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Over the past fifty years or so, one or two investment themes have dominated each decade, and many of those themes have become breeding grounds for financial manias and asset bubbles.
In the 1960s, it was a group of 50 large-cap stocks that offered solid growth and high dividend yields.
In the 1970s, the key market theme changed to runaway inflation. A massive speculative bubble formed in hard assets. Gold prices, in particular, experienced a parabolic rise.
In the 1980s, the financial world was dominated by the “Japan Miracle,” which drove up Japanese stocks and real estate prices.
In the 1990s, the overriding theme was technology. Many of us can still remember investors getting caught up in dot-com mania, and the huge bubble in tech stocks.
In the 2000s, the story that defined the global financial markets was China’s economic ascendance, which culminated in a boom in commodities and emerging market stocks.
It may be too early to define a dominant investment theme for the 2010s decade, but so far, the Federal Reserve seems to be setting the pace. It has kept interest rates artificially low and printed trillions of dollars, putting income-producing assets in extremely high demand.
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| Has the Fed fueled a bubble in high dividend stocks? |
As a result, some of the best-performing names during the recent stock market rally have been large companies in defensive sectors — stocks that offer solid growth and high dividend yields.
Sound familiar?
2010s: 1960s Redux?
The mania of the 1960s had its root in the economic and financial conditions that prevailed in the 1950s. During that decade, the U.S. economy expanded rapidly, but interest rates were kept artificially low by a government policy known as Regulation Q. It imposed strict ceilings on various interest rates, forcing investors to look beyond the bond market for returns.
They didn’t have to look any further than the New York Stock Exchange. Some of the largest names on the big board offered very high dividend yields, and were considered no-brainers. In other words, investors thought they could buy these fifty stocks and hold them forever, and get a steady stream of profits and income in return.
As we know, that strategy didn’t work out so well for them. The explosion in the prices of the stocks was a bubble, and like all bubbles, it burst.
The similarities to this decade’s bull market are striking. Artificially low interest rates? Check. Investors reaching for yield? Check. Huge gains in the price of large-cap, dividend-paying stocks? Check.
In fact, the S&P 500 Dividend Aristocrats Index, which tracks the performance of companies with long records of dividend growth (shown in the table below), has nearly tripled since the stock market hit bottom in March 2009.
What Makes the Dividend Aristocrats So Attractive?
It’s no secret why investors are flooding into U.S. stocks. Just as with every previous asset bubble, easy money is sparking the speculative flame. Central banks are flooding the global financial system with billions upon billions of dollars of liquidity each month.
In addition, worldwide economic growth remains sluggish, meaning the Federal Reserve is likely to keep interest rates near zero for a long time to come.
Many investors have huge excess savings on their hands, and no incentive to park that money in bonds that offer very little yield. In this environment, large-cap stocks that are considered to be safe, and pay healthy dividends, are logically drawing increased attention.
And it’s not just defensive stocks that are posting outsized returns …
Over the past couple months we’ve seen signs of a rotation into more cyclical sectors, such as basic materials and energy-related stocks. These sectors have been out of favor for a long time, so the momentum behind the shift could be incredibly strong. There’s still plenty of liquid fuel waiting to pour in.
Furthermore, it seems clear that the Fed and other central banks are happy to see stock prices re-inflated, because higher stock prices could lower capital costs and promote capital investment.
For these reasons, investors can expect the “Bernanke Put” to remain in place for quite some time.
What’s Ahead for these High Dividend Stocks?
The term “Bernanke Put” might send a shiver down the spines of investors with long memories. After all, it was the “Greenspan Put” in the second half of the 1990s that fanned the flame of the dot-com bubble.
But I don’t think there’s any reason for investors to worry about another stock market bubble … yet.
The S&P 500 Dividend Aristocrats Index I mentioned earlier — the one that’s nearly tripled in value in just over four years — is still trading at a Price-to-Earnings ratio of 18. Utility stocks, meanwhile, are trading at 19 times trailing earnings. These valuations are high, but not yet as high as they would be in a bubble.
In other words, if there’s a bubble forming in high dividend stocks, it’s still in the budding stages.
In addition, there’s some dispute whether a bubble will form at all. A bubble, by definition, is built on unrealistic expectations. But many investors say that defensive stocks behave like fixed-income products, so would be able to weather market corrections or shakeouts.
As of now, the jury is still out on these questions. I suspect that a bubble is forming in high dividend stocks, and that it will burst eventually. But that won’t happen until interest rate expectations begin to rise, which could be one or two years away.
Until then, investors holding these stocks can’t be faulted for sitting back and enjoying the ride.
Best wishes,
Douglas
