The jobs report is the latest in a recent string of weak economic data. The U.S. economy is clearly weak and the recovery is struggling to gain any sort of traction. Listening to earnings reports from some of the economically sensitive companies such as Caterpillar (CAT) does not offer a lot of hope for a quick recovery. The Federal Reserve has told us rates will remain low because of economic weakness for a very long time. While I understand the need for low rates to save the economy (and keep the larger banks in business), I am frankly surprised we are not seeing a seniors revolt. Those trying to live off their investments have a serious problem in this age of zero interest rate policy.
If you retired 10 years ago, you could have locked up some fixed income investments that offered a safe and relatively high yield. Today this is not the case. Treasury and CD yields area below 3% and corporate bonds are not much better if you are sticking to quality issues. Savers are forced to be investors, a role many are not comfortable with when it comes to their retirement nest egg.
The meme for the past few years has been to buy dividend-paying stocks. Like all memes, it was a great idea when it began and everyone thought it was ridiculous and too risky. The five portfolios of high-yield stocks I suggested at the end of 2009 not only provided a yield of more than 5%, the combined portfolio has risen more than 50% since then. Buying my suggested portfolio of dividend stocks in August of last year resulted in a portfolio yielding over 4%, and it has appreciated by more than 15%. Buying dividends has worked even for more risk-averse retirees for the past two years and helped to offset the pain if low yields in the fixed-income markets.
It may have worked too well. It is now a very popular meme and I am a hearing the dividend stocks as fixed income replacement strategy suggested loudly and often. The brokers are pushing it, new income stock newsletters and advisory services are popping up on what seems to be an almost daily basis. I have been around a long time and have far more gray hair than brown these days and over the years I have learned one very powerful lesson. If all the brokers and advisory services love a particular strategy or approach, it is probably closer to the peak and the approach is not going to work much longer. Too much money chasing one idea, no matter how sensible the idea may seem, inevitably leads to grievous losses for the last ones in the pool.
Let's look at the stocks in the Dow Jones Industrial Average to get an idea of the problem created by aggressive yield-chasing in blue chip stocks. The highest yielding stock in the Dow is AT&T (T). At the current price, the stock yields 4.9%. That's not too bad but a closer look shows us the T shares are up nearly 20% year to date and trade at 2x book value. The enterprise to EBIDTA ratio is about 7, a level I find uncomfortably high for an established large company. A 4% or better dividend is nice but a 20% decline in the stock price will wipe out four years of payments. Verizon (VZ) is the second-highest yielding stock in the index (4.4%), although it is a little cheaper than AT&T, but the stock has gained 12% so far this year. It may have a nice yield but it is not cheap and there is no margin of safety in the shares.
Chasing yield is one of the worst mistakes an investor can make. The search for higher-yielding stocks has pushed many dividend-paying stocks higher to the point where the risk-to-reward ratio no longer makes sense to conservative investors. It can be frustrating to be patient when you need the income, but income-oriented investors must exercise caution now and wait for a better entry point.