February 18, 2009 Letters to the Editor
Updated: February 26, 2009.
Further to my post from late last year re. risks to Dividend cuts and impact to DVY
I received this letter from Michael.
Hi John - Late last year I questioned whether given the financial turmoil, if we should expect cuts in dividends to be greater than historically the case simply because even prudent and sound companies could potentially see sources of financing cut off / much more expensive and cutting dividends may in fact be necessary or in fact wise.
Over the last couple of weeks, we have seen DOW cut their dividend for the first time ever (by more than half) and Pfizer do the same. I don't know if this is necessarily representative or a leading indicator as both have very specific merger-related costs to contend with. However, as an extension, thru today (2/17/09), the S&P has lost 13% YTD while DVY has lost a whopping 25.5%... I have no idea if the market on some of the Dividend names is overreacting, but simply a word of caution: you could potentially be facing the double whammy of less income via the cuts and a portfolio that is substantially down even on a relative basis as the market tends to hammer these companies that cut dividends.
Not at all trying to discredit the very sounds, dividend investing philosophy, but thinking from a pure risk management perspective, you need to know, like everything else, there is no free lunch...
HERE IS MY RESPONSE
Thank you for excellent insights.
Many dividend investors seek only a stable, growing income stream. They are not overly concerned with prices. DVY’s price decrease, although painful, is not a critical factor.
I believe that we will do better to focus directly on earnings than on dividends when judging a company’s financial health. I think that you are right concerning the negative impact of reduced financing, especially from sources other than banks. I think that many of our Government’s actions are making matters worse.
I view a dividend cut as a compelling, immediate signal to sell. I have paid a financial penalty every time that I have allowed myself to do otherwise. Somehow, the bad news never ends with the first dividend cut. This is known as the cockroach theory. There is never just one.
Nevertheless, I have allowed myself to hold onto such an investment at times. I still own my 100 shares of Fannie Mae FNM. I am to blame. It was my own fault. I knew better.
Here is additional background material from the Graphs page (button on the left). DVY has recently lowered its quarterly income by 20% from its peak. It is down about 10% from the trend.
S&P500 Dividend Theory
DVY Dividends
When We Hit Bottom May Not Matter As Much as Some Think
I received this letter from Rob Bennett.
I enjoyed your article on "Turning Points E," which explores the question of when the stock market will hit its bottom. It's an insightful and unique article on an important topic.
I wanted to add a caveat that some (including me if this hadn't been brought to my attention by a post that was put to the Bogleheads.org board) might otherwise overlook. Stocks can offer a great deal in the years before the market hits a bottom. I have recorded a podcast that has not been posted yet that explores this question in some depth. It is RobCast # 71 -- The Bull Market Started in 1975, Not 1982.
I have often said that the great bull started in 1982. That's the conventional wisdom on the question. I believe that this is because the market hit its valuations bottom in 1982 and then started up and continued going up for 18 years.
However, the best time to get back heavily into stocks was 1975, not 1982. There were some drops in valuations from 1975 through 1982. But the stock market offers an average annualized return of roughly 6.5 percent real in times when the P/E10 level remains stable. Small drops in valuations do not bring the return enough below that to make it a good idea to be out of stocks. The full reality is that stocks offered strong returns all the way from 1975 through 2000.
I see great value in exploring the question of when we will hit bottom. Knowing the odds of various outcomes helps us to understand stock investing better and understanding stock investing better helps us to gain confidence in our long-term strategies. We need to see more of this sort of article.
I just don't want people to get the mistaken idea that it is a good idea to remain out of stocks until we hit bottom. No! This is black-and-white thinking. Black-and-white thinking is characteristic of Passive Investing, not Rational Investing. It could well be that we will not hit bottom for many years but that now is the time to be increasing one's stock allocation all the same.
The question is always -- Do stocks offer a strong long-term value proposition today or do they not? Stocks offer a strong long-term value proposition today.
The benefit of understanding when we are likely to hit bottom is that this knowledge helps us to prepare ourselves emotionally for what is going to play out in coming years. Many Passive Investing advocates are still thinking that the return to reasonable price levels was some sort of mistake and that we may soon be returning to the dangerous price levels that applied from 1995 through the first part of 2008. Those holding that mindset will become discouraged if it takes years for us to hit bottom. So they very much need to be informed that it may be years before that happens. I think they also need to informed that it can be a big mistake to wait for the bottom before increasing one's stock allocation back to the levels that applied before the bull market got truly out of control.
HERE IS MY RESPONSE
Thank you for addressing an important issue.
Waiting for a bottom is a serious mistake. Being on the sidelines temporarily while the knife is falling is not. These studies show that you can act prudently. You never need to buy in a rush. You never have to sell in a panic. You do need to be aware of valuations and your likely range of outcomes in the reasonably defined future (ten to twenty years).
We should not expect the market to duplicate history exactly.
One thing that these Turning Point studies bring out is the wide range of possible future outcomes. Markets can rise and fall rapidly or slowly. Markets can rise and fall sharply or gently. We need to prepare ourselves for all reasonable possibilities.
We can use the Stock Returns predictor to prepare for the future. The emotional issues are the most important by far. Knowledge of how the future may unfurl helps us build our confidence as we go along.
I was very pleased to reach the final conclusion of Turning Point F. Our methodology is generating results that calculate the most likely peak to peak or valley to valley market variations of 34 to 35 years. Yet, the range of possible outcomes is very wide.
Strategy Tester!
I received this letter from Michael.
Congratulations on getting that up and running...just started playing with it and it looks great. More feedback as I play around more.
HERE IS MY RESPONSE
Thank you. It is a wonderful tool.
I suspect that it will have many applications that I have not imagined yet. That was my experience with the original Scenario Surfer.
I just hope that we can correct the bug right away. It prevents the use on some computers. This includes my wife’s.
The Investment Strategy Tester
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