Regardless, it is the abandonment of dividends for capital gains to finance our retirements that has resulted in a bubble. And even in using the dividend yield (dividends divided by price), the picture painted is much worse. Stocks, even with the crash in the past two weeks are still overvalued based on the only thing that matters; dividends. We're still not even close to the historical average dividend yield of 5%. Ergo, why buy stocks now?
Of course in light of today's 600+ point rally, people are suggesting I have egg on my face and that the bottom has indeed been reached (no doubt from hence forth stocks will perpetually go onward and upward as Obama will be elected and we'll all have warm financial fuzzies). But allow me to point out two minor things;
1. What if all the increase in stock prices for the past 30 years was due to cash flowing into the stock market from retirement plans, not necessarily because those stocks were good investments making them fundamentally overvalued.
and
2. What do you suppose will happen to stock prices if not only Obama is elected, but the democrats get a veto proof majority?
Enjoy your cute little rally.
Please publish your book in audio version, with YOU narrating !
ReplyDeleteThe author tends to give emphasis to the right aspects of the ideas.
I greatly enjoy audio books, in particular the ones in which the author narrates.
Good work, always enjoyable blog (every day...)
Cheers
P
How doomed are we? Nobel laureate Paul Krugman?
ReplyDeletewow -- I couldn't agree with you more on this. To me the entire market looks incredibly over-valued. I mean consider that a modern company that yields 2-3% dividends is rather high paying to its common stock holders -- that's about what my savings account at a local bank would bring in and for a lot less risk.
ReplyDeleteThere are even some whacko companies like Sun Microsystems (JAVA) that, as policy, don't pay dividends. What is the basis for the worth of their stock then??? How is buying into that stock an "investment"? I can make a capital gain if someone in the future buys it for more than I did, but that begs the question why would THAT hypothetical person buy it? It's almost a Ponzi scheme.
I hadn't thought about the infusion of capital from retirement funds, etc. but I have to admit, that makes an awful amount of sense as to why the market is so high in comparison to dividends.
There are gains to be made from both dividends and capital gains from stock price growth.
ReplyDeleteDividends are distributions from a firm's current profits. A good, forward-looking firm might forego dividends and put profits back into the firm for investment.
Some companies, like oil companies, must reinvest about 50% of its profits for R&D, exploration, and replacement of depreciating capital.
Low dividends does not necessarily mean a bad company or a bad investment.
The price of a firm should, in an efficient market, be based on expected long run profitability.
Amazon's stock was trading at extraordinary heights while it was losing hundreds of millions a year. But now they are profitable and my predictions years ago of its demise were wrong.
Retirement investors should be investing for the long haul, so daily, seasonal, or even annual fluctuations shouldn't matter. As one approaches retirement, your portfolio should become less risky, i.e. selling stocks and buying treasuries.
Retirement funds certainly did push up overall stock prices, but that's a very good thing. It adds depth and breadth to the stock market. The problem comes only when they herd into the same risky asset classes.
When Chile privatized Social Security, it created pension funds (AFP's) with strict guidelines on risk and balance.
That is exactly the model we need to follow here.
If you have a guaranteed fixed-income pension, you can afford to be more risky in your portfolio, but fewer and fewer people have a defined-benefits pension plan anymore and some of those companies, like GM, are going belly-up.
All your eggs in one basket (job and stock) is absolutely idiotic!
This is ignoring the fact that due to the demands of shareholders more and more corporates are doing sharebuybacks instead of dividends. From 2003 to 2007 S&P 500 companies spent $1.7tr doing share buybacks.
ReplyDeleteThe Arnott-Bernstein research paper does an excellent job explaining why stocks are still overvalued.
ReplyDeleteTheir point is that the 8% assumed annual stock market growth is based on several historical events that have no guarantee of repeating. For example, going off the gold standard. We can't do that again, so the effect on stock risk premiums will not be repeated.
What many people keep missing is that no one is making an argument AGAINST STOCKS.
We are making an argument against buying them at their current valuation.
The global financial bubble we were in, coupled with the relentless flood of baby boomer retirement investment dollars has pushed stock valuations too high.
Right now, the best place for IRA/401k dollars is in the safest assets possible.
When traditional valuations are reaced, that will be the time to buy into stocks. The so-called long term strategy can lose you a fortune in an extended bear market.
Why should IRA/401k investors blindly stay in the market while much of the value is being lost.
A famous quote: Every game has a sucker. If you don't know who it is, it's you.
I finally found the link to your previous article and now I see where you're coming from.
ReplyDeleteIf all this "new money" comes into the stock market, it artificially increases prices above their "correct" level of expected long-run profits. Perhaps there is a market failure.
But one would have to wonder if this money really is "new." If the employers didn't match 401(k) funds, would that money have not been in the stock market? If it were distributed as dividends, would the stockholder spend it or roll it over into more stock purchases?
Some people believe the housing bubble was actually caused by a "search for yield." After interest rates dropped, real estate became the best investment. But why did stock prices remain so high? We had a lot of foreign money pouring in because of great returns and the low value of the dollar.
Well said. I've long noted (much to the displeasure of many of my coworkers) that my company was trading right where it belonged--at the lower end of the acceptable P/E range due to its history of inconsistent profits. Now you add the reality that returns need to be real in the form of dividends.
ReplyDeleteYet another area where tax code, which punishes dividends but (relatively) rewards capital gains, is distorting corporate governance and ruining things for everyone.
I can't quarrel with your premise, but I think you need to look at individual stocks. Warren Buffett, no fool he, recently bought big equity shares in Goldman Sachs and General Electric. Buffett seems to look at the individual companies for good values other than the market as a whole.
ReplyDeleteI posted this at Small Dead Animals. Thought it might be valuable for this discussion.
ReplyDeleteFrom http://www.eipny.com/pdf/FreeCashFlow01092006.pdf by William W. Priest
Chief Executive Officer, Chief Investment Officer & Portfolio Manager
Epoch Investment Partners
"There is more to this than just dividends. A corporation has has only five real options when considering how to use its cash. The first two options, acquisitions and internal capital projects, require that the return on incremental capital deployed by management exceed the average return on capital currently earned. If this criterion cannot be met, then the cash should be returned to shareholders by means of the three remaining options for free cash flow use: cash dividends, share buybacks and debt reduction. Together, these three options define shareholder yield, a more inclusive determination of relative value."
Taking all of these factors into account presents a picture that today's stock valuations are marginally below long term. That being said, there are stocks that have much higher valuations when using a free cash flow model than their current market value. I suppose this is why Buffett is so bullish.
Cap'n:
ReplyDeleteWhat is not really factored into this equation are three features of the current S&P 500 landscape.
1) How often is it that three of the top 20 companies in the S&P 500 are companies with a combined market cap of 310 billion, trade at an average 18 times P/E, and pay no dividend? CSCO, GOOG & AAPL (to further Nate's point).
2) The entire retirement landscape changed in 1980 when the 401k came into being. As companies phased out pensions for the 401k, more and more money is being sunk into the S&P 500 since the laws are written so that you can't have too much risk in a 401k plan and therefore most 401k plans include a index fund.
3) Island ECN & Datek Online. two companies tore down the walls that traditional brokerage erected to restrict access to the markets. I can remember seeing my grandfather's trade confirmations, costing him as much as $125 on a 100 share trade of IBM (in the 80s). Island ECN enabled electronic clearing of stock trades, and Datek dropped that per-trade price down to $9.99. As access to the stock market (And the S&P 500) became a "Wide Moat" to a "No Moat" business, where companies now compete on execution time, pricing, and online features, more money that would have been sitting in cash accounts in a bank found its way into the stock market because who wants to earn rates just above inflation on long term investments when the average 10 year return (since 1926) is 12.76% (without even re-investing those dividends).
Duratek here,
ReplyDeleteWE currently sit with SPX dividend yield near 3.57% and PE ratio of around 17, but the experts have 2009E earnings at $90 !!! The recent trough was near $40 in 2000 what if we reach $40 again (take out financial and energy co's ability to help) at even a 10 PE we would get a bottom of current rout near SPX 400 DOW 4,000 maybe SPX 600 or DOw 6,000.
Previous Bear was not allowed to do its job, SPX landed 35 PE 2% div yield (more like a TOP!!!)
take out historic consumer spending (no more home atm) and YOU tell me what drives spending and earnings going forward?
IN attempt to override a return to the mean, FED had nearly DOUBLED the monetary base n JUST 2 months...goodluck
D
Even conventional financial commitment consultants are suggesting that property owners re-finance their present loans. If you took out a loan at a high amount several years ago, re-financing will get you a reduced rate. happy retirement
ReplyDelete