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August 2010
CURRENT COMMENTS
Nothing scares investors more than bubbles. Bubbles occur when certain trades become "over-crowded". Recent examples include the internet craze of the late 90's and the housing frenzy between 2000 and 2007. All bubbles eventually burst for one of two reasons. Once, the idea becomes so "over-bought" that there is no one left to buy into the trade. Or two, some new catalyst emerges that negates the fundamental reason why everyone rushed into the trade in the first place. A burst bubble is defined by a huge and sudden sell-off, which ironically causes the trade to swing so far in the opposite direction that it often then becomes "over-sold".
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The current bubble lurking out there is widely thought to be in the bond market. The bond market is considered expensive right now, yet investors continue to pour in. Those seemingly late to the party argue that bonds are not in a bubble, but are in the beginning of a long-term trend driven by an aging population seeking income in a slow growth economy. True or not, there is a catalyst looming out there threatening to crash this party. Higher interest rates - a virtual certainty - will be the catalyst to begin the exodus from bond funds. The only question is when.
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Fortunately, there is a way to avoid being caught in the fixed income bubble that comes courtesy of a cheap stock market. Many equities are paying dividends in excess of rates which can currently be achieved on high quality corporate bonds. Furthermore, stocks seem inexpensive based on historical valuations, especially when accompanied by solid earnings reports and guidance. Equities also possess the potential for long-term appreciation which could enhance their overall return. Investors looking for a hedge to higher interest rates might be wise to consider dividend paying equities for a portion of their assets.
MARKET WATCH
August markets started off strong and then changed their mind. Investors must be worried how companies can continue to grow in a flat economy. Answer is - do what Intel did and buy it! Don't be surprised to see a M&A wave jumpstart some much needed interest in this range bound market.
8/20/10 Close
% Change since 12/31/09
DJIA
10213.62
-2.06%
S&P 500
1071.69
-3.89%
Russell 2000
610.78
-2.34%
Nasdaq Composite
2179.76
-3.94%
INSIGHTS
Low interest rates may be fine if you are in the market to borrow money but they are not fine when you are in the market to make money. Interest rates are hovering at all time lows and that is making it hard to find decent returns without taking on loads of risk. So what's an investor to do? Invest in high quality, dividend paying stocks, of course.
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In our current financial environment, high-quality paying stocks offer a yield premium over high-quality debt obligations (bonds). Stocks also afford investors the opportunity for capital appreciation. And while it is true that you could also experience capital depreciation don't let yourself get fooled into thinking that bonds are a sure thing. Unless you plan to hold your bonds until maturity you also run the risk of losing money on bonds if interest rates start to rise.
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Why do we like dividends? There are many reasons! First, dividends offer flexibility to investors. During your working life you can reinvest your dividends, increasing the rate at which your investment returns compound. Once you retire you can use those same dividends as income to live on. we also like dividends because they are paid from a company's cash flow. This is important because it signals that the company is successful and making a profit. Non-dividend paying stocks on the other hand can often be influenced positively or negatively by marketplace panic, hype or analyst interpretations. Finally, we like dividends because they are taxed at a preferential rate. Currently qualified dividends are taxed at a maximum rate of 15% with the possibility of becoming 20% next year. But for investors in the 25% marginal tax bracket or higher these tax rates are highly desirable.
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A dividend seeking portfolio can be an attractive option for many investors, especially retirees or those who are simply risk averse by nature. Dividend seeking portfolios are conservative investments in the equity world and tend to be less volatile than the overall market. This means that the portfolio should out-perform in down years and under-perform during up years. In other words, you will end up sacrificing some returns in order to reduce your investment risk. But given the wide swings of the stock market over the last few years some investors prefer to lean towards safety in lieu of high rewards. .
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