Tuesday, 29 March 2022 — Gold Coast

By Vern Gowdie Editor, The Daily Reckoning Australia

[8 min read]

• Investment income is NOT one dimensional
• The 4% line in the sand
• Lessons from the 2020 COVID correction
• Dividends, like interest rates, are variable
• Learn from history or your capital will be history

Dear Reader,

Interest rate suppression backed yield-starved investors into a corner.

They were forced to seek out (or remain invested in) higher yielding investments.

The recent volatility on Wall Street, combined with the RBA’s belligerent approach to maintaining NEGATIVE real (after inflation) rates, means investors are now facing a serious conundrum.

More and more people have been asking me, ‘What should I do?’

Well, the options are rather limited:

1. Go…cash up and be content with the ‘return OF your capital’.
2. Stay…remain invested and receive a ‘return ON your capital’.
3. Or…a combination of 1 and 2. Reduce exposure to markets and increase exposure to cash.

When presented with these options, the ‘cake and eat it too’ responses generally follow.

‘If I cash up, then I’ll earn next to nothing on my money.’
‘If I stay invested, the market could fall further.’

In my experience, investors invariably want the best of both worlds…the security of cash AND the yield of shares.

The late Bernie Madoff had a product offering the same characteristics…it didn’t work out so well for Bernie or his investors.

Wall Street’s recent recovery has somewhat slowed investor pulse rates.

Is this ‘recovery’ a sign of things getting back to normal OR an uneasy calm before the mother of all storms is unleashed?

Personally, I struggle with the ‘things getting back to normal’ option.

The old normal — that created the greatest asset bubble in history — did not have food shortages, rising energy prices, higher inflation, upward pressure on global interest rates, newly drawn geopolitical fault lines, and murmurings of nuclear war to contend with.

Underneath the surface, something big is building. There are stresses and tensions in this highly leveraged system that are yet to be publicly revealed. When they are, anxiety and volatility levels will mirror each other.

To make an informed decision on whether to stay or go, investors who’ve chased dividend yield need to look at the entire investment story…not just the one dimension of higher income.

You need to consider ‘What’s the capital price to be paid for that additional income?’

The 4% line in the sand

In the years following the GFC, the All Ords struggled to match the S&P 500’s performance.

Why?

I think it was because of the interest rate differential.

In the US, rates went to zero and stayed there.

Whereas, here in OZ, we were still receiving more than 5% on cash and term deposits.

In weighing up the risk versus reward equation, popular thinking went something like this: security of capital plus 5% versus market risk plus 4–6% dividend.

That risk versus reward equation changed when the RBA decided to get serious about punishing savers and rewarding borrowers.

My gut feeling tells me a 4% interest rate was the line in the sand for investors in need of income. When that line was crossed, investors started looking around.

According to the RBA’s own spreadsheet, deposit rates dipped below 4% in January 2014:

The Australian Financial Review offered anecdotal evidence of the 4% line on 19 February 2014:

‘…investors in Australia turned to shares of the big four banks as cash rates were cut…’

As they say, ‘Why be a deposit holder when you can own the bank?’

Higher yielding bank stocks were (and still are) the popular choice for those yield-seeking investors.

Let’s assume our prudent (former term deposit) investor (with $500k) decides in January 2014 to invest in the bluest of blue-chip, dividend-paying companies…the Big Four PLUS Telstra (which, at that time, was paying a very high dividend).

This might surprise you, but since January 2014, four of the five blue-chip stocks have been in negative territory. The exception is…Commonwealth Bank.

On an equally weighted basis ($100k in each stock), over the past eight years, the blue-chip portfolio has been down…MINUS 6.5%:

The original $500k portfolio is, at present, valued at $467.5k.

Ah, but what about the income?

On a simple maths basis, let’s say the portfolio’s grossed-up yield average is around 6%.

Over an eight-year period, this contributes around 50% to overall portfolio performance.

With the combination of capital and income, the total is…$717.5k.

Assuming cash/term deposit rates averaged 2% over the same period, capital and income in the bank would be around $580k…about $135k less.

It appears to be an open and shut case for the higher yielding blue-chip shares.

But nothing in the investing world is ever so simple or straightforward.

Lessons from the 2020 COVID correction

Prior to the COVID crash in March 2020, our blue-chip portfolio was down, on average, about 15% in value.

Add back six years of dividends (at 6% per annum), and the NET positive from January 2014 is around 20%.

Not all that much better from money in the bank…six years at 2% per annum. An extra few percent but with a lot more risk to capital.

And we got a glimpse of that capital risk in March 2020.

At its lowest point, the portfolio was MINUS 39%; the original $500k was down to $305k. OUCH!

Add back six years of dividends and you’re just about back to the $100k breakeven.

By comparison, in March 2020, money in the bank would have been around $560k.

Yes, I know, the market has recovered, and a snapshot of March 2020 is now purely academic…maybe, maybe not.

What happens if next time the Fed cannot manufacture a rapid recovery?

Capital value stays down AND…

Dividends, like interest rates, are variable

Dividends are NOT cast in stone.

Like interest rates, they too can rise, fall, and stagnate.

In 2014, Telstra was paying a dividend of 29.5 cents per share. Today, Telstra’s annual dividend is 16 cents.

Not only has our 2014 investor had an almost halving in dividend, but the Telstra share price is also down 25%:

During the COVID crisis, the banks also reduced dividends.

As an example, the CBA, prior to March 2020, paid an annual dividend of $4.31 per share.

In 2020/21, the dividend shrank to $2.48 per share and is now back to $3.75 per share:

PLEASE NOTE: The share falls (four of the five stocks) and dividend reductions have occurred in the GOOD times…what’s going to happen when the greatest asset bubble in history final does blow its top?

Learn from history or your capital will be history

Investors who bought into the ‘higher yield’ narrative might like to take heed of what happened to US blue-chip shares in the Great Depression.

In February 2017, I wrote an article about the impact the Great Depression had on ‘blue-chip’ companies to pay dividends.

Here’s an extract:

‘In 1929, the [S&P 500] index produced average earnings of US$22.60…three years later, earnings had fallen to one-third of this figure.

‘It took nearly 20 years for earnings to reach the US$22 level again.

‘When a share market suffers a fall of 80%, you can be assured there will be economic consequences. People have less money to spend. Less money going through the cash registers means less corporate profits.

‘If businesses are earning less, guess what happens to dividends?

‘They are reduced or even, cancelled.

‘In Barrie A Wigmore’s rather lengthy book The Crash and Its Aftermath: A History of Securities Markets in the United States, 1929-1933, there’s a treasure trove of data on what happened to shares during the Great Depression.

‘Here’s a selection of blue-chip companies and the level of share price fall suffered from 1929 to 1933 and dividend being paid in 1933.’

Three of the seven ‘blue-chip’ companies ceased paying dividends. The other four appeared to be paying a high level of dividends…but, as mentioned earlier, in the investing world, nothing is ever simple and straightforward.

Take Gillette…paying a 13.77% dividend.

On the surface, this looks good.

However, that dividend percentage was calculated on a share price 95% lower than it was four years earlier.

Here’s the maths:

‘To keep this exercise simple, we’ll work in whole numbers:’

In dollar terms, the dividend shrank more than 80%…from $4 per share in 1929 to 70 cents per share in 1933, AND the share price fell 95% in value.

The only difference between Gillette circa 1930s and Telstra is that the percentages are bigger.

But it’s the same principle.

The lesson from 1929 (and the COVID correction) is that when the share market goes through a significant correction and the economy struggles to respond to stimulus efforts, dividends will be cut…and cut hard.

If you think it’s difficult now to live off a 0.5% return on 100% of your capital, what will it be like living off a reduced dividend payment on less than half your current capital value?

Knowledge pays the best dividends.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning Australia

By Bill Bonner Editor, The Daily Reckoning Australia

Dear Reader,

As predicted…rich Russians are using the US’s sanctions war to get richer.

Bloomberg:

‘…almost one month of suspension, shares in Moscow climbed, with the benchmark MOEX Russia Index rising as much as 12%. While only 33 stocks resumed trading, Russians with fortunes linked to them added $8.3 billion combined, according to the Bloomberg Billionaires Index tracking the wealthiest 500 people in the world.

‘Scores of Russian billionaires got sanctioned by the European Union and the U.K. after the Kremlin started its war against Ukraine. Some got their possessions in those jurisdictions seized, and others rushed to shift ownership of their stakes while they still could. But for the 10 tycoons whose shares resumed trading, the advances were adding to their paper gains.’

Western sellers dump their stocks at fire sale prices. Who buys them, for pennies on the dollar? Russians!

Bonehead central

Oh, what a wicked world! A pistol in every hand…and every target has toes. The whole sanctions program is backfiring…driving Russians, Chinese, Iranians, and Indians closer together…hastening the decline of the dollar-dominated international money system…raising prices for US consumers...slowing US economic growth…and leaving the oligarchs with more real wealth than they started with.

Whose boneheaded idea was it to get involved in this Russo-Ukrainian squabble anyway?

That is our subject for today: Where do these boneheaded ideas come from?

Chelsea Clinton didn’t have to figure things out entirely by herself. She attended Stanford and Oxford, for example. But we have it on the authority of German journalist Ernst Wolfe, who may be a complete crackpot for all we know, that she has another alma mater, not listed on her Wikipedia page.

Run by the World Economic Forum (sponsor of the Davos shindig…where rich influencers fly in on their private jets and lecture the middle classes against using gas ovens)…it is by invitation only.

And the list of those who wear the school colours is breathtaking: Larry Fink, Larry Page, Christine Lagarde, Emmanuel Macron, Justin Trudeau, Gavin Newsom, Mark Zuckerberg, Bill Gates…almost the entire company of the great and good…captains of industry…cherubim and seraphim…the leaders of the New World Order…the indefatigable improvers of the world we live in. Yes, it’s a very elite club, dear reader, and you ain’t in it.

Some reports put the number of ‘Davos Deciders’ in the thousands. Indeed, if all these people were laid end to end…well…that would be nice.

The (dis)invitee list

Conspicuously absent from the list is Donald J Trump.

The elite never accepted Donald Trump. Out of control. Shooting from the hip. He said what he thought. And often, what he thought was neither very smart nor very nice. Most importantly, it was ‘off message’. That’s why the media worked so tirelessly to unseat him, claiming that the election of 2016 was illegitimate because of Russian interference. The charge was preposterous from the get-go. Everyone was trying to influence the election; there was no plausible reason to think that the Russians, with a very limited budget and very limited reach, would have had any effect.

The mainstream elite saw ‘The Donald’ as a threat. It turned out they had nothing to worry about. Instead of dismantling the elites’ programs…he expanded them. He didn’t close a single overseas military base. He didn’t cut a single dollar from the federal budget. He went along with the COVID panic…pushed for even lower interest rates…and then borrowed, spent, and printed more money than any president in history.

Also not among the distinguished alumni of the WEF is Russian President Vladimir Putin. He explained why in a speech on 18 October 2021; he wanted no part of it:

‘We see with bemusement the paralysis unfolding in countries that have grown accustomed to viewing themselves as the flagships of progress. Of course, it’s none of our business…the social and cultural shocks that are happening in some Western countries…Some believe that aggressive blotting out of whole pages of your own history, the affirmative action in the interest of minorities, and the requirement to renounce the traditional interpretation of such basic values as mother, father, family, and the distinction between sexes are a milestone…a renewal of society.

‘…The recipes they come up with are nothing new…the Bolsheviks followed the dogmas of Marx and Engels. And they also declared that they would go in to change the traditional lifestyle, the political, the economic lifestyle, as well as the very notion of morality, the basic principles for a healthy society. They were trying to destroy age- and century-long values, revisiting the relationship between the people, they were encouraging informing on one’s own beloved, and families. It was hailed as the march of progress. And it was very popular across the world and it was supported by many. As we see, it is happening [again] right now…

‘…when great authors of the past such as Shakespeare are no longer taught in schools and universities because they [are considered] as backward classics that did not understand the importance of gender or race.’

But the assault on the past goes beyond the ‘woke’ values of California and East Coast universities. Of special interest to us is the attack on traditional money; that’s where the real damage will be done. Today, the dollar is being intentionally inflated and sanctioned away.

And now, the feds have no choice. Stuck in an ‘inflate or die’ trap, either they inflate the dollar and destroy the US’s middle class…or they crash the stock market, the economy, and much of their wealth and power. The elite deciders will make the call. Which way will it go?

Regards,

Bill Bonner,
For The Daily Reckoning Australia