Just as there are no atheists in foxholes, there are also no strangers at cocktail parties. Every guest, supposedly, has some connection to the host, and when that shared status is leavened with a few Grey Goose martinis, some interesting, albeit not always memorable, conversation can ensue. The stock market was once a standard topic among both friends and veritable strangers, but when the markets became more a source of frustration than of bragging rights, the movements of the Dow Jones surrendered to that other staple of common interest, at least among men--sports. Several months ago, when volatility ruled the trading day, I couldn't help but join in and signal my interest when the stock market was being dissected between nibbles at the olives among a few of those otherwise strangers.
My conversation partner got around to asking me if I was worried about the market, and I replied that, yes, I was somewhat worried about it.
"How low do you think it will go?" this gentleman asked, as if he were just about to receive a bad report from his physician.
"Oh, I'm not so worried about the market going down. I'm worried that it will go up too much," I replied, hoping he would take the bait. He did.
"You must be short," he insisted.
"Five-eight, actually. But no, I don't short stocks." More bait.
"Well then why would you be worried about the market going up?" he demanded, obviously in need of the bartender.
"Because," I explained, "if the market goes up by some tremendous amount, and it's starting to look like another speculative asset bubble, then I am going to be compelled to sell some of my stocks. And then I won't have anywhere to invest the proceeds."
He acknowledged his empty glass and excused himself. I never saw him again.
Back in the early 1980s, as President Reagan took office and just before Fed Chairman Paul Volcker declared war on inflation by ratcheting up interest rates, thus plunging the U.S. economy into a recession, it was possible to take $500,000 and invest in 30-year Treasury bonds, then yielding north of 12%, thereby locking in annual interest income of $60,000+. That may not sound like a fortune, but with the mortgage paid off and the kids out of your house--and your wallet--that's a nice guaranteed annual income for retirement. Today that same $500,000 invested in 30-year Treasuries at 3% would get you a whooping income of $15,000 per year. Low interest rates are great for the economy, for businesses, for stocks, and for people who are buying a home or refinancing a mortgage (borrowers, in other words). Higher interest rates would certainly choke off the economic recovery, so we definitely don't want rates to go higher. The only problem, though, is for savers who need to invest for income, and I think many people just don't realize how challenging it will be to replace their current earnings income in their retirement years.
What to do about this? As Chief Brody (Roy Scheider) in Jaws said to Captain Quint (Robert Shaw) after Brody first saw the Great White up close while the men were on their shark hunt at sea, "You're gonna need a bigger boat." The most obvious solution is that people are going to have to save more over a long period of time so that they will end up with a larger retirement portfolio in their golden years. It's going to take a greater amount of assets to generate a dollar of annual income once those assets are invested to establish an income stream. A bigger boat, indeed. It also means that people need to start saving and investing early, and that their investments need to be focused on growth--the general rule is that the more years you have until retirement, the greater percentage of your assets should be invested in equities to generate that growth. While there is no "one size fits all" rule for financial planning, for most people it makes sense to have significant exposure to stocks when they are young, and then slowly reduce the allocation to stocks and increase exposure to fixed-income (bonds) as they get closer and closer to retirement.
The bigger picture here is that as bond yields have fallen, bonds prices have risen. In order for bond prices to increase, interest rates would have to decline from current levels.There are some prognosticators who say that this recovery will not last and that yields will fall even further. However, if we tally up all the reasons why interest rates don't have much further to fall, it's hard to make a case that bonds are not over-priced. Foreign buyers of Treasuries continue to finance our government's appetite for debt, and the political will to meaningfully reduce the budget deficit seems nonexistent. Easy money from the Fed could ignite inflation down the road. On balance, the forces are arrayed to move interest rates higher (and bond prices lower), not meaningfully in the other direction. Even with the recent rally, stocks still appear more reasonably valued as an asset class than bonds.
Some articles in the financial press have warned of a potential "dividend bubble," as investors chase those stocks that pay attractive dividends. So just where is there any evidence of such a speculative bubble? Johnson and Johnson (JNJ, $65) has a dividend yield of 3.5% (higher than the 30-year Treasury, and JNJ has a better credit rating than the U.S. government); the stock is up about 1.3% over the last six months. Abbott Labs (ABT, $55) yields 3.48% and is up about 10% since August. Pepsi (PEP, $63) yields 3.2% and is up less than 1% in six months. Why have these stocks not risen more? Well, because some of the better dividend-payers are in the consumer staples sector, which typically offers stable earnings, but investors turn their focus to higher-beta, more economically sensitive stocks when the economy is improving. As a result, some of the more reliable dividend-payers are still offering up about the same attractive yields they offered before this most recent move up in the market.
When sizing up dividend-paying stocks, I always look for companies that still have potential for growth and where the dividend payout ratio is no greater than about 65% of earnings. This means that the companies can still invest some of their earnings for future growth--and that the dividend is well-covered by those earnings. The relatively stable earnings we find in consumer staples and healthcare are a plus here. I also like companies that have a solid record of increasing their dividends year after year. The one thing the U.S. Treasury--or any bond issuer, for that matter--will never do is increase the amount of interest you receive each year. If you invest $100,000 in the 30-year bond, you'll receive about $3,000 in interest payments for 30 years. That same $100,000 invested in high-quality stocks of companies that have shown a commitment to returning money to their shareholders has the potential for a much higher total return, a combination of growing dividend payments and capital appreciation.
Of course, dividends, unlike interest payments on Treasury bonds, are not guaranteed. That is why bonds are the preferred investment for people in retirement, because that interest is their only source of income, and it has to be safe and secure. When you are receiving the gold watch, that is not the time to be buying Apple (AAPL, $523, no dividend). So just what qualifies as a "safe" investment? The risk in long-term bonds, at these interest rate levels, is that inflation will flare up and erode the purchasing power of our $100,000 principal and the $3,000 in interest we would collect every year. That's why we need to distinguish between nominal returns and real returns, the latter taking account of inflation. The only conclusion I can reach here is that bonds, at these interest rates, are not as safe as some would have us believe, and that the types of stocks I've mention are not, relatively speaking, as risky as some would have us believe. Our conception of safety should include more than just the guarantee that we'll get our $100,000 back at the end of 30 years.
The stereotypical image of retirement has Grandma and Grandpa driving across the country in a Winnebago, stopping off at 4:30 for dinner at the Cracker Barrel, and turning in early for the next day's trip to the new fishing hole. The financial assumption here involves our elderly couple living off of just the interest and dividends from their investments while never touching the principal, which they would leave to their heirs. I just don't know any retired people who live that life. The folks I know who have the most rewarding retirements no longer spend the hours of nine to five at their jobs, but many of them are still earning something from their old careers. As one example, I have a friend who owns his own consulting business. He has also written a few books, so I imagine that when the day comes that he leaves the office behind, he'll either still write books or collect some earnings from the ones he has already had published. The ultimate key to retirement planning may be to continue, in some form or fashion, the income from your lifelong career. In that case, investment returns, whether they be from dividends, interest, or capital gains, make for a nice way to supplement your lifestyle.
Just remember that the bigger boat we need is not that Winnebago, but instead a portfolio that needs to grow in value over many years. And, for the relatively young, remember the investment advice from The Rolling Stones: Time is on my side.....
Life is short. Get busy.
Jim
Disclosure/Disclaimer: My family members and/or I own shares of AAPL, ABT, and PEP. Stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as investment advice or the recommendation to buy or sell any security.
No comments:
Post a Comment