The Big Change is afoot ...Gather Your Yield Where You May

Gather Your Yield Where You May

By DoctoRx, on July 21st, 2012

A growing number of people “get” the message that utility stocks are today’s techs.  From Charles Hugh Smith’s blog post that was reposted on Zero Hedge yesterday titled What’s So Bad About Deflation?, he concludes:

Everyone assuming the Federal government has the power to create inflation and that inflation is “good” should examine the interests of those who control the government’s policies, i.e. those who own the debt.

Put another way: here’s what will be scarce: reliable income streams and liquidity.

His final conclusion is where much of the investment world is, I think, going for at least a bit longer, and it’s interesting seeing a deflationist argument come not from a David Rosenberg or Gary Shilling type but from a progressive thinker.  

What’s old is becoming new again. 

Once again, the dividend yield on the Dow 30 and the SPY exceeds that of the 10-year T-note.  This relationship flipped from its long-term historical pattern between 1958 and 1960 into a “new normal” where stocks yielded less than long-term bonds all the way into early 2009, and now this hallowed historical relationship may be settling back to its conservative relationship for the long term again.  The Dow’s yield is roughly where the 30-year T-bond is.  In this “old normal” world, the cornerstone for individual investors, for fiduciaries such as bank trust departments, etc. is for the “safest” dividend-paying stocks to be prized once again as the cornerstone of a portfolio.  In other words, preservation of capital has emerged as a key to investing rather than growth of capital.  Adieu (for the nonce), growth stock investing, gone with the Facebook winds of overvaluation?

Amongst the small number of stocks covered by Value Line’s Investment Survey for which fair value is measured not by P/E or price:cash flow metrics, one mostly finds utilities.  These are regulated monopolies to the extent they have not diversified into unregulated activities such as trading electric power, building wind farms, etc.  Thus they are pseudo-governmental.  These are amongst the very few cases where a believer in free markets accepts the benefits of the lack of a free market.  There can only be one Con Ed for its areas of New York.  Imagine twice as many manholes in New York streets from a competing power provider!  Plus, electricity cannot be stored, except through batteries and the like.  So there’s something truly special about electric utilities and to the extent that they are regulated local monopolies, natural gas utilities as well. 

If the Economic Cycle Research Institute (ECRI) is correct in its belief that the U.S. is already in at least the second month of a new recession, then in the context of an incomplete recovery from the 2007-9 “Great Recession”, earnings and even stated corporate net worth will be quite challenged.  In this setting, perhaps a “safe” company such as one of the mega-cap consumer products companies will trade unchanged or even up in price as investors rush to lock in a “safe” and “probably” rising dividend yield, but that’s a “maybe” in my view.  The consensus I see the market already voting invovles new all-time or multi-year stock price highs in a number of utilities.  It’s a return of/return on capital approach that could be a major trend for months and years to come. 

Dividend-paying stocks, especially the quasi-governmental regulated utilities, have become the new momentum stocks.  A lot of rationalists correctly doubted the sustainability of the tech stock boom in 1995.  Four years later, they had either capitulated or correctly continued to doubt that move, having missed the greatest bull market in decades.  Utilities are, almost bizarrely, hot again.  Comparisons with the prior relationship their yields had in past years with the 10-year Treasury lead to the conclusion that they just might soar even from today’s elevated levels simply to play catch up with the massive interest rate move in the past year and past few years, even in a setting where Treasury yields rise again from today’s record lows.

The game’s afoot.