In a Mean Market, One Investment to Love
A good asset is hard to find these days. The just concluded Morningstar Investment Conference found most of the big-name money managers in the rhetorical equivalent of a defensive crouch, transfixed by the $1.6 trillion deficit, the looming tsunami of Baby Boom entitlement spending, and the possible hyperinflation and currency collapse that will follow. When asked for his overall investment advice, FPA Crescent (FPACX) fund manager Steve Romick said, "If you have a rock, hide under it." (More constructively, as MoneyWatch's Jack Otter reports, Romick and other doomsters like Jeffrey Grundlach of Double Line Total Return (DBLTX) and Rudolph-Riad Younes of Artio International (BJBIX)are recommending a kind of pre-Apocalypse portfolio of energy, gold, and busted mortgage-backed bonds.)
But one group of stock investors did come into the conference with an upbeat story to tell. Hersh Cohen of Legg Mason Clearbridge Dividend Strategies (CSGWX), Don Killbride of Wellington Management and Joe Matt of American Funds specialize in high-quality dividend paying stocks. The big steady-going consumer companies and manufacturers that make up their universe lagged the rally since the March 2009 low, so that they are arguably undervalued. Compared to small-company stocks and even to bonds, they look like one asset category a prudent investor could love. (Their arguments, by the way, reinforce cases made previously in CBS MoneyWatch by Jim Grant and Jeremy Grantham.) Plus, they'll pay you a dividend while you wait for things to turn around. Here's the case:
For the first time in 60 years, many high-quality U.S. stocks have higher yields than 10-year U.S. Treasury bonds When the yield on stocks dropped below that on bonds in the 1950s, it was considered a practically a violation of natural law and a sure sign that stocks were overvalued. But dividends remained lower than bond yields and investors explained the new natural order by pointing out that equities, unlike bonds, can grow in value as their earnings increase and, also unlike bonds, they can increase their dividends. Both explanations are still true, which means either of two things: a) In a world still traumatized by the 2008 crash, blue chips are bargains; or b) investors have been wrong for 60 years and the natural order has been restored .
Dividend playing blue chips have better balance sheets than Uncle Sam Unnerved by the crash, corporations loaded up with cash and paid off debt. The U.S. government juiced up on debt. Who would you rather invest with?
Dividends have been on the rise As Paul Lim reports in the New York Times, 136 companies in the S&P 500 have raised or initiated dividends this year. Only two have cut them. In the past, a turnaround in dividends has often been followed by a bounce in stock prices.
Stocks have more tools to deal with inflation than bonds do If inflation raises the cost of the goods, the managers of, say, Wal-Mart can raise the store's own prices to preserve profits. They can expand into foreign markets where the currency may be stronger, and can branch into related businesses to keep revenue growth ahead of inflation. The Treasury can do no more than pay you back in the promised number of dollars every six months. If inflation returns, the value of those dollars can do nothing but decline.
Some great companies are trading at dividend yields that only make sense if Armageddon is around the corner. Jim Grant ran a partial list in his newsletter recently, reproduced below. The stocks (which he not entirely ironically dubbed "Treasury alternatives") have high return on equity, decent price-earnings valuations and low-debt balance sheets. Hersh Cohen of Clearbridge was pounding the table for many of the same stocks at Morningstar:
There are no sure things in the investment world. Stocks, even blue chips with fat dividends, are riskier than bonds, which is why you expect them to pay off more than bonds in the long run. But at the moment, investors seem acutely aware of those extra risks-maybe even obsessively so. History would suggest (but never promise) that means it's a good time to buy.