocks and markets.  Rather, an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super contagious emotions that swirl about the marketplace.”

I believe ‘good business judgment’ is owning high quality franchises that pay us high and rising cash dividends and only selling our stake when the market is so excited about them that it offers us a truly enticing premium to sell.  If we treat our stakes in great businesses as an owner, we wouldn’t want to sell if we weren’t offered a fair price… The market is definitely not offering us a fair price at this time.   So good business judgment likely means holding and in some cases adding to these positions…

Benjamin Disraeli, a former British prime minister once said; Patience is a necessary ingredient of genius.”  As hard as this is to practice sometimes, if we have a good, time tested plan as an investor, this patience is vitally important.

An analyst we often read, Don Hays, wrote this excerpt in his blog today and we wanted to refer to it as it encapsulates well some key thoughts.  

“So today, should we run from cover like those fast traders? No!! In fact, it is a truism that severe corrections don’t stop until the pure technicians turn bearish.  Furthermore, as Ed Yardeni points out, there is now $8.3 trillion in money market and savings accounts.  We’ve often said that bear markets don’t start until the monetary liquidity dries up, and today the monetary liquidity is exactly the opposite.  You can bet on it, the Fed is going to do all in its power to entice investors (and corporations and banks) to put their low-yielding money to work.

So…the bottom line is that this is “hard hat” time, a time when investors have to temporarily hunker down and resist the panic of the herd.  It is a personality trait that all good investors learn over the years, but it never gets easier it seems.  Every time there is a new threat trying to knock over those valuable disciplines of the past, but history tells us to stay the course, and continue to rely on the instrument panel.  These storms do die down, and your patience and fortitude will be rewarded.”

He’s correct, it is ‘hard hat’ time, but the positive news is that we do have good ‘hard hats’, as in very high quality, dividend paying companies.  I want to leave you with a few statistics on that.  Here is a sampling of the kinds of companies we own and how long they have been sharing their profits with investors through durable and growing dividends:

  • Johnson & Johnson, 1944
  • International Business Machines, 1916
  • Conoco Phillips, 1934
  • General Electric, 1899
  • Norfolk Southern, 1901
  • Kimberly Clark, 1935
  • Exelon Corp, 1908

I believe that these companies, and others owned in our strategies, will not only survive these times, but prosper in the future like they have throughout generations – often with events that appeared even more dire than what we now face.

market volatility comments

The stock market has had a rough couple of weeks, and the volatility might continue for awhile. The uncertainty over Congress pushing the debt ceiling debate to the 11th hour and some less than stellar economic reports (possibly exacerbated by the Washington induced uncertainty) has made for some stomach churning days.  Couple those ingredients with a time of year often associated with some of the least favorable historical returns and the combination can make us all fret.  But try not to let it.  These are not conditions that should make us alter our long term strategies.  It is true we as a country have some serious fiscal issues that need to be addressed – as does a good portion of the developed world- and our quarterly Point of View we sent out in April acknowledged and tried to address that issue.

There is a quote we have heard in the past that is timely and accurate – “Investing in an uncertain world is the only certainty”.  This rings very true – as from almost every juncture in history we can pull a litany of items from the time that seemed destined to alter the investing landscape.  Very few do however when viewed in the context of someone’s long term needs and goals for their money. From our viewpoint it is vitally important for us as investors to focus on the kinds of qualities and characteristics we just discussed in our July Point of View letter.  It may also be helpful to remember the fundamental underpinnings and some current data points of our Core Dividend strategy.

  • Currently produces an average weighted equity yield of 3.81% as of 8/2/11.  The companies producing this income are very high quality multinational enterprises with balance sheets much healthier than the countries in which they live.  Their income will help offer long term support and ultimately growth in their prices.
  • The companies in our portfolio have grown their dividend income at almost 12% per year for the last 5 years, which includes during the depths of the financial crisis.  This growing income stream is vital for us as investors and ultimately is not ignored by the market.
  • The prices of these stocks, as demonstrated by an average PE multiple of under 12x, which is well below historical market averages, may also offer support and possibly significant opportunity.
  • To date, the stock market has noticed these kinds of attributes as we continue to outperform the market YTD as demand has grown for these types of companies.

We will always go through these periods of time; it is a fact of life for any investor.  The S&P 500 has only had one year in the last 30 years where the largest pullback didn’t exceed 5% and 17 of those 30 years produced one or more pullbacks exceeding double digits.  We need to use these times to stick with (and add) to those franchises that continue to pay us handsome dividend income while we wait out those volatile periods, and that ultimately drive their prices forward over the intermediate and long term.

…by observing strict economy (i.e. thrifty management)

Our rulers will best promote the improvement of the nation by strictly confining themselves to their own legitimate duties, by leaving capital to find its most lucrative course, commodities their fair price, industry and intelligence their natural reward, idleness and folly their natural punishment, by maintaining peace, by defending property, by diminishing the price of law, and by observing strict economy in every department of the state. Let the Government do this: the People will assuredly do the rest.

Thomas Babington Macaulay, British historian, poet & politician. 1800-1859.

show us the $, Mr. Softy

Microsoft (MSFT) recently reported earnings for their fiscal year end June 30th and the report highlights the capability they have to grow into a significant dividend payer.  The measure that is most astonishing in our mind was reported free cash flow  – this figure exceeded $24.7 billion for the year.  To put this number into perspective, it means 74.6%  of all the companies in the S&P500 have a smaller total market value than the free cash flow just generated by MSFT over the last 12 months!   With less than $12 billion in long term borrowings and total cash on the balance sheet of approximately $53 billion, the opportunity to continue to pay investors a higher cash dividend is clearly present.  Their current dividend commitment to investors is under $6 billion per year – this can and should increase.  We’ll be watching.

an orchard for fruit and bees for their honey…

“Earnings are only a means to an end, and the means should not be mistaken for the end. Therefore we must say that a stock derives its value from its dividends, not its earnings.  In short, a stock is worth only what you can get out of it.  Even so spoke the old farmer to his son:  A cow for her milk, a hen for her eggs, and a stock, by heck for her dividends. An orchard for fruit, bees for their honey, and stocks, besides for their dividends… The old man knew where milk and honey came from, but he made no such mistake as to tell his son to buy a cow for her cud or bees for their buzz.” John Burr Williams, The Theory of Investment Value, 1938