The world is slowing down. China’s GDP growth is not what it used to be. And if you’re sceptical about Chinese statistics, you probably know it never was what it used to be.
The Americans still haven’t found their feet, despite epic stimulus efforts. Europe is a basket case and probably in recession. In short, it’s time to invest in shares.
Sounds stupid, but apparently that kind of thinking works. At least according to Ben Inker from GMO:
‘The first point to understand about stock returns is their relationship with GDP growth. In short, there isn’t one. Stock returns do not require a particular level of GDP growth, nor does a particular level of GDP growth imply anything about stock market returns. This has been true empirically, as the Dimson-Marsh-Staunton data from 1900-2000 shows.
‘Many investors are utterly convinced that strong GDP growth is the primary reason why one country’s stock market will outperform another. …this was certainly not the case in the 20th century. Insofar as there is any relationship here, it’s a perverse one. All else equal, higher GDP growth seems to be associated with lower stock markets returns.’
Inker then goes on to do all sorts of fancy empirical analysis showing how GDP and equity returns have been inversely related. But it’s his reasoning for the odd finding that’s interesting.
For example, companies tend to raise capital during boom times, and then spend that capital on all sorts of investments. This dilutes earnings and uses up cash. Neither are good for equities if you’re hoping to collect profits yourself.
Only once things slow down and investments become less viable is the profit actually paid out to shareholders in the form of dividends and share buy backs. (More on capital gains in a moment.)
So yes, there’s money to be made during bad economic times. Who would’ve thought?
Dividend investors, that’s who. Inker’s GMO white paper also explains where equity returns come from. And the answer is dividends, not capital gains. ‘When we look at stock market returns, dividends have a very large impact on the total, providing the bulk of equity investor returns for most of history’. Finance Academic Jeremy Siegel has the chart to match the words:
The chart shows that dividend payers come up on top. The highest dividend payers perform best, followed by ‘high’ dividend payers. Next up in terms of performance, but lagging well behind, you have your stock standard S&P500 index, followed by ‘mid’ range dividend payers.
The low and lowest dividend payers are back to where they were around 15 years ago. The chart also shows that high dividend payers are less volatile in their returns.
So all you have to do is pick a bundle of high dividend paying shares that can survive a depression, and then hang on for dear life. Investing solved.
Not quite. We live in a manipulated market. Telling you to wait for a better buying opportunity is Mr Hussman of Hussman Funds:
‘The enthusiasm of investors about central-bank interventions has reached a pitch that is already well-reflected in market prices, and a level of confidence that with little doubt, investors will ultimately regret. In the face of this enthusiasm, one almost wonders why nations across the world and throughout recorded history have ever had to deal with economic recessions or fluctuations in the financial markets. The current, widely-embraced message is that there is no such thing as an economic problem, and no such thing as risk.’
At some point, risk, economic problems and market prices will re-emerge into the light. GMO’s Inker is quick to acknowledge that those moments can be defining, even for long term investments. And there’s no shortage of crises waiting in the wings. So what do you do? Buy and hope, or wait?
It’s the surprising variety of other options that has kept us busy over the last few months. If the stock market isn’t dishing up what you want, why not look elsewhere? Or apply new tools and strategies to the same game?
One idea is surprisingly simple. It’s called a corporate bond ladder.
The problem with bonds is that they carry price risk. Despite paying out a fixed amount on a fixed day, bonds can still fluctuate in price. Explaining all the reasons why takes forever. Default risk is the easiest one to understand — the riskier the bond, the cheaper it will be.
Price risk can cause problems when you sell bonds, because the price could have fluctuated significantly. That’s not good if you want a fixed payout and fixed return — the whole point of a bond.
Using a bond ladder avoids the problem of price risk, because you hold all your bonds to maturity — the day they pay out a fixed amount. The idea is to invest in bonds that mature when you need the cash in retirement.
So you might invest in a bond that will mature in one year, one that will mature in two years, three years, and so on. Each year, you will receive a payout that is very predictable, no matter what the prices of your other bonds are up to.
The risks of this are obvious. Inflation and default are still a possibility. But to secure a steady, predictable cash flow without having to worry about the stock market, this is a good strategy.
for Markets and Money
From the Archives…
When the Trickle Becomes a Flood
10-08-2012 – Greg Canavan
What Central Planners Can Never Know
09-08-2012 – Bill Bonner
The Central Bank Big Bazooka in Theory and Practice
08-08-2012 – Bill Bonner
In Thrall to the Iron Fist
07-08-2012 – Dan Denning
Cracks in the Foundation
06-08-2012 – Dan Denning