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Still No Cushion

For the record, the S&P 500 and Nasdaq are down 5.4% and 3.9% since Friday, gold is down 3.2% and 10-year Treasury yields are 10 basis points lower. Amidst this week’s weaker stock market action comes the news that household net worth fell last for the first time in at least 55 years. Given that 55 years is quite a streak for increasing anything, the drop in consumers’ "book value" is big news. After all, the period covers some tough times, including the deep 1973-74 recession, stagflation, double-digit interest rates and disco. It’s no surprise that the stock market is the culprit in this reversal of fortune. Stocks have not only fallen far, but Americans own more of them than ever. The value of household real estate, on the other hand, rose 10% last year. It will be interesting to see the net worth figures once the residential real estate bubble pops.

In other news, Barron’s reports that at least one telecom analyst doesn’t believe that demand for fiber is infinite. In fact, Susan Kalla warns that service providers and equipment makers will continue to be victims of excess capacity and the weak pricing that accompanies such an environment. Kalla comes to these conclusions by a wildly innovative approach - she checks sources other than company management. This includes interrogating telecom customers to get a handle on demand. Kalla thinks fiber prices are dropping rapidly for good reason, capital costs are rising for service providers, and consolidation in the industry will hurt equipment makers. Moral? New economy, same old law of supply and demand.

Speaking of demand, dividends are something investors haven’t demanded much lately. Yet, the market’s yield is one more indication that stocks remain expensive despite the downdraft over the past year. The S&P 500, for example, yields a paltry 1.3%. This is well below normal. According to the Leuthold group, the median yield of S&P 500 since 1957 is 3.4% vs. 1.1% of late. The Dow sported a 3% dividend at its peak prior to the ‘73-‘74 bear market.

The stock market’s dividend yield is hardly riveting cocktail chatter, but historically dividends have provided much of the return from stocks. It is only in the last half-decade that the return from dividends has been swamped by capital appreciation. In fact, there was a time when dividends provided almost all of the return to investors. According to Global Financial Data, stocks provided a return of 5.9% from 1802 to 1900, with dividends (and their reinvestment) accounting for 5.1% (or almost all) of the gains. Over time, the price of the stocks themselves increased in importance. Still, from 1900 to 1995, dividends chipped in 4.9% of their 9.8% annual return. Even the second half of that period, from 1945 to 1995, dividends provided 4.2%, or about one-third of 12.4% total return from equities.

Even in the latest bull market dividends were not chopped liver, providing 4% of the 17.1% annual return delivered from August ‘82 through December ‘ 95. But by 1995, stock prices were so high that the role of dividends greatly diminished. From year-end 1995 through 1999 dividends accounted for just 2.1% of the massive 26.3% annual return from stocks.

The point, if there is one, is that today’s dividend dearth is just one more factor making the current bear market less bearable. For example, if you would have bought the Dow at the peak of the ‘73 market and held it through January 1983, you’d find the Industrials only about 2.7% higher 10 years later. But by reinvesting the dividends every quarter, your total assets would have grown by more than 60% over the period. Not great for 10 years, but it beats the alternative. But remember, the Dow was yielding 3% in January ‘73. Performing the same exercise of buying the ’73 market peak with today’s paltry yield cuts the increase over the period in half, resulting in a return of less than 3% a year.

The easy response to such an exercise, in addition to yawning, is to argue that today’s tax laws have made dividends less attractive, so investors have no choice but to bank on higher stock prices. True, but notice that dividends have typically delivered something in the ballpark of 4% a year until quite recently, a period when capital appreciation has been off the charts. In fact, the ‘80s and ‘90s were the best back to back decades for stocks in 200 years. If stocks market returns revert to their long-term average, stocks could go nowhere for some time. For example, if the S&P 500 delivered a respectable 7% a year in capital appreciation over the 10 year period beginning in 1995 and ending in 2005, the index would sell for only 1211, very close current levels. Keeping the 7% pace through 2015 would put the S&P 500 at 2383, resulting in an increase of about 5% annually going forward. If reality comes anywhere close to this supposition, it would be nice to have more dividends to reinvest along the way.

The bottom line? The dividend yield may be telling investors who think the market is near a bottom to wait. And then wait some more.

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