Vedran Vuk here, filling in for David Galland. Today I’ll start with a commentary on the financial news cycle. It seems that every few quarters we get a repeat of the same stories. Then I’ll discuss a warning sign to be alert for when considering high-dividend stocks to buy. Next I’ll share a map of Gaza and Israel which reveals much about the conflict. And last, I’ll share some funnies from The Onion.
But before I begin, I want to remind you that Doug Casey has just published a new book, Totally Incorrect. It’s a compilation of Conversations with Casey interviews with Doug that have appeared in past Casey Daily Dispatch issues.
Doug covers a wide variety of topics in the book, including terrorism, voting, health, WikiLeaks, World War III, and – of course – the economy and investing.
It’s an enlightening, thought-provoking, and downright fun read that I’m sure you’ll enjoy.
The Never-Ending Parade
By Vedran Vuk
As I’m currently living in a fairly small Texas town, I don’t have the pleasure of seeing any of the bigger holiday parades in person. Let me describe the local parade from last year. My friend and I got to the venue early and patiently waited for it to start. First, a haphazardly assembled float came by, followed by a horrendous cacophony from the local marching band, and then a few people passed waving from their convertibles… then another excuse for a marching band and a couple more floats slowly made their way past the crowd.
Altogether, the parade must have been less than ten minutes. As last float passed by, we stood there dumbfounded along with the rest of the crowd. Was that it? Perhaps a trailer had broken down and held up the rest of the parade, cutting it into two parts. The rumors and possibilities filled the crowd’s conversation. After about 15 minutes, someone yelled, “Look, there’s the rest of the parade!” The crowd cheered as they saw lights way down the street. Everyone’s lively mood was restored.
But as the parade drew closer, discontent swept the crowd again. I didn’t understand why until the parade had come closer still – it was the exact same group that had passed earlier. The parade had just gone around the block and essentially made a big circle!
Doesn’t this sound just like the financial news for the past four years? It’s the same parade making its way around the block. And somehow, we’re hopelessly duped into coming out in the cold to watch it every year.
First up in the parade is the threat of Obama’s regulations ending the world. Some shriek in fear and others in joy as he leads the parade. Then the band of Fed officials trumpets another round of quantitative easing. Again, members of the crowd shout out in excitement. Don’t forget our other revelers such Portugal, Spain, Greece, and the rest of the PIIGS dragging their feet in the parade. Of course, there are also the debt-ceiling and fiscal-cliff themed floats. And then there are the Middle East drums of war setting the rhythm for more panic. To top it off, finish with a Chinese dragon growing slower and weaker in its movements.
And just like my local, small-town parade, this one doesn’t pass around once, but comes back for a second and third time. While some floats disappear around the bend, it’s only a matter of time until they show up on the other end of the street. Every few quarters, there’s a meltdown in Europe, and then it goes away… only to repeat. Every few quarters, there’s an event in the Middle East that promises to end the world: the Arab Spring; an Iran conflict; rockets from Gaza… and then it goes away. When there are bigger problems at hand, the fiscal cliff and debt issues vanish, but as soon as there is a lull in the news, they come roaring back. Fears of a Chinese slowdown have been in and out of the news since the 2008 crash. And the only reason no one mentions the Fed lately is because the fiscal-cliff float is currently passing by. As soon as the can is kicked down the road again, attention will redirect toward the Fed.
I’m trying to recall any issues which have completely have left the parade… maybe only Ireland and Iceland have done so. There’s almost no media coverage of those two troubled countries these days. Everything else continues in a never-ending loop – a horrid merry-go-round of economic problems.
So what can one do about this dreadful parade? First of all, stay home. Don’t get yourself sick standing out on the cold with your eyes peeled for the next float. You can do yourself a favor by tuning out much of the news. If QE3 didn’t fix the problem, guess what… QEs four and five won’t either. If the millionth European bailout hasn’t fixed the problem, the billionth won’t. It’s just another loop in the parade – don’t get too excited about the media’s overblown crises.
Does this mean that you should live carefree and turn into a bull on the market? No, not at all. The economy is still in incredibly poor shape. Stick to good defensive equities, a strong allocation to precious metals, and keep some cash safe on the sidelines. Keep your eyes on the big picture rather than focusing on the float parading in front of you at the moment. A good example is the current fiscal cliff. Suddenly everyone is hysterical over the issue, but is the US’s fiscal situation really any different than it was six months ago? The big-picture problem is our never-ending addiction to debt. The fiscal cliff is a short-term symptom of the larger problem. If you can keep your eyes on the bigger problems, you can always be prepared for the worst while also avoiding the stress of the most recent “terror” in the financial news.
A Warning Sign on High-Dividend Stocks
By Vedran Vuk
A lot of people are pushing high-yield stocks these days, so it’s extra important to differentiate the good from the bad. I’m not going to cover every single warning sign of high-dividend-paying stocks in today’s article, but I will touch on one of the most overlooked red flags: a high dividend matched with a weak credit rating. I can already see some of our longtime readers rolling their eyes here and saying, “We get it: the higher the return, usually the higher the risk.” Of course that’s true, but this simple risk-and-reward trade-off is not what I’m going to discuss today.
The problem with stocks with high dividends and a low credit rating is a strategic and theoretic problem. It is not as simple as the risk-reward relationship.
To start, let’s answer this basic question: “Why should a company pay a dividend?” If your answer is, “To provide shareholders with a return,” you’re halfway right, but also wrong. Companies should pay dividends when they have nothing better to do with the money. If a company has a great idea for a new project which could safely make a 20% return on the money invested, the firm should start that project. You don’t want a company paying out its excess cash in the form of dividends just to appease shareholders searching for yield – that’s short-term thinking. The whole point of investing is to have a company grow your assets.
Now, companies don’t always have blockbuster idea after blockbuster idea, so it’s a good thing that dividends are paid out. You don’t want cash just sitting on the balance sheet doing nothing – or even worse, getting eaten away by inflation. The money is better in your hands, if the company has no projects with greater returns than what you could safely earn on your own.
The problem with companies with low credit ratings is that they always have a worthwhile place to use the money, i.e., paying off the debt. Even if a company doesn’t have a project earning 20% returns, it can save their shareholders 6% or 7% by paying down the debt early, rather than paying out a dividend.
As a result, if a company pays dividends despite debt problems, there’s a strategic problem with how the company is run. It’s paying shareholders to appease them, rather than fixing the company’s debt and liquidity situation which would benefit the shareholders more so in the long run. This is more problematic than a simple ratio of two things on a balance sheet. Paying high dividends while faced with bad credit speaks badly of the company’s strategic planning.
Now, as I said initially, this is a warning sign – it is not a litmus test. There are circumstances where a company can have a weak credit rating and a high dividend. For example, if the debt is relatively new or the company is going through a temporary rough patch, it might make sense to keep a dividend high and stable. Suppose a company raised a lot of debt for a takeover. Its credit rating might be suddenly very bad, but it shouldn’t want to change the dividend, as the situation is transitory. Typically, lowering a dividend sends an extremely negative signal to the market about the company’s long-term prospects. So, paying off the debt by lowering the dividend might send a signal to the market which does more damage than good.
Another situation where this might be acceptable is when a company doesn’t foresee any major capital expenditures in the near future. A bad credit rating only really hurts if you’re issuing new debt. If there’s no new debt, then it’s not such a big problem. A smooth dividend might be seen as more attractive than slightly improving the company’s credit when there are no plans for raising capital.
These are just a few exceptions; you really have to get in the details of the company to make sure that everything is all right. It’s also important to make sure the company has a low payout ratio if it already has a low credit rating. However, the most important takeaway is that when you see a stock with a high dividend and a low credit rating, you’ve spotted a flag that needs more investigation. This doesn’t warrant immediately dropping the stock, but you definitely need extra due diligence on the pick.
A Map Is Worth a Thousand Words
By Vedran Vuk
Recently, I was looking around the world on Google Maps, as I often enjoy doing. I came across an area which I hadn’t examined closely beforehand: the border between the Gaza Strip and Israel. You may have heard a lot about the conflict, but the picture below might be worth more than a thousand articles on the subject matter.
Notice that I took off the labels from the map. I’ll let you guess where Gaza starts and Israel ends.
(Click on image to enlarge)
Just by looking at this map, it’s easy to imagine why some of those young Palestinians are so upset. I’m not saying that the conflict is entirely an economic issue, but I would bet if the left side of the map looked a lot more like the right side, you’d probably have about 75% fewer young Palestinians ready to fire rockets at Israel.
When people are gainfully employed and living reasonably well, it’s a lot harder to get them to follow extreme causes. There are plenty of parts of the world where ancient animosities are present, but because of an economically satisfactory environment, no one is taking up arms – i.e., Northern Ireland, Scotland, the Basque. I know what you’re thinking: Ireland and Spain aren’t doing that great. Sure, but if I had the choice between living in Gaza or Ireland, it wouldn’t be a tough decision.
It’s easy to see that the Arab Spring was inseparable from economics as well. Do you really think any uprisings would have happened if the populations of Egypt, Syria, and Libya were living the typical American lifestyle, worrying about Christmas shopping and Black Friday sales? I think not. Or what about Western conflicts such as World War II? Without hyperinflation devastating the German economy, I would find Hitler’s rise to power somewhat more challenging to accomplish.
Unfortunately, our foreign policy ignores the economic factors much of the time. In fact, our solution to aggressive countries is often to economically isolate them even more through sanctions. When people have nothing to lose, one doesn’t have to give up much to join a radical movement of some sort. Considering that the global economy is still in a rut, this doesn’t bode well for the future of peace over the next few years.
In today’s Friday Funnies, I want to introduce our readers not yet familiar with it to an extremely funny political satire website called The Onion. Sometimes the writers can push the satire a little too far, but they also knock it out of the park on a regular basis.
You may have recently heard about the website’s most recent spoof. The Onion named Kim Jong-Un, the dictator of North Korea, as the sexiest man of 2012. Here’s what The Onion had to say:
“With his devastatingly handsome, round face, his boyish charm, and his strong, sturdy frame, this Pyongyang-bred heartthrob is every woman’s dream come true. Blessed with an air of power that masks an unmistakable cute, cuddly side, Kim made this newspaper’s editorial board swoon with his impeccable fashion sense, chic short hairstyle, and, of course, that famous smile.”
The award itself is hilarious, but the really funny part is that a newspaper in China didn’t get the joke. Its staff thought it was a real award and published a 56-photo gallery of the dictator. Read all about the hilarious fiasco.
In honor of The Onion‘s recent well-played joke, I’ve included two more of their very funny spoof videos.
Recession-Proof Jobs Include Any in Which You Witness Your Boss Kill Someone
Here’s a great C-SPAN spoof: Congressmen Submit Emergency 3 AM Bill Demanding IHOP Stay Open All Night
Before we wrap up today, I want to mention that there are two new Casey Phyles starting, one in New York City, and the other in in the Otsego and Delaware county area of New York state. If you’re interested in either of them or in seeing if there’s a phyle near you, send an email to [email protected].
Last, I talked with David Galland earlier this week, and he’s all settled into his new place in Argentina. Unless something unexpected happens, he should be writing the Daily Dispatch next Friday. I’ve enjoyed our time together. Thank you for reading and subscribing to Casey Daily Dispatch.
Casey Senior Analyst