Weekly Commentary September 26th, 2011

The Markets

The Federal Reserve did “The Twist,” but the financial markets ended up in “A Knot.”

In a much anticipated action dubbed “Operation Twist,” the Federal Reserve announced last week it would reshuffle its balance sheet by selling $400 billion of shorter-term Treasury securities and use the proceeds to buy longer-term securities. The Fed said it hopes the action will lower longer-term interest rates and, “contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery.”

So far, as it relates to interest rates, the Fed’s action has worked. The yield on the 30-year Treasury bond declined from 3.2 percent the day before the Fed’s announcement to 2.9 percent just two days later, according to data from Yahoo! Finance. That’s a rather dramatic decline for such a short period.

Unfortunately, the stock market failed to respond positively to the Fed’s announcement as the S&P 500 index lost 6.4 percent for the week. The market’s drop, though, went beyond disappointment in the Fed’s action. The following also contributed to the market’s red ink:

• Intensified fears of a Greek default.
• Rising concern of a world-wide financial crisis, with sovereign debt at the epicenter.
• Growing signs of sluggish economic growth in China, which had been one of the few countries immune to economic turmoil.
• A 13 percent drop in the price of copper on Thursday and Friday of last week, which is concerning because the price of copper is often viewed as a proxy for worldwide industrial growth.
Sources: Wall Street Journal, MarketWatch, Bloomberg

With the market’s blood pressure rising, it reminds us of what flight attendants often say, “Ladies and gentlemen, the Captain has turned on the fasten seat belt sign. We are now crossing a zone of turbulence. Please return to your seats and keep your seat belts fastened. Thank you.”

Likewise, as your “Financial Captain,” we know there may be market volatility along the way, but, as always, we’re focused on trying to help you arrive safely at your financial destination.

AN OFTEN OVERLOOKED ASPECT OF SUCCESSFUL STOCK INVESTING is the importance of dividends. In bull markets, investors tend to focus on price appreciation, meaning, they look for stocks that can increase in price. In heady times like the late 1990s, investors feasted on stocks that would double or triple in a matter of months. Watching a stock go from $20 a share to $40 or $60 a share is exhilarating and makes for good cocktail party chatter. On the other hand, watching a stock sit at $20 a share for several years while you collect and reinvest a 3 percent dividend is rather boring and not worth sharing on the social circuit.

However, just like the old story about the tortoise and the hare, the slow and steady growth of dividends plays a very important role in making money grow over time.

The past 10 years is a great example of how dividends have helped improve the returns of an otherwise disappointing stock market. Here’s the data:

• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 1.3 percent excluding reinvested dividends.
• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 3.6 percent including reinvested dividends.
• As shown above, receiving dividends and reinvesting them added 2.3 percentage points per year to an investor’s return compared to the return generated by price appreciation alone of the underlying stocks in the S&P 500.
Sources: Morningstar, Yahoo! Finance

In today’s environment of low returns, finding a way to possibly eke out an extra 2.3 percentage points of return per year is attractive.

Over a longer period, receiving dividends and reinvesting them has accounted for one-third of the total return of the S&P 500 index over the past 80 years, according to Standard & Poor’s.

Standard & Poor’s also points out the following benefits of dividends:

• Dividends allow investors to capture the upside potential while providing some downside protection in the down markets.
• When bond yields are low, like they are now, dividend paying stocks might be a way to enhance an investor’s current income.

Just like any other investment, though, you need to figure out how dividends fit within your overall investment strategy. Are you looking for dividends to provide stability, income, or growth within your portfolio? Or, perhaps it’s some combination of all three.

Considering how dividends fit within our clients’ portfolios is just one more way that we’re trying to add value.

Weekly Focus – Think About It

“Do you know the only thing that gives me pleasure? It's to see my dividends coming in.”
--John D. Rockefeller