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No Bubble for Income Stocks

7/2/2013 1:38:00 PM
By: Kiplinger
Referenced Stocks:

The voice, always edgy, was borderline breathless. "Jeff," began Jack, a man in his seventies from Philadelphia who is a Kiplinger's subscriber and regular caller, "some of my stocks are bothering me. Ya think I oughta sell AT&T and Verizon and American Electric Power? Whaddya think is going on?" This was on a day when the Dow Jones industrial average fell 106 points (less than 1%). But some of Jack's stocks and other top-notch dividend payers, including utilities and real estate investment trusts, took far bigger hits.

See Also: 12 Stocks to Get Dividends Every Month

Consider: In roughly two weeks, Verizon Communications (symbol VZ ) fell from $53 to $48; American Electric ( AEP ) dropped from $50 to $46; and my favorite REIT, Realty Income ( O ), tumbled from its all-time high of $55 to $45 (prices are as of May 31).

The proximate causes were the frothy prices of these stocks (they had rocketed in April) and a sudden jump in interest rates. In just a month, the yield on ten-year Treasuries surged from 1.70% to 2.16%. Because rising rates could enhance the appeal of bonds for income-oriented investors, the decline in these scalding stock groups is not illogical, although a government bond paying 2.2% still isn't competitive with a utility yielding 4% or a REIT at 5%.

But what shocked me, and surely scares a guy like Jack, is how the retreat of divi­dend payers conjures up so much loose use of the dreaded word bubble. From CNBC to the blogs on Seeking Alpha to brokerage analysts' commentaries, bubbles are everywhere--dividend bubbles, REIT bubbles, bond bubbles and now a new housing bubble. You'd think that the Nasdaq was back at 5000, inflation was surging, janitors were buying $800,000 McMansions with gains from money-losing Web firms, and Ben Bernanke was set to announce a big hike in short-term interest rates (the ones that are currently near zero).

Those would be, to quote a sensible definition of a bubble, events that "foster and amplify" wild herd behavior that culminates in a disaster. The original bubble, the blowup of the South Sea Company, lured Englishmen in 1720 to bet their spare pounds in a failed scheme to get rich trading with South America. South Sea shares soared some 800% in months and collapsed even more quickly. The affair led to hostil­ities between Britain and Spain as well as an economic meltdown. How does that correspond to an 8% correction in an electric utility index that, at its peak, was up 18% for the year? Or to a $10 fall in the shares of Realty Income, a growing REIT with secure earnings that began 2013 at $40 and ended May at $45? Folks, it doesn't.

Don't panic. Remember, most of you buy dividend stocks for the income and maybe a tad of appreciation. Sometimes, the stocks fall. But there is scant evidence that utilities, property-owning REITs, oil-and-gas pass-throughs and cash-rich industrial firms are in a bind that could result in an interruption in tomorrow's dividends. I'm a bit more worried about mortgage REITs, which need higher long-term interest rates to recharge their sagging profit margins. But even the biggest of that breed, Annaly Capital Management ( NLY ), which at $14 is sitting at a four-year low, earns enough to cover its 45 cent quarterly dividend (although the payout may soon fall to 40 cents).

I did advise Jack that if his stocks were making him nervous, he should sell, even if it meant incurring a tax bill on his winners. But that doesn't mean it's a good idea to turn into a trader. Are you prescient enough to sell AT&T for $40 and buy it back at $35? And repeat the feat with other stocks?

The more critical issue is whether (to borrow a phrase from the policy wonks) there is an "existential threat" to the future of dividend-paying stocks. In a slow-growth, low-inflation economy in which companies are rich in cash, there isn't--unless you see bubbles that aren't bubbles.

Jeff Kosnett is a senior editor at Kiplinger's Personal Finance.