Question: Why the Change to Dividend Stocks allocations?


Read “Coxe Strategy Journal May 2014”. You wrote: “We have previously recommended blue chip dividend stocks as a component of income investments. We do not recommend them at this point…” Could you please go into greater detail? Thank you.


I’d like to stress that the change in our Portfolio Asset Allocation for Dividend Stocks applies to Pension Fund portfolios. Canada gives more generous tax treatment to dividends (from Canadian Companies) than does the U.S. So this advice may not be appropriate for tax-paying Canadian retail investors, who should discuss these ideas with their advisers. Pension funds are tax-free, so increasing income from bonds at the expense of dividends from stock is a decision that has no tax consequences.
For many years, we recommended that investors emphasize reliable dividend-paying stocks at the expense of bonds offering historically low yields. We have turned cautious on that highly successful recommendation for three reasons:

  1. The huge rally in the S&P means that dividend yields have trouble keeping up with stock prices; investors are assuming greater risk for their rewards than even two years ago;
  2. Companies have been helping to underwrite the continued climb in the stock market by buying back their own stock at astounding rates. Since overall corporate earnings are growing merely modestly, many companies are paying for the buybacks by borrowing money at those Fed-suppressed rates. (Buybacks are also hugely beneficial to insiders with stock option programs.) Result: the endogenous risk in the bull market increases even as the recovery draws nearer senility and expiry.
  3. Those who fund their retirement by overweighting their exposure to high-dividend-paying stocks should never forget that dividend income is not as reliable as bond income. Companies can – and do – shrink or eliminate their dividends when times get tough and the covenants in their bonds become restrictive. Bond interest will keep getting paid unless the company goes bust. A dollar of dividends to individual investors is taxed at a far lower rate than a dollar of bond income – and is of lower quality than bond income.

Are we being too cautious?

According to the consensus of Street experts, and according to the Obama Administration, the U.S. economy was supposed to grow at 2.5 per cent (or more) in the first quarter.

However, the U.S. government’s first GDP growth estimate was a barely observable 0.1 per cent. But last week, they reported, upon further review of the data, that the economy actually shrank by 1 per cent – and U.S. corporate profits fell 13.7 per cent – the worst since 2008. Naturally, U.S. stock prices went up on that announcement! If the U.S. economy continues to underperform the Street’s bullish expectations, how should Canadian investors allocate their savings?

We remain cautiously optimistic about the global economy, and remain believers that global commodity stocks belong in the economic growth-oriented sector of almost all investment portfolios. They have, in general, been outperforming the S&P lately as scarcities begin to emerge – from cattle to hogs to oil to gas. Precious metals owners benefited from Putin’s attempt to take over the choicest parts of Ukraine, but have retreated sharply now that he seems to be contented with Crimea – and isn’t seeking international crime on a larger scale. We don’t share that optimism about this sudden onset of good will from a long-time KGB officer.

We believe individual investors should modestly reduce overweighted positions in stocks, and increase exposure to bonds, which have been strongly outperforming stocks recently. The Fed has been propping up the U.S. economy and – even more – the US stock market, but it is slowly pulling in its horns. That certainly doesn’t mean a recession, but if sustained growth doesn’t return, North American stock markets will switch – probably painfully – from ebullience to caution.