When Everyone Sees It, That's Your Exit Sign

 | Jan 30, 2012 | 2:30 PM EST  | Comments
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Stock quotes in this article:

pfe

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wpc

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mrk

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duk

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pom

Over the weekend, as I contemplated the almost sports-less month of February looming ahead, I spent some time talking to friends and associates around the country. One of the hottest topics was the Fed's decision to maintain a zero interest rate policy (ZIRP) though 2014. Incredibly, I read an article saying that, when the full Fed board was surveyed, 11 of the 17 governors thought 2015 was a better target than 2014.

The Federal Reserve's action and subsequent statements do not jibe with the talk I hear of a slowly developing economic recovery. Of even more importance is that, over the past two years, we have learned that ZIRP is very good for stocks. It provides a reason to buy the dip and invest in dividend-paying names.

For the past three years I have been a huge advocate of dividend-paying stocks for traditional fixed-income investors. High-quality stocks have offered a decent yield and the potential for increasing payouts over time.

When I started saying this back in late 2008, as the Fed was cranking down rates, I was considered to be a little "out there" by many. Taking that CD and buying Pfizer (PFE) or WP Carey (WPC) was considered pretty risky by fixed-income types who were afraid of the stock market. If you were a risk-averse income investor, buying stocks required a huge adjustment in attitude and volatility expectations. Of course, with the always highly accurate look in the rear-view mirror, it has worked exceptionally well.

It may have worked too well. With the Fed's announcement, my Twitter, Facebook and inbox have become flooded with advertisements and discussions about buying yield in the stock market. Everyone is advising fixed-income investors to use stocks to replace lost income from bonds and CDs. The financial press and talking heads are on the bandwagon, as well, and dividend-paying stocks are starting to feel like the latest new paradigm to me.

Throughout my career, whenever everybody has known something to be true, it has been very close to being proved false. The theme could be stocks always averaging 10% a year, or commodities never going down, or the Internet being worth 100x sales -- or buying dividends. It doesn't matter. When everyone is suggesting it, it is the wrong course of action for most investors.

I believe we are pretty close to that right now for dividend portfolios. This weekend I talked to one momentum trader who had more than half his portfolio in electric-utility stocks. I heard from chart guys who were looking at several higher-yielding blue-chips because they were close to breaking out.

This strikes fear into my cheap, cantankerous, contrarian heart. I look at stocks like Merck (MRK), Pfizer, WPC and even Duke Energy (DUK) and Pepco (POM) -- which I have suggested and purchased as dividend stocks -- and I now see potential losses for new investors. They are no longer cheap and unloved at current levels, and they certainly do not appear safe to me.

I am not suggesting that those who own these stocks should rush to sell. You cannot replace the yield right now, especially if you were buying a year ago or more. When I first suggested stocks as a fixed-income alternative, I talked about the need to live with increased volatility and just collect the payout for long periods. We have been very fortunate, because most of the dividend-stock volatility has been to the upside for the past few years. Now we may need to buckle in and prepare for some of the downside variety for a while.

What I am suggesting is that, if you have new money or are just starting to put together your income portfolio, it's a good idea to hold off for a bit. "Everybody's doing it" is not an acceptable excuse from your kids, nor is it a good tool for portfolio construction. I believe that, because everyone now knows ZIRP is good for stocks, there may be a momentum bounce for a few more weeks -- but once everybody is in, it has to go down. I would rather earn zero on cash for a few weeks, or even months, than lock in a capital loss and lower yield on my portfolio.

Dividends will work for the long run. However, it is best to let some of the easy-money, headline-driven crowd take a few hits here and then put new money to work.

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