It’s all about the divvys bout the divvys bout the divvys no cap gains.
Did he just butcher a Megan Trainor song? This blog has officially hit a new low. She’s not even attractive.
Whatever, Italics man. I dare you to get this song out of your head. It’s scientifically impossible.
Wait. Stop everything.
I’m sorry. I’m so sorry. Italics man is right.
What are we talking about again?
(Furiously studies notes)
(Realizes he has no notes)
Uh, let’s start over.
I’ve been hearing a great deal about how a dividend bubble is forming in the market. Basically, people contend that because there are no decent fixed income yields out there, investors are forced to move into equities, REITs, and other riskier assets in search of yield. This has really pushed up the valuation of traditional dividend growth stocks, which the naysayers contend is a bubble.
I think my favorite personification of a dividend bubble might be Realty Income (NYSE:O). Even after falling nearly 20% off its recent highs, it still only pays investors a yield of 4.1% and trades at 20 times adjusted funds from operations, which is essentially a REIT’s version of free cash flow. It has a market cap of $15.2 billion versus a book value of $6.8 billion because hey, who doesn’t want to pay double market value for a bunch of strip malls in suburban Atlanta and Houston?
Realty Income is overvalued because it has been able to deliver consistent dividend growth for about the last 15 years, and baby boomers who need income to retire absolutely LURVE IT. They don’t care about the value of the assets. They care about the income these assets spin off.
It isn’t just the dividend growth guys who are all about the yield, either. Damn near every baby boomer I know asks me about some monthly dividend-paying stock, usually the ones that yield more than 5%. They’re looking for a way to convert their meager savings to income, and what better way to do so than buying stocks that yield 6, 8, or even 10%?
No fixed income
Back in the day, getting dependable income from your investments was easy. You’d put the cash in the bank, collecting 4-5% in annual income from a GIC and move on with your life. If you had a paid-off house, a decent pension, or even just CPP and OAS, you’d have enough to survive without touching the principal.
Things are a little different in 2016.
Getting more than 2% on a GIC without some pretty major restrictions is tough. Other fixed income products aren’t much better. The largest bond ETF yields a whole 2.8%. Preferred shares yield more, but they got annihilated a few months ago before recovering a decent amount.
Some investors are scared shirtless of bonds too. They’re convinced we’re in a bond bubble, and a world of hurt will be in store for investors who load up on the asset today. Interest rates are bound to return to normal levels.
Dividend bubble: more supply than demand
On the one hand, we have a giant glut of people who are going to start investing for income. They have to. There are no other reasonable alternatives, and they need to start converting cash to cash flow.
Where do you think this capital is going to head? There’s only one logical solution. Stocks are easy enough for the average Joe to understand, and he can easily build a diversified portfolio using a balanced fund or one of the dividend ETFs. Some might go to mortgage funds or high yield debt too, but for the most part it’ll stay in stocks. We love stocks.
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Then there’s interest rates. As rates go up, so will demand for previously shunned fixed income products. Poof! There goes your dividend bubble.
I used to think rates were going higher. I even wrote a post encouraging people to lock in their mortgage for 10 years at (gulp!) 3.99%. Now I know better. I have a variable rate mortgage today, and I have no intent to lock it in. Because rates aren’t going up anytime soon, if ever.
Canada’s economy is a garbage fire right now. Oil is more depressed than stupid sad Eeyore. Retail sales are bad because we’re up to our eyeballs in debt. And the government is actively trying to kill our only hot sector, housing. Thanks a lot, Trudeau. At least pot will be legal soon.
We can’t afford to raise rates
Can you imagine what would happen to the average consumer if mortgage rates went up 2-3%? I can. It would be a fate worse than debt for many people. So many people would be screwed. Just screwed.
It’s not just individuals who would be in rough shape. Western governments have borrowed like crazy in an attempt to fund long-term spending plans. That’s a prudent move by governments during an era of low rates, and they can afford the interest. It’s harder to afford the interest at 3% or 5%, and at 8%, it’s over. Every government in North America and Western Europe would be insolvent.
Take a look at Japan if you don’t believe such a thing can happen. They’ve had essentially zero rates for decades now, and it hasn’t jump started that economy.
Basically, the argument goes like this. There’s no dividend bubble because the thirst for yield is higher than the supply. Interest rates should stay low for a very long time, which will force savers and retirees into riskier assets looking for higher returns. There’s no other alternative.
More and more companies will raise dividends because they can’t find decent investment alternatives. Plus they’ll want to attract investor cash.
Even if a crash comes and knocks down Realty Income and other stocks like it 20%–and it will come, it’s only a matter of time–retail money looking to lock in decent yields will come flooding back in. If we are in a dividend bubble, we have a long way to go until it pops for good.