High Risk in “Safe” Stocks

Posted On Aug 1, 2016 By Dave Gonigam

  • Five years on: The budget deal that dinged Uncle Sam’s credit score
  • Five years of investors “reaching for yield” bring us to an inflection point
  • The trouble (now) with blue chip dividend payers
  • Markets move sideways as manufacturing slows and B-Dud opens his yap
  • How nearly two-thirds of the biggest companies manipulate their earnings
  • Forced farm labor to alleviate shortages… the teacher-logger debate rolls into a new week… a modest proposal for taxpayer-funded stadiums… and more!

“In most cases, I’m a big advocate of buying blue chip dividend stocks,” says our income specialist Zach Scheidt. “But in today’s market environment, there’s a lot more risk than most investors realize.”

What are those risks? And what should you do about them?

Answers shortly. But first, we’re compelled to enter the Wayback Machine…

It was five years ago today the U.S. House approved a budget plan that prompted the downgrade of U.S. government debt.

The Senate approved the deal the following day, and the president signed it. With that, Standard & Poor’s decided at week’s end that Uncle Sam was no longer a AAA credit risk. U.S. Treasuries were downgraded to AA+.

The decision came after one of those insufferable debt-ceiling showdowns between the White House and Congress. It proceeded as most of them do: The party not occupying the White House grandstands about “fiscal responsibility,” right up to the last minute — and then surrenders in spendthrift humiliation.

For reasons that look increasingly silly with the benefit of hindsight… S&P decided this occasion in 2011 was a bridge too far.

Yes, the national debt has ballooned from $14.3 trillion then to $19.4 trillion now. But rising credit risk is supposed to be reflected in rising interest rates. Instead, the yield on a 10-year Treasury note has fallen from 2.77% on this day five years ago to 1.48% as we write this morning.

As awful a credit risk as Uncle Sam is, the rest of the world’s sovereign governments look worse — especially when they’re resorting to negative interest rates.

Meanwhile, S&P’s downgrade in 2011 left a handful of U.S. corporations with a higher credit rating than Uncle Sam.

We pointed this out a few weeks later with our fearless leader Addison Wiggin in the gone-but-not-forgotten Apogee Advisory. A mere four companies held a sterling AAA rating: Johnson & Johnson, Microsoft, Exxon Mobil and the payroll processor ADP. (Both XOM and ADP have since been downgraded.) Investors starved for both yield and safety could do worse than invest in the bonds of those companies.

But for many retail investors, the $5,000 minimum purchase for a single bond issue makes that notion a nonstarter. Better, we suggested, would be the dividend-yielding stocks of those firms. And better still would be a fund that has all four of those companies, and a few others that might not be AAA but are still rock-solid and have a long history of raising their dividends every year.

The resulting recommendation: The Vanguard Dividend Growth Fund (VDIGX). Addison called it “your best bet for collecting rising streams of income from blue chip companies.”

Our recommendation five years ago had little to do with it, but last Thursday, Vanguard closed VDIGX to new customers.

Mutual funds do that when they become too big and unwieldy to manage. VDIGX’s assets have doubled in just the last three years, as yield-starved investors slowly figured out what we did in 2011.

What’s more, this morning’s Wall Street Journal informs us that investors are now piling into older technology names like Cisco. CSCO didn’t even pay dividends during the go-go ’90s, but it yields 3.4% as we check our screens today. (Heck, a 30-year Treasury bond pays a pitiful 2.23%.)

“Some investors,” says the Journal, “fear that the gains in shares of Cisco, IBM and other income generators are a sign that the embrace of dividend stocks has gone too far.”

Which brings us full circle to Zach’s warning at the top of today’s episode of The 5 — a warning he shared with his readers a month ago, made more urgent by these new developments.

“Blue chip dividend stocks are typically a great way to generate income and protect your wealth,” he allows.

“But low interest rates have caused investors to crowd into dividend stocks like a herd of cattle crowds a stream. At some point, too many cattle make the stream dry up (or leave it full of mud and urine).

“Sorry for the nasty word picture, but that’s what is happening to some blue chip dividend stocks right now. Investors crowding to this area have sent shares of dividend stocks higher. By paying too much for these stocks, you’d be taking a big risk that shares trade lower once interest rates finally DO move higher.”

So if Treasuries yield next to nothing… and many blue chip dividend payers are turning risky… what do you do?

It’s a strategy Zach revealed to 31,000 readers last year — a strategy that delivers anywhere from $400 to $4,700 a month. Let Zach tell you all about the strategy at this link. Fair warning: For reasons you’ll see when you click, we might have to take down this presentation at any time.

The mighty U.S. industrial machine is slowing down, judging by the new ISM manufacturing survey — out this morning, as it is the first of every month.

Numbers above 50 indicate a growing factory sector; below 50, a shrinking one. The number for July rings in at 52.6 — down from the month before, and less than the “expert consensus” was counting on. Still, it’s five straight months of slow growth coming after five straight months of contraction.

Traders can barely be roused to react to the number. As we check our screens, the Dow industrials and the S&P 500 are ruler flat compared with Friday’s close. Gold is likewise little moved at $1,349.

If it’s excitement you’re looking for, it’s in crude; a barrel of West Texas Intermediate is down 2.4% as we write, to $40.62.

Perhaps remarks from New York Fed chief Bill Dudley — “B-Dud” as he’s known to David Stockman’s readers — have put a lid on the stock market froth for the moment. He gave a have-it-both-ways speech in Bali in which he said “it is premature to rule out further monetary policy tightening this year” — typical Fedspeak of late, aimed at talking down the market.

But he also said the risks of acting prematurely are greater than the risks of waiting too long to act. A shift in the Fed’s “forward guidance”? That would be in keeping with the secret “Shanghai Accord” Jim Rickards said was negotiated last winter. Already, the poor GDP number on Friday has pushed the U.S. dollar index down substantially from four-month highs reached last week.

“An overwhelming majority of America’s blue chip companies are purposefully promoting false earnings,” says our trend follower Michael Covel — throwing a cat among the pigeons here in the thick of earnings season.

“Traditionally,” he says, “companies report earnings using ‘generally accepted accounting principles,’ or GAAP.” But as corporate greed and corruption have spread, companies have been turning to non-GAAP accounting measures to inflate earnings and stock prices.

Michael points to a recent study by MarketWatch that finds 32 of the 50 biggest S&P 500 companies promoted non-GAAP numbers in their January 2016 quarterly announcements. Using non-GAAP numbers can inflate earnings up to 44%.

“According to Bank of America Merrill Lynch,” Michael goes on, “the number of companies reporting non-GAAP earnings has increased sharply over the past two years. They estimate roughly 90% of all companies now play this earnings game.”

Michael’s suggested remedy for your portfolio? Its right here.

“Trying to tackle Venezuela’s severe food shortages by forcing people to work the fields is like trying to fix a broken leg with a Band-Aid,” says Amnesty International’s Erika Guevara Rosas.

We could turn Venezuela’s slow-motion economic train wreck into a daily feature if we had more than 5 Mins. to work with. As it is, we haven’t traipsed through the late Hugo Chavez’s socialist paradise for five months… but a sharp-eyed reader points us to an item we can’t overlook.

The woman from Amnesty was not overstating things: “In a vaguely worded decree,” reports CNN, “Venezuelan officials indicated that public- and private-sector employees could be forced to work in the country’s fields for at least 60-day periods, which may be extended ‘if circumstances merit.’”

Bonus points: Under the decree, businesses must continue to pay workers their full pay while they’re away… and make sure their job is still there when they come back.

But hey, it’s not all bad: Based on black-market exchange rates, Professor Steve Hanke at Johns Hopkins University estimates Venezuela’s inflation has slowed from 449% when last we checked on March 1… to 62% now.

“Bull,” writes the reader who called out teachers last week and unintentionally launched the “logger vs. teacher” thread — one of the more impassioned email debates we’ve had in The 5 for a while.

“I taught for five years, my mother is a teacher and — golly, gee whiz — I watched her every night growing up. My brother is a teacher, my sister-in-law is a teacher and when I am between consulting gigs, I still substitute teach. There indeed are a few times people have to work late, and it is indeed an honorable profession.

“But teachers do NOT work until 11 p.m. except at end of term or similar time. As noted, they have off massive amounts of time, and — as I wrote earlier — the one family member who retired at 56 at $7,000 per month is — as nice as she is — a financial leech on society (she ended her career making $110,000 per year… as they said in the Depression, ‘Nice work if you can get it.’

“Friday’s writer talks about union-negotiated salaries and to take it up with our politicians if we don’t like it. But of course, our politicians are utterly bought and paid for and know how to pander to the hoi polloi (see the Chicago Teachers Union and its $1 billion in debt).

“But here’s the final thing: GM also had ‘union-negotiated salaries’ — and went bankrupt. Our dear overpaid teaching cadres don’t get it: They can negotiate all they want, have politicians pander to them all they want… but I am voting with my feet, and then, as Bastiat noted, they can all live off of each other. I ain’t going to pay for their life of leisure.

“Friday’s writer insults the intelligence of anyone who has been around teachers. I suggest instead of reading The 5, he go back to reading the Socialist Daily Tattler.”

“I have relatives who are loggers and some that are teachers,” writes a reader who wishes to establish his bona fides off the top.

“The teachers are PAID to have a bigger impact on young lives. They are NOT humanitarians. Take the paycheck away and they don’t show up to have any impact. My beef with today’s public schools is what their priorities are.

“My niece just graduated from high school. Her mom (my sister-in-law) is a principal at a grade school. My niece was complaining a few days ago about having to get groceries to take with her on her way to her college she will be going to soon. Why? Because she doesn’t even know how to cook, so why does she have to buy groceries! My niece received piano lessons but not cooking lessons! Great priorities there. And most of the kids I saw at the graduation were overweight, so clearly, they didn’t get any good health lessons. Sad. And very unhealthy.”

The 5: Two-income families are too busy to pass along guidance about anything like cooking to the next generation… and the relentless Common Core testing regime has muscled aside the time that used to be set aside for things like home ec.

Result? “Convenience foods” from the middle aisles of the grocery store that fuel obesity.

Just a handful of the consequences that have followed from Nixon cutting the dollar’s last tie to gold in 1971 and making it impossible to enjoy a middle-class lifestyle on a single salary.

“I have a proposal,” a reader writes on the subject of taxpayer-subsidized pro sports stadiums.

“All sports franchises shall be named after their owners, instead of the location of their playing grounds.

“My reasoning is this will make it clear where the money goes with these teams. It does not go into the city’s coffers that carry the name of the team; it goes into the pockets of the owner whose name is now associated with the team.

“I speculate whether the Jerry Jones Cowboys would get as many fans paying to attend their games as the Dallas Cowboys do. And whether the Art Rooney Steelers would have as many supporters as the Pittsburgh Steelers. And so on.”

The 5: Heh… Of course, time was that team owners named the stadiums after themselves — i.e., the Buffalo Bills’ Ralph Wilson Stadium mentioned here Friday. But that was before the whole naming-rights thing caught fire.

Come to think of it, how did a Buffalo-based bank — M&T — ended up getting its name slapped onto the football stadium here in Baltimore?

Best regards,

Dave Gonigam
The 5 Min. Forecast

P.S. Here’s another steady way to generate investment income at a time many blue chip dividend payers are starting to look dicey.

To do it right, you need to be a little more well-heeled than the everyday investor. In fact, we strongly suggest you put at least $20,000 of capital into this strategy for maximum benefit. But once you do, the payoffs can be sizeable — and instantaneous. See for yourself right here.


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