Dividend Ten

Freelance & personal finance journal

Stock Talk

Yes, the great dividend bubble is inflating…and here’s why it’s just beginning

Welcome to Wonderland.

It’s well known that we are well into one of the greatest bull runs in history, driven by sham monetary policy that kicked the 2008 financial crisis down the road for us to deal with in the future.

So what’s an investor to do this late in the cycle with some cash looking at equities at their historical highs and bonds looking bad? Many are holding cash on the sidelines, many see historically that this is a crazy bull run and equities are overvalued and are selling.

Yet could it be that we’re not even close to the top of the bubble?

Right now investors are willing to pay up bigly (to borrow my favorite word from Donald Trump – like him or not – this is an awesome word!) for normally staid, solid consumer staples companies. P&G, for example, whose revenue fell 8% on a reported basis, is paying a 3.1% yield, which apparently is enough for investors to pay up 23x fiscal 2017 earnings.  Remember, this isn’t a growth stock. It’s a mature company that has declining earnings.

By any normal measure, this is completely insane.

Yet where else are people going to stick their money? In cash where it will continue to lose value? In bonds, whose value is sure to decline in the longer term?

There are no good alternatives – so 3.2% for KO starts to look very nice. Despite it having a shrinking top and bottom line and trading at 23x current year earnings.

So what’s going to happen here? There’s no doubt that stocks are expensive in a normal world…but are they really expensive today?

No – if anything they’re undervalued – because we’re living in an Alice in Wonderland NIRP & ZIRP environment where the laws of finance are starting to break down.

What do I mean?

Look at negative interest rates. Right now there are a whopping $10 trillion in total negative-yielding sovereign bonds outstanding worldwide, according to a report by Fitch Ratings. This is a completely absurd concept when you think about it. Why should I pay a bank for the privilege of them holding my money? Which also means that the traditional concept of the time value of money – or the fact that a dollar today is more valuable than a dollar in the future, and a fundamental concept behind stock valuation, starts to break down. In fact, in a negative interest rate environment, a dollar in the future is more valuable than a dollar today.

How do you value stocks & risk in this environment?

What will happen?

Down is up, and up is down.

Alice in Wonderland.

Meanwhile, look at what happened with Brexit. Why did the markets come roaring back quickly after the initial hit? Because there was cash sitting on the sidelines and because the uncertainty told the smart money (who move the markets) that there were increased chances of rates staying low for the forseeable future.

Yes, the market misprices things, but more often than not, it’s pretty darn smart.

So while on a value oriented basis you can think that the market is overheated, in fact, the value of the market remains a function of what people are willing to pay. And given this crazy financial experiment the central banks have engaged in, cash flows will continue to flow into equities. It is a natural and obvious consequence of this grand global monetary policy experiment.

And as long as we have low and negative interest rates, dividend stocks will still be the only game in town. Not to mention…more and more people are retiring, and since this has been a terrible time for fixed income investors (bonds and cash pay nothing), logically they’re putting their cash in great quality dividend payers. And who is really going to sell great companies like J&J when there’s really no other alternative where to stick your money?

And if J&J does have a correction, all the yield starved investors with cash on the sidelines will swoop in to prop up prices and drive them even higher.

Now surely the Fed will raise interest rates, right? At which point we should see a flight from dividend stocks into Treasuries and such, where we can get yield without all the risk of equities.

But I’m not so sure this is happening anytime soon. As mentioned, I’m no economist, but I don’t see how the Fed can raise interest rates meaningfully anytime in the next few years. They’ve painted themselves into a corner here. Look at Brexit – it’s impact on the global economy is still out there in the future, and the massive rally since the news was a function that the market surmised that interest rates would have to remain low, as our tender economy couldn’t sustain a jolt of rising interest rates with the uncertainty of Britain unwinding itself from the Euro, and the potential domino effect this would have on the disintegration of the Euro itself and its’ impact on the global economy. What about the uncertainty from the upcoming elections?

Raise interest rates too quickly, and the economy could implode.

Moreover, the US is $19 trillion dollars in debt. Every percentage point that we increase interest rates increases our debt payments. I don’t see how we can substantially raise interest rates in an uncertain environment and with the gargantuan debt level we have currently.

So yes, we’re in a bubble, And in my estimation the bubble is just going to keep inflating. And hyperinflating for the next few years yet.

Why not Dow 25,000? 30,000?

The tipping point for when the house of cards comes tumbling down – aside from a black swan event – will be when inflation starts to become a real issue in consumer goods, and the Fed has to start tightening quickly. Then we’ll see a flight from assets – and the inevitable crash. Then dividend investors will have to make some difficult decisions.

Until then, the market remains hostage to the effects of this grand experiment in monetary policy. And equities will continue to inflate in value. For me, I will continue to watch closely, buy on the dips and corrections, as the market continues it’s march inexorably higher for the forseeable future.

Because it really isn’t overvalued in light of our current environment.

Again, I’m not a professional, so don’t listen to what I say. as with any future prediction, I could be completely wrong, or right. This is just how I see it at the current point in time.

Until then, let’s continue to enjoy the ride! Up is down, and down is up. And the party will go on. Welcome to Wonderland!

What do you think? Am I wrong? Is the market crash just around the corner? Or are we just seeing the beginnings of the bubble inflation?

welcome_to_wonderland_by_mewthespaz

 

4 Comments

  1. Dan

    Greg,

    Great post! I WILL listen to you because I think you’re exactly right! Not to plug my own blog, but I just wrote about two things almost exactly as you mention them in your article: mine were negative yields, http://passiveincomedude.blogspot.com/2016/07/negative-yields-yikes-quick-explanation.html and expecting very low returns going forward: http://passiveincomedude.blogspot.com/2016/07/bad-news-you-will-absolutely-need-to.html

    My plan is to stay ‘mostly’ invested, but primarily in large index funds, and to transition to R.E.

    Thanks for the post,
    Passive Income Dude

    • Greg Gee

      Agreed, sounds like an interesting plan – thanks for stopping by!

  2. Interesting way to look at the current state of the market. I definitely agree that everything is backwards right now and there’s really no sense to be made. I also agree that the bubble will continue to grow into the foreseeable future, what other option do people have, they have to get a return somewhere! I look forward to stopping back soon, keep up the good work!

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