February ended on a bleak note for the major stock markets with Thursday and Friday's declines wiping out the week's earlier gains. The reason behind the fall in stock prices was mounting evidence that the current economic slowdown in the US might be neither short nor shallow and that conditions in the credit markets continue to worsen.
Nearly all of the economic data coming out of the US over the last weeks has been weak. Confidence readings are at their lowest levels in 16 years, house prices and home construction continue to fall, the index of leading economic indicators is in recession territory and the regional purchasing manager indices are collapsing. The last point is all the more noteworthy because until now manufacturing had held up quite well, while the services survey had already weakened dramatically in January.
Credit conditions also continue to worsen. After initially responding favourably to news that the 2 major monoline insurers will hold on to their rating, many credit benchmark spreads are currently hitting new extremes with interbank spreads also rising again despite the central banks' efforts to inject liquidity. There are also now clear signs that the problems have spread from the housing sector to commercial real estate and other forms of credit. Estimates of subprime losses continue to rise but most of the losses outside of housing will not become clear until later in the year.
The major risks weighing on equity markets obviously intensify each other. Problems in the financial sector have led to tightening lending standards which reduce the supply of credit and thus increase the risk of a deep recession. A weaker economy on the other hand leads to more problems in the financial sector. It is far from obvious how this vicious circle can be broken.
The Federal Reserve has made it clear that it currently sees the fight against recession as its number one priority. It will therefore continue to cut the Fed funds rate aggressively. This might lead to temporary rebounds in stock prices, especially since most equity markets have already lost between 15 and 20% since the end of October 2007. Investors should not however mistake these temporary rebounds for the beginning of a lasting upturn.
Anonymous said:
Good morning Mister Wagner,the overall markets may not be a buying opportunity, but I wonder about stocks with high dividends. There are mainly three kind of dividend stocks that I'm looking at: financials (that you obviously don't like); energy (like Royal Dutch) and some industrials (like General Electric). What do you think about those investments?
11 March 2008 - 11:30 AM
Guy Wagner said:
Numerous studies have shown that buying companies with high dividend yields is usually a very profitable strategy over the long run. This makes sense given that a high dividend yield is often associated with companies selling at low prices in relation to earnings or book value. A decent dividend also instills confidence about a company's business given that a company needs to have real earnings to pay a dividend. And, contrary to a popular view, historical evidence has shown that companies that pay out a big part of their earnings as dividends actually grow their earnings faster because they have the discipline to maximize the value of their retained earnings.Companies with high dividend yields are especially attractive in the current market environment where economic and financial risks cast doubt over the other source of equity returns, capital appreciation coming from earnings growth and P/E expansion. A decent dividend also often creates a floor under a company's stock price by attracting income-seeking investors.
Banque de Luxembourg has launched a global high dividend fund (in EURO) in November 2007 because of the aforementioned factors. Although the timing has obviously been bad, the decline in the fund's NAV has been somewhat tempered by the fund's high cash position (which currently stands at 20%). The weighted average dividend yield of the fund's equity holdings at today's prices is 6.5% (gross), an attractive level in a low interest rate environment.
12 March 2008 - 06:11 PM