Yesterday I spoke with Stirling Faux about recent rate trends and the growth outlook. You can hear the 15 min clip here.
A couple of readers have asked me this week why I don't advocate the idea of continuing to hold “defensive” or dividend paying stocks during a bear market. The reason (as I have explained many times) is that stocks, even defensive stocks, in modern markets are heavily correlated. When the trends break down, they do so pretty much across the board. Holding on to something paying you a dividend of 2, 3, 5, or even 10% makes no sense if share prices drop 20-45% while you are holding them. Recall that during secular bear markets (like we are in presently) cyclical pull-backs tend to take back 100% of the prior cycle gains. Bear market declines typically register in the -45% range, and cyclical recoveries are lucky if they make back 80-100% of the prior cycle losses. So throwing your capital under the bus to try and collect a fraction of your losses in income is nonsensical. This is especially true if you have already amassed the bulk of your life savings or are trying to live off of your capital in retirement.
Last night I happened to read the daily remarks from veteran Dow Theorist Richard Russell who was answering a similar question from some of his readers. He had this to say:
“Some subscribers tell me, “Look Russell, I'm holding on to five stocks that are doing well, despite today's rotten climate. All five of these stocks show rising earnings, and two have actually increased their dividends. So I'm going to stay with these seven OK?
Not OK. Here's the point I want to get across. The big killer in a primary bear market is not necessarily the lousy economy. The big killer is always a collapse in price/earnings. It's what investors will pay for earnings in a bear market. Your seven stocks may have a current average price/earning ratio of 18. But at the bear market bottom, the price/earnings (this is what investors are willing to pay for earnings) may drop to 6 or 8. Imagine where your “great” stocks will be (and they're still doing well) if their average price/earnings drop from the current 18 down to 6 or 8. Yes, the real killer in a bear market is often a collapse in the price/earnings ratio.
Another argument — Russell, taxes, I can't afford to pay the taxes on some of my long-term holdings.
My answer — OK, then sit with your long-term holdings through the bear market. By the time the bear market hits its lows, believe me, you won't have any tax problems.”
Ah yes, the “I am collecting dividends” and “I don’t want to trigger capital gains” excuses for not protecting capital from big draw-downs…typical responses from people who routinely lose money “investing”.
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Cory’s Chart Corner
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Let say I bought Royal bank shares last March at 25 bucks a share, paying dividends with nearly 10% yield. Those shares more than doubled in price in less than a year, plus dividends. Bingo!
Now the bear takes those prices back to $25 again, and in theory, if
that price stays there for long, than I need more than 7 years to double the original capital again from the dividends alone, provided the price and dividend stayed the same. So sell it near the top, lock in the profit and buy them back for lower price.
Sell some other losers, create capital loss and apply the gain against it.
Your commentary is spot on Danielle. My recent quarterly RRSP statement included the usual newsletter this time proclaiming that dividend paying stocks were “compellingly priced”.
No thanks.
I remember reading an article on CNN/Money a few months after the 2008 crash. They profiled a couple who had lost ~$230,000 in the market yet consoled themselves with the fact that they had gotten ~$20,000 in dividends in 2008.
Talk about rationalizing…………………..
That's a good one, plus on top of it they can't apply the capital loss against the dividend gain.
By the way, I have found your Daily Bell site very readable. Cheers!