Sunday, February 11, 2018

Reversal to the Mean - Stick with Dividends - A Message from TheMoneyMadam

If you are trying to make sense of this market, consider that it is different this time. 

  • Internet and technology stocks with no earnings only hyped up hopes fueled the "Dot Com" bust in 2000
  • Major credit market disruptions caused the real estate and stock market crash in 2008
  • Over valued dividend stocks are fueling the market fluctuations of 2018 as robots that are programmed to preempt risk are trading stocks rather than rational income investors

Let's look at these three major market disruptions:


In 1999 the dot com bubble helped a lot of investor who took profit and ruined many who did not.  More than one of my clients said "I want to get into this market."  Some did get into the high flying dot com stocks but their real money was in income producing stocks, bonds (they were paying over 7% back then) and real estate.  The point is the dot com debacle did not bring down everything.  It was isolated and only those who failed to follow the investing rules of thumb were devastated.  Dividend growth investing still worked back then.

I remember October 2007 vividly.  It seemed the only asset class that didn't get hurt was real estate.  No more than a few minutes after that thought crossed my mind, I got a call from the general partner who ran a private placement investment of multi family apartment buildings in Texas.  The message:  those properties have failed and were going into bankruptcy.   None of my clients was in these investments, I was the client in this one.

My husband was retired and I was still working but we lost about 25% of our investment income when those properties failed.

Not long after that we watched Lehman Brothers fail and saw the value of our portfolio cascade down with the credit crises.   Even money market funds were in trouble. We lost about 30% of the value of the stocks and bonds in our retirement portfolio but we did not lose any additional retirement income.

This second major disruption affected asset values, but dividend growth stocks survived, continued to pay their dividends and some even continued to raise dividends.  We were not able to save as much money with the loss of the apartment income.   It took a lot of patient counseling to get investors to stick with their dividend growth strategies

The market volatility we are experiencing right now has totally different dynamics than any of the previous occurrences noted above.  While we have over valued stocks in some areas, we are not looking at the kind of hyped up value from dot coms and our credit markets are solid.

Today, we have reversal to the mean. 


You cannot fight the law of nature.  Too much money chasing too few dividend, dividend growth, and generally solid companies and it was bound to correct.

Interest rates are not yet competitive enough for me to make a change back to bonds.  They're just high enough that I can pay closer attention to cash management but I am not pulling my money out of dividend growth stocks to invest in bonds.

Yet, it is this threat that makes the programmers enact algorithms to protect against this interest rate risk.  Without a doubt, the 30 year bond bull market is finished.  We will be facing inflation and interest rate risks.  These will affect equity asset prices.

Enter the algorithmic traders, and you have significant volatility.  The "bots" may be the vehicle for volatility but regression to the mean is the fundamental reason that over priced, quality stocks are suffering.

I am sticking with my program.  I use covered calls to force me to sell at a profit.  It does restrict upside potential but it also enforces portfolio rebalancing.  When I have a quality stock called away, I certainly am not going to put those funds in a stock like Caterpillar (CAT) with a P/E (price earnings ratio) of more than 100.

Equally, when I see a stock that I fundamentally like and it takes a hit during these times of volatility, I add.  I make a list of all the stocks I own that pay 4% or more and when they correct I add.

Stock prices move quickly and I do not expect this to stop soon.  We are back to an extended period of volatility.  You have two choices, don't look, or keep your wish list active, put in limit orders, never market orders, and pick up some bargains.

This will not be the last time you are concerned about the market, but it does not need to ruin you.  We are just reverting to the mean.  Each stock is different.  Do your research, decide what price you want to use to add, and be brave.

M* MoneyMadam

P.S.  One half of those Texas properties did emerge from bankruptcy and paid back our principle plus some of the principle we lost in the half did totally fail.