Horsesmouth: Dividends Do Matter

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Dividends Do Matter
By Walter Deemer Sept. 28, 2011

If financial markets are heading toward a long-wave low for the rest of the decade, investors are going to become more and more conservative as it does.

Editor's note: Starting this past January, Walter Deemer stepped into semi-retirement after more than a decade as Horsesmouth's daily market technician and more than 50 years in the business. Horsesmouth will continue to publish Deemer's valuable market insights, but no longer on a daily basis. Instead, he'll be issuing periodic updates on his own schedule. The markets are in his blood. So while the frequency of his updates will change, we expect his market wisdom to be as strong as ever. Watch for his new reports and let us know what you think.

I strongly believe that dividends are going to matter more and more as the decade rolls on. To understand why, we need to first look at the stock market from a very long-term standpoint. The longest financial cycle is the Kondratieff wave, or "long wave," which is (very roughly) a 54-year cycle. It is highly irregular, though, so for our purposes let's just say that the financial markets go from a period of extreme apathy to one of great exuberance and back to extreme apathy over a period of many, many decades. The last such period of extreme pessimism was in 1974-1982, the last period of great exuberance was in 2000-2007, and the pendulum is now swinging back to the next pessimistic low. Since these very long-term pessimistic lows are roughly 54 years apart, the financial markets should generally be getting less and less exuberant for the balance of the present decade. (This is especially the case since the current contraction phase is being accompanied by a debt deleveraging/unwinding/contraction process, which tends to make the cycle longer than usual.) Shorter term, meanwhile, the four-year cycle is making its presence very much felt at the present time. In the process, it has also knocked the presidential cycle out of the ring; the recent market action is very much in keeping with the four-year cycleand is completely incompatible with the presidential cycle. (The pre-election year is supposed to be a good one; this one hasn't been.) The last four-year cycle low was in March 2009, so we can look for the next one in early 2013 (yes, right after the next president is sworn in). Markets, however, don't go straight down for the last six quarters of a four-year cycle, so several one- to three-month rallies can be expected to take place between now and the eventual four-year cycle low. Looking

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beyond early 2013, though, the position of the long wave suggests that the market will remain in what David Fuller has called its "secular revaluation process" through at least one more four-year cycle after this one bottomsand very possibly two of them (which would take us to 2021 or so). And what does all this have to do with dividends? Everything! If the financial markets are going to be heading toward a long-wave low for the rest of the decade, investors are going to become more and more conservative as it does. In the process, these more-and-more-conservative investors are likely to back away more and more from the numbers that justify high valuations during periods of great exuberance (think Internet eyeballs) and rely more and more on the only two hard numbers, or metrics, they have to work with. The first hard number, of course, is the stock price; the price of a stock is what it is, and you can buy it (but only with real American dollars) or sell it and get real American dollars for it. You may not like the price, but it is what it isand it is readily convertible to real American dollars. The only other hard number investors have to work with is dividends. Not earnings; earnings can be whatever managements tell the accountants to make them, and as we have seen in all too many cases, reported earnings don't always reflect reality, with managements doing things like deliberately goosing earnings to inflate the value of their stock options, taking writeoffs of "extraordinary" items that are anything but extraordinary, and so on ad infinitum. Dividends, though, are real; they are paid in real American dollars, and shareholders can take the checks to the bank, cash them, and do anything they want with the proceeds, from buying more shares in the same company to having a Happy Meal at McDonald's. You can't take earnings to the bank! Investors have been paying more and more attention to dividends this yearbut given the position of the long wave, I think investors' increasing focus on dividends is likely to continue through the balance of the decade. In addition, since the current generation of investors has been indoctrinated with the importance of growth, I think the dividend growth rate is going to become one of the most important fundamental metrics in coming years.

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Source: Walter Deemer

How far could the enthusiasm/pessimism pendulum swing before all is said and done? A lot of long-term studies (Edson Gould's Senti-Meter, shown below, being the pioneering one) have found that yields are above 6% at secular lows, and I suspect they'll get there again before the current secular revaluation process runs its course. (The S&P's yield was 6.7% at the 1982 secular low.) This does not, I hasten to add, mean the S&P 500, which currently yields 2.16%, has to go down more than 60% in the process of getting the yield up to 6%. If I am right about the growing importance of dividends, managements will ultimately take noticeand could decide that giving excess cash to shareholders in the form of dividends will ultimately benefit their stock's price more than just going into the market and buying their stock back. (If I told you five years ago that Intel would yield 3.8% today, you'd have had me committed.) Given where we are in the long-term scheme of things, then, I think that dividends do matterand are going to matter more and more as the decade unfolds. And I think the dividend growth rate is going to become one of the most important
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fundamental metrics in coming years. (If you're curious, the five S&P 500 components with the highest five-year dividend growth rates currently are Coca-Cola Enterprises, CenturyLink, UnitedHealth Group, AmeriSourceBergen, and CF Industriesalthough I hasten to add that stocks cannot be bought on the basis of just one fundamental metric.)

Walter Deemer is a market strategist with more than 40 years of experience and a rare talent for spotting market trends. He is a founding member and past president of the Market Technicians Association. The daily updates are provided through a special arrangement with Horsesmouth and excerpted from his daily subscription service to institutional clients. Deemer was interviewed as one of 13 technical analysis experts in Bloomberg Press's January 2009 book, The Heretics of Finance: Conversations With Leading Practitioners of Technical Analysis. He's also been recently published in The Journal of Wealth Management, co-authoring "A Way Forward," a commentary using long-term market cycles to put recent market behavior into historical context.

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