Some Light at End of the Economic Tunnel
I think it's quite possible that things are just a little better than they were a month or two ago.
Justifiable Pessimism
I know that's not what many of you are thinking -- everything seems to be moving in the wrong direction. The price of oil and basic commodities like wheat are way up (any pizza fan knows this), while the value of the dollar, our homes, and our stock investments is falling.
It's so bad that we're worrying whether our money is safe in our banks and brokerage accounts. No wonder a recent survey of consumer expectations about what's on the financial horizon registered a low confidence score not seen since 1973.
I understand that many of you are pessimistic about the future. You have good reason to be. But I think some recent events qualify as at least a glimmer of hope in what has been a very dark start to 2008.
Moving Away from Doom and Gloom
At the start of March I was firmly in the doom-and-gloom camp. And when the S&P 500 lost more than 5 percent in the first two weeks of the month I wasn't feeling any differently. But that's about when the Federal Reserve stepped in multiple times to try to alleviate credit and market pressures.
From opening its discount window to investment banks to lowering the federal funds rate another 0.75 percent, and then playing a central role in brokering JP Morgan's takeover of Bear Stearns, the Fed has been working overtime on damage control. There's no shortage of debate on whether this is the correct role for the Fed -- and the impact on U.S. taxpayers -- but at the same time it's important to look at what's transpired in the wake of all the Fed action: a 5 percent rally from the mid-month lows.
Another encouraging development was the late-March change in capital requirements for Fannie Mae and Freddie Mac, which will help thaw the tundra-frozen mortgage-backed securities market.
Better, but Not Perfect
I'm not suggesting that we're completely out of the woods -- far from it. Even with the mini-rally from its mid-March low, the S&P 500 is still 15 percent below its October 2007 highs. And I envision that we're going to see plenty more stock market volatility through most of this year as the market continues to wring out its excesses.
(I expect it to take even longer for housing to regain its footing in markets that rocketed during the boom. The recent reports of 10 percent price declines over the past year are just a beginning; I wouldn't be surprised if it takes 18 months to 2 years for many regions to truly bottom out.)
But here's the important thing: I think we're a lot closer to the end of the bad times in the stock market than to the beginning. Again, I'm not saying the good times are going to return next week or next month. We're probably looking at next year. But what concerns me is that given the utter lack of consumer confidence reported in recent surveys, you may be toying with the notion of bailing out of the stock market right about now.
Stick to Your Guns
Even if you're thinking "enough is enough, I can't take anymore losses," fight the urge to bail.
One of the biggest risks at this juncture is that you'll lose faith in your long-term investment plan. It's understandable to feel worn down -- and fearful -- amid all the bad news. But I urge you to keep your investing resolve. I've covered this terrain before, but it bears repeating: If your investment horizon is 10 or more years off, just keep doing what you're doing.
Ten years is the minimum here -- not three, not five. There have been many times when the markets have taken more than a decade to work themselves out. Yes, your 401(k) value is falling, but another way to look at it is that now your contributions are buying more shares than they did three months or six months ago. When the markets rebound, the more shares you have the better you'll do.
Is it easy to stick with? Of course not. But it's the right thing to do. And if you bail out today, you may end up making your life a whole lot harder down the line when you realize you don't have enough socked away for retirement.
In Search of Income
One of the toughest challenges right now is generating income. A consequence of the Fed's aggressive rate reduction is that it's pretty much impossible to earn returns on bank deposits that can keep pace with the current 4-percent-plus rate of inflation.
That doesn't mean you should pull your emergency savings out of the bank, though. Yield isn't the most important factor with an emergency cash account -- safety and instant liquidity come first. That said, you should still make sure you're earning as much yield as possible from your bank accounts -- obviously, 2.5 percent is still better that 0.2 percent.
If you need income and have at least eight months of living expenses saved up in a bank savings account (or money market mutual fund), and your finances are in good shape (the mortgage is affordable, there's no lingering credit card or car loan debt, etc.), dividend-paying stocks deserve a look. Again, this is only for long-term investors; money you need in three or five years doesn't belong in the stock market. Never has, never will.
The Deal on Dividends
With that warning out of the way, here's why dividend stocks look interesting to me. First, the income stream from many blue-chip firms is well above what you can earn in the bank today. Dividend stocks also deliver a nice tax advantage: While interest you earn on bank savings is taxed at your income tax rate (a high of 35 percent), the vast majority of stock dividend payouts are currently taxed at just 15 percent. That means keeping more in your pocket after taxes, which is especially helpful right now.
As examples (but not recommendations), DuPont currently generates a solid 3.2 percent dividend payout for its shareholders, while General Electric has a 3.4 percent yield and Pfizer's yield is 6.2 percent. For even higher dividend payouts, the battered financial sector is full of stocks that currently have yields above 5 percent, thanks in large part to plummeting stock prices in the wake of the subprime crisis. For ETF investors, there's the Financial Select Sector SPDR (XLF).
Could there be more downside over the short-term? Without a doubt. But in the meantime you'll pocket the dividend payout, and when the markets do come back -- and eventually they will -- you have the chance for upside stock gains.
Comments