Dividend-Paying Stocks
The fourth quarter really couldn’t get here fast enough. After eight good months in which my favorite investment themes performed even better than I had hoped, we had a nasty correction in September. Income-oriented investment got absolutely hammered in the (misguided) belief that Fed tightening is imminent.
Fed tightening — to the extent it happens at all — will depend on economic data continuing to come in strongly. Thus far, the data has been mixed at best and we should remember that we are now more than five years into the current economic expansion.
I’m not forecasting an imminent recession, but in the entire span of U.S. history since the Great Depression, the longest stretch we’ve ever gone without a recession was 10 years — and that was during the 1990's tech boom. Since the Great Depression, the average time between recessions was four years and nine months.
Again, I’m not necessarily predicting a recession around the corner. But expansions do not last forever, and we should remember that our current expansion has been aided by record federal deficits and the loosest monetary policy in U.S. history. I think it’s highly likely that we will indeed see a recession at some point in the next two years.
Why does this matter? Because bond yields tend to fall in recessions. And we should also remember that, with yields in Japan and Europe hovering near all-time lows, demand for U.S. Treasuries should keep a tight yield on Treasuries for the foreseeable future.Bottom line: Dividend-paying stocks, REITs, and MLPs–and particularly those with a solid history of aggressively raisingtheir dividends–remain very attractive places to invest. With U.S. stocks currently priced to deliver lousy returns over the next 5-7 years, a disproportionate share of your returns is likely to come from dividends.
Emerging Markets
I also wanted to give a quick update on emerging markets using Brazil as an example.
From watching the action in the iShares Brazil Index (ARCA:EWZ), you might think we were back in October of 2008 rather than 2014. As of Wednesday’s close, EWZ had dropped a staggering 22% in less than a month.
The “reason,” if you can ever identify a reason for a drop of that size, is the growing probability that president Dilma Rousseff will win reelection in this Sunday’s election. Hopes had been building that Rousseff would lose to upstart Marina Silva, but the race is now too close to call and Rousseff appears to have the momentum.
So, what are we to make of this? Is Dilma that bad?
Yes, Rousseff is a lousy president with a terrible understanding of basic economics. But let’s look past the politics here. The fact is that Brazilian stocks are wildly volatile, both on the upside and downside.
In a little over three months from late October of last year to early February of this year, EWZ dropped by about 27% before turning around and rallying by 42%. The current 22% drop is significant in that it happened in the proverbial blink of an eye, but its magnitude is nothing special. Over the past ten years, the Brazil ETF has had 11 instances where it dropped 20% or more. And that included a period in which EWZ rose by a factor of five.
In other words, unless you have a stomach for volatility, you have no business buying a Brazil ETF.
Is It A Buy?
So, after the recent rout, where does that leave us? Is EWZ a basket of cheap bargain stocks, or is it value trap better left avoided?
Let’s play with the numbers a little. As of Wednesday’s close, EWZ is nearly 60% below its 2008 high and nearly 50% below its highs of as recently as 2011. Some of this decline is due to depreciation of the Brazilian real, which has lost 31% of its value relative to the dollar. The real is now sitting close to its 2008 crisis lows.
Though the real is still slightly overvalued by the back-of-the-envelope calculations of The Economist’s Big Mac Index, I don’t see it falling much lower from these levels. The U.S. dollar has been exceptionally strong since the start of the third quarter on the assumption that the Fed will be raising rates soon. While that might matter vis-à-vis the euro or yen, I don’t buy the argument for high-interest-rate countries like Brazil.
Currency issues aside, EWZ is very attractively priced at a cyclically-adjusted price/earnings ratio (“CAPE”) of less than 10. Now to be fair, the ten-year average includes the inflated earnings years of the mid-2000s commodities boom. But then, it also includes the 2008 meltdown and global recession that followed. Whatever you might think of President Dilma and her policies, Brazil is cheap right now, and its recent selloff is within its historical norms.
Could there be more downside from here? Sure. But if the past is any guide, we could see EWZ jump by a quick 40% or more over the next six months and by several hundred percent over the next several years. It’s not an investment for “widows and orphans.” But it’s one that I expect to be very profitable.
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