Most people look at investing in bubbles as a human weakness. The investment lore is filled with tragic stories of people investing at the top of crowd mania. You don’t have to look far on the investment horizon to see the carnage. The fabulous run up in value of single family homes culminating in the giant collapse of value of house values we are into now, the dot.com bust and attendant tech crash in 2000- 2002 and to a lesser extent the fabulous appreciation of stock prices in the 80’s and 90’s that created a decade of sub par returns in the 21st century to date. I used to look askance like most people at bubbles and tried to stay clear of them until a clever friend of mine, said he wanted to find the next bubble, and the bubble after that. You want to invest in bubbles actually he insisted. You just have to be early.
Now I know that still sounds like financial heresy. But thinking out of the box is how you make money in the markets, not crowd following. For example there is some reason to believe we are in the throes of a zero interest rate bubble right now. After all long-term Treasury bonds went up over 20% last quarter. When the safest least risky asset can go up that much in value, I don’t know how you could characterize it as anything other than a bubble. Don’t you wish you had foreseen that. One popular Wall Street pundit, I know did foresee this very thing and wrote a book in May 2010 promoting this theory to some degree. Gary Shillings, Age of Deleveraging strongly advocated long-term and zero coupon U.S. Treasury bonds.
So with that in mind, I challenge the Sax Angle readers to think about where the next bubble will be. I wrote back in early December, about the need for the $17 trillion in retirement assets that are searching for yield. Most public and private retirement plans have built-in assumptions about what kind of benefits they will have to pay out and the rate of return needed to provide the cash flow at the time of required payout. Most of these plans assume they can make between 7-8% on their assets under management. That’s absolutely impossible today in any fixed income investment unless it’s junk bonds. Retirement assets are conservatively invested by nature as they should be and they are not going to invest in junk bonds.
So where is the $17 trillion going to go? I’ll tell you. There is only one place logically it can go. That’s in blue chip type dividend yielding stocks. Just look at the Dogs of the Dow, a popular theory that picks the top 10 yielding Dow stocks in January and holds them through the year. As of Dec. 21, this strategy has returned 12.5% on appreciation. Add another 4-5% for dividends and you have a total return yield an eye-popping 17% or more. Now that’s what I’m talking about.
The S&P Dividend Aristocrats, SDY, yields as expressed by the ETF that emulates it yields around 3.3%. The actual yield is probably .36% higher than this when you account for the ETF management cost. The Dividend Aristocrats are a list of large cap blue chip stocks that have increased their dividends for 25 consecutive years or more. Considering many of these company’s pay less interest on their corporate bonds than their dividend yield, one could make a strong argument that this yield will go down as the stocks appreciate in value. If the risk free 10 year treasury remains at or below 2%, it’s easy to make a case where the dividend yield of these Aristocrats could go below this where historic dividend/treasury yield ratios have been.
The SDY closed on 12-21 at $53.44 and paid out a dividend in the latest quarter of $.507 or at that rate $2.02 per annum. So assuming the dividends are kept current (oxymoron), let’s talk a look at the price action that would have to occur for the yield to drop to 2%. Just divide the annual dividend of $2.02 by .02(2%) and you get a price of 101. In other words the SDY ETF would have to rise by $47.56. That’s an 88% plus return. Now that’s the kind of bubble investing I can handle. How about you?
It’s important to note that investing in this ETF SDY has NOT been a great investment over the last several years. The SDY for the last five years has returned an annualized 1.58% but YTD is up 6.47%.