Agora Financial’s Rude Awakening

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Dubai, UAE

• A dead end for dividends – how the market stacked up this past decade,
• Approaching Peak Intervention with the central bankers in Jackson Hole,
• China comes back online after the Olympics and plenty more…

Joel Bowman, reporting from Dubai in the Persian Gulf…

The Make Nice games are over. Now it’s time to get back to work.

For China, that means cranking up all those factories that were closed during the Olympics, around 13 gigawatts worth, in fact. To put that into perspective, China will bring production back online equivalent to around half the total industrial capacity of Mexico.

What next for the Asian giant? Dare we say, “double time?”

More on that later in the week…

Meanwhile, back in the home of the brave and the land of the relatively free, a who’s who of policy wonks retired to Jackson Hole over the weekend to discuss the fate of your money. All the usual suspects were in attendance to defend their records and make the obligatory power grabs.

For his part, Bernanke took the opportunity to argue for new Fed powers and to validate its role in providing “comprehensive supervision of systemic risk.” Not satisfied that the “Too big to fail” phraseology extends enough scope for the Fed to intervene in the free market, Bernanke introduced the somewhat more nebulous “Too interconnected to fail” concept.

Former Fed Vice Chairman Alan Blinder explained Bernanke’s proposal for a “new regulatory supervisory mechanism.”

“There’s still work to do in the emergency room,” Blinder observed, much to the chagrin of wincing non-interventionalists across the land. Blinder went on to explain that while bailouts like that of Bear Stearns fit neatly under the “Too big to fail” doctrine and set important precedents, Bernanke and the
Fed now need to look more at “linkages.”

“If this link in the chain breaks what else happens and what do we have to do?” he said.

We wondered if anyone was impolite enough to bring up the possibility of “too stupid to succeed”…

Jean-Claude Trichet was also on hand to pat himself on the back. The situation in Europe has been handled rather swimmingly, according to the ECB President. “What has been done until now has been pretty well done under very difficult circumstances.”

But even by Trichet’s own measure, things look decidedly worse for ware. Inflation is on the march at more than double the ECBs 2% target rate and GDP in the 15-country eurozone contracted by 0.2% during the three months of the quarter.

“The euro zone economy shows every sign of qualifying for the strictest definition of a recession,” noted one columnist writing for the Belfast Telegraph. Trichet must have forgotten to mention that.

Will the central bankers be able to nut out a financial panacea to save the world? We doubt it. One thing is for sure though; they’ll do their best to fan the flames as the conflagration spreads…

Back in the stock market, Adrian Ash takes a look at the underwhelming performance of equities in what he calls the “Decade of No Returns.” Details below…

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The Decade of No Returns
By Adrian Ash

What a difference a decade can make! Over the last 10 years of the 20th century, anyone buying and holding US stocks made a total return approaching 18% per year.

Their initial stake, as a 2002 research paper noted, increased five times over. Now that’s real money!

But roll forward ten years, and the total return on the S&P500 was actually negative for the decade ending on 30th June 2008.

Yes, you read that right. For the 10 years to the end of last month, the S&P index delivered less than zero. That’s even after accounting for dividends (good) as well as inflation (bad).

In short, U.S. equity buyers just suffered a “Decade of No Returns.” Looking back to the late Nineties from the late Noughties, it barely seems possible.

The S&P enjoyed two strong bull markets during that time. The first added nearly 50% in the 18 months following July ‘98; the second delivered more than 87% in the five years to September ‘07. All told, the S&P rose in 69 months out of 120 - and yet anyone holding the 500 stocks included in
Standard & Poor’s index just wound up with a total return of sweet fanny adams.

Whatever happened to holding stocks for the long term?

“[The Noughties] are well on the way to being the worst decade for stocks since 1930-40, back when things were really messy,” says the Wall Street Journal. It cites a note from Richard Bernstein, chief investment strategist at Merrill Lynch, who spotted this Decade of No Returns last week.

Even “the somewhat more-bullish Tobias Levkovitch, chief U.S. strategist at Citigroup, pointed out recently that the S&P 500 returned just 1.66% from 2000-2007,” the Journal goes on.

“He notes that all of the returns so far this decade have come from dividends; price return is slightly negative.”

Dividends remain crucial to stock-market investing, in short. Ever more crucial, in fact…and perhaps more crucial still than either Bernstein or Levkovitch dare guess.

It should little surprise us. But while U.S. equity investors saw the S&P’s valuation rise more than four times over during the 1990s, its 500 constituent stocks didn’t actually pay out four times as much in dividends each year.

Indeed, the capital gains enjoyed by Nasdaq and S&P owners between January 1990 and the end of 1999 came at the cost of decent yields offered to new stock-market buyers. That decade saw dividend yields on the S&P fall in half, according to data from Robert Shiller at Harvard University - down from 3.3% to below 1.15% per year.

Any wonder the derriere eventually fell out of the “Long Boom” at the start of this decade? By way of comparison (and as marked on BullionVault’s chart above) the long-run historic average sits nearer 4.3%.

That’s the long-run average running back 120 years and starting in January of 1888.

The equity bull market of the 1990s, in other words, stands out as something of an aberration…an “outlier” event as dramatic in its own way as the stock-market wipe-out of the 1930s. But while the Great Depression took stock prices so low, dividend yields shot up towards 14% per year, the vanishing yields of the 1990s needed the bear market of 2000-2003 to set things right.

Only, of course, it didn’t. Yields slumped and stayed slumped as the Tech Crash drowned financial, industrial and retail stocks in its wake. S&P dividends fell lower right alongside stock prices. Even at the low of October 2002, the dividend yield offered by America’s 500 biggest corporations remained well below 2.0%.

Fast forward to mid-2008, and the gap between what you might now earn in dividends and what investors have traditionally expected remains very nearly as wide as it was throughout the 1990s. The upshot? Unless things really are different this time, and investors are willing to buy stocks that pay less than half the rate of inflation - and less even than U.S. Treasury bonds! - then the current bear market might be expected to roll on for a while longer yet.

Why? Because to push this decade’s dividend-yield back towards the long-run historic average, the annual pay-out from S&P stocks would need to reach a staggering and never before witnessed 19% - and stay there - for the next 18 months.

Short of a market-wide “earning surprise”, you can guess what that would mean for stock prices, currently offering a little over 2.1% per year in dividend yield.

Before stocks look a good income-paying asset class once again, investors had better hope and pray that either earnings rise sharply or inflation in their cost of living goes negative.

If not, they’re likely to continue swapping stocks for other investments until the return offered by equities gets somewhere near to its historic average - more than twice the current level today.

[Joel's Note: A decade of no returns, a hemorrhaging dollar and negative real interest rates. What’s an investor to do? Buying gold is part of the answer but, alas, many feel they’ve missed the boat; that the price has risen too far and that if they invest now, they’ll be just in time for the downturn. They could be right, of course…but we doubt it. When adjusted for inflation, gold is not even half way to its last market peak. That means you’ve got plenty of potential upside remaining.

Whether or not you believe gold will go to $2,000, $3,000 or beyond, it is probably a good idea to have at least SOME stuffed under the mattress. For more information on how to ready your portfolio for the next upswing, check out Adrian’s plentiful and thorough research at BullionVault.com

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[Rude Endnote: “How about the USA at Peak World Dominence, or the dollar at Peak Confidence (Con), or the US politics at Peak Circus,” offered one reader in response to our “What Peak comes next” question from the weekend.

“If you can find ‘Peak Political Correctness’ you’ll be my hero,” mused another.

Got some thoughts of your own? Send them along with your comments from today’s column to the address below.

Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening

aussiejoel@the-rude-awakening.com