Friday, August 26, 2011

Is Another Test on the Way?

By Steve Cook
All American Investor


The indices (DJIA 11149, S&P 1159) ended their winning streak yesterday. The DJIA finished the day within its intermediate term trading range (10725-12919). The S&P dropped back below the 1172 level, furthering the argument that 1101 will ultimately mark the lower boundary of the S&P intermediate term trading range (1101/1172-1372)--that is, if stocks are not setting up for another leg down.

Unfortunately, if there is any follow through to the down side today, then will stocks will have made a lower high on Wednesday. Thus, stocks will have made a higher low followed by a lower high, meaning that there is little reason to argue that there is any kind of up trend off the early August low. On the other hand, an immediate move up that would result in a close above 11522, 1207 would form the beginning of a very short term up trend

Of course, if stocks continue their decline, then we should get a better reading on the strength of support at 10725/10791, 1101/1120. As I said yesterday, the ideal pattern would be for the Averages to bounce off a level equal to or higher than the last higher low (10791, 1120); that would add a lot of weight to the notion that the early August lows were the bottom of the recent sell off. A more nerve racking but still positive scenario would be a full on test of the 10725, 1101 early August low. The bad news clearly would be a break below those levels.

Volume picked up while breadth fell off. The VIX was up circa 10%, keeping it in the upper zone of its trading range--not a positive for stocks.
After trading below the lower boundary of its short term up trend intraday, GLD snapped back to close modestly above it. While it didn’t feel like a bottom had been made, it was still a positive that it found support at that trend line. I am watching for any follow through today before taking any action.

Bottom line: it remains debatable whether stocks made their lows in early August or the bears have just been taking a breather before commencing the next leg down. Yesterday’s pin action may be the start of a test of either the 10791, 1120 and or the 10725, 1101 levels. If that challenge is unsuccessful, then our Portfolios will resume Buying stocks; if it is, then our focus goes back to our Sell Discipline.



Before the Market opened, weekly jobless claims were reported--they sucked but nobody cared. Because offsetting that was Buffett’s announcement that he had invested $5 billion in Bank of America preferred. This got virtually everyone tip toeing through the tulips on the thesis that one of the perceived weak links in the US financial system was being backstopped and that would strengthen the entire system.

Stocks spiked on the open, then investors apparently realized that what they have been worried about of late was not the US but rather the EU financial system. So Warren latest deal’s half life was about an hour and the nosedive in the German stock market (driven by developments in Greece) took precedent. Stocks sank fast and never recovered.

Helping that process, I think was some profit taking on the run up in stock prices ahead of Bernanke’s speech today. Investors seem to be worried that they may have gotten too jiggy about what he might say/do and decided to take some money off the table. Realistically, I don’t see how he can do anything much more than just mouth some platitudes and/or make a tweak to the system. That said, I think that it would foolish to under estimate the pressure that is likely being put on him as Obama’s poll ratings sink day after day. We will know soon enough whether or not Ben’s speech is much ado about nothing.

And the counterpoint (short):

And finally (short):

Bottom line: yesterday may have begun the second test of the August lows as the European economic mess begins raising its ugly head again and Bernanke has to s*** or get off the pot on further monetary easing. Another successful test will increase my confidence in putting money back to work in what our Model indicates are numerous undervalued equities.

Thoughts on Investing--from Low Sweat Investing

Dividend investors seem a usually cheerful bunch. And why not? Every few months nice people at companies all over the globe send them money, just for owning their stocks. Stock went up? Here's your money. Stock went down? Here's your money. You own the stock, you get the money. Cheers!

But not everyone likes the party at this particular punchbowl. Now and then some persistently stubborn soul takes a dusty book from the shelf, pulls out an adding machine and some green eyeshades, and figures that investing in dividend stocks violates the most sacrosanct rules of book value, business management and common sense.

When companies pay dividends, these party poopers bluster, it technically reduces the companies’ value. On top of that, the companies could have used the money themselves. Continue giving it away, the sharp pencils warn, soon enough the business will suffer. And how much will the stocks be worth then? It all adds up. Case closed.

No doubt, businesses need to retain some portion of their profits to reinvest for future growth. And dividend growers do that. Moreover, decades of real-world experience make clear that dividend stocks, especially those with growing dividends, are stellar investments for income strategies as well as total returns.

So for the benefit of those less interested in numbers from book theories than from their brokerage accounts, here are nine real-world reasons to own dividend-growth stocks, presented in plain language and backed up by broad-based data. (Click the accompanying links for details.)

1. These stocks simply go up more. Study after study shows total returns from dividend stocks, especially dividend growers, clobber the market and cream non-dividend payers, decade upon decade. How is this remotely possible if paying dividends detracts from companies’ real value while not paying dividends enhances it?

2. Dividend stocks deliver above-average returns with below-average risk. Meanwhile, non-dividend payers trail the market, yet expose investors to above-average risk. The standard statistical measure of risk-related returns (known as “alpha”) shows dividend stocks’ clear superiority. Higher returns, lower risk. How sweet is that?

3. When you own dividend-growth stocks, you own stakes in superb businesses. These tend to be profitable companies (pdf) with strong business models and disciplined management. Weak companies can’t and don’t raise dividends for decades. Return on Equity and Return on Assets provide good measures of this. Dividend stocks trounce non-dividend payers on both.

4. Dividends provide cash income that doesn’t require selling assets in weak markets; income strategies based on asset sales create a real risk of running out of money in retirement. Bottom line: it may be true that selling 4% to 5% of capital annually is safe 80% to 90% of the time. But those are roughly the same odds you get in Russian Roulette. In both cases, you won’t like what happens if you lose. Put another way, risk is not defined solely by the probability of success, but also by the consequences of failure.

5. Dividend growth means cash income grows to offset inflation. Contrast this with fixed income strategies, which ensure lost purchasing power to inflation over time. For example, the CPI calculator shows that for every $100 of income ten years ago, you need $125 to buy the same stuff today. Or you could take a 25% haircut on your quality of life every decade.

6. Related to this, growing dividends mean the yield on one’s original investment, called yield-on-cost, keeps rising. Money invested at a 3% yield and 7% dividend growth will yield nearly 12% after 20 years. And while a bond will always yield the same coupon rate and dollar amount you start with, 7% dividend growth means $100 of income doubles to $200 after 10 years.

7. Dividend-growth investors can diversify across sectors, market caps and style boxes, tailoring their portfolios to their own goals and outlook. So don’t just think of stalwarts like Abbott Labs (ABT), McDonald’s (MCD) and other classic choices. For example, the Dividend Champions, Contenders and Challengers, comprising roughly 450 stocks with at least 5 years of dividend growth, include small cap rockets like Atrion (ATRI), midcap technology growers like Factset Research Systems (FDS), international names like Unilever PLC (UL) and diversifiers like Kinder Morgan Energy Partners (KMP), Realty Income (O) and even Royal Gold (RGLD).

8. Because dividend growers tend to be above-average (pdf) companies with above-average returns, investors enjoy a powerful statistical advantage that amplifies their stock picking. To illustrate, suppose a fisherman can choose a lake filled mostly with big fish or one filled mostly with little fish. At any level of skill, the fisherman’s chances of catching big fish are much better at the first lake. Statisticians call this phenomenon “baseline probabilities.”

9. Finally, despite what we might think after the 2008-2009 meltdown, a dividend income strategy generally runs a low risk of dividend cuts. In normal times, dividend cuts among high quality companies are rare. Of forty-two 2010 Dividend Aristocrats, only one cut its dividend. Just four S&P 500 companies cut their dividend in 2010 and only twelve in 2007. That’s out of 300+ dividend payers in the index. Of 200+ Dividend Achievers last year, just two cut dividends. (For research on factors that help predict dividend cuts, click here.)

So there you go. Nine real-world reasons to own dividend-growth stocks. Certainly, some investors will prefer other strategies and are welcome to them. Your money, your call. But for income investors facing a choice between green eyeshade theories and green cash in their pockets, dividend-growth stocks make real sense.

And of course, nothing in these nine reasons says every dividend grower makes a good investment, or every non-payer a poor one. As always, doing your due diligence makes all the difference.


This Week’s Data

Second quarter gross domestic product was reported up 1.0%, in line with expectations; the GDP deflator came in at +2.4% versus estimates of +2.3%.


Consumer spending (of lack thereof ) says it all (medium):

The false WWII analogy (medium):

The latest CBO look at the budget deficit (medium):

What the West can learn from Japan (medium and today’s must read):

Rail traffic continues to grow (short):

Steve Cook earned an MBA at Harvard and did post graduate work in economics and financial analysis at New York University. He earned his Chartered Financial Analysts designation in 1973. Steve has 40 years of investment experience including institutional portfolio management at Scudder Stevens and Clark and Bear Stearns. He managed a risk arbitrage hedge fund and an investment banking boutique specializing in funding second stage private companies. Steve now manages Strategic Stock Investments which focuses on wealth building through strategic stock investments.