Why over-valuations matter

With all the complacent talk and soothing reassurance from the “always-long stocks” sales force, one would think that “volatility” is but a benign nuisance that causes the odd hiccup but no lasting pain. Grin and bear; stiff upper lip; all in a normal day’s investing. Sure.

Except when valuations have become stretched to egregious levels like today. In those instances, volatility typically strikes to evaporate chunks of invested principle along with years of apparent growth and income all in a matter of hours, days, weeks or months. This chart of the Canadian Financial Sector since this secular began in 2000, demonstrates the point.

XFN Jan 27 2014

Beginning in the fall of 2012 when misplaced faith in the Fed’s Q’eternity plan went epidemic, the Canadian financial ETF (XFN)rocketed up 62% (along with the S&P and some other dividend paying sectors). Because of this huge price spike, the dividend yield dropped to 3% (from what had been above 7% if one had bought after share prices had plunged 50% in 2001-2003 and 2008-2009).

A 3% dividend may have looked like a good deal to the naive while prices were rising or staying flat, but once prices begin to give back, the irrational exuberance of the prior rally serves to devour buy and holders (most of them thinking they are in “conservative, dividend-paying, blue-chip” blah, blah, broker bologna).

So far this year, the sector is off about 4.4% since the December high. So in a couple of short weeks, holders have lost more than a year of the dividend income they were banking on and 1% of their principle. And that is nothing. To correct for all the QE nonsense since 2012, the financial sector would have to fall a further 35% from here. To retest the support it found in the last 2 bear markets, it stands to lose more than 60% from present levels. Don’t worry be happy?

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