Weeds Grow in the Stock Market’s Yield of Dreams; Investors’ intense focus on dividends could yield problems for them later on

May 7, 2013, 5:35 p.m. ET

Weeds Grow in the Stock Market’s Yield of Dreams

By JUSTIN LAHART

Investors’ intense focus on dividends could yield problems for them later on.

Usually when the Federal Reserve is in easing mode, investors set their sights on the stocks of companies whose fortunes are most likely to rise fastest with rising economic growth. But with the Fed sopping up $85 billion in Treasurys and mortgage bonds each month—and driving yields across a spectrum of bonds lower in the process—the hunt for investments that can provide a modicum of income has intensified. So the shares of companies with a history of paying dividends, which investors more typically eschew when the Fed’s foot is on the gas, have been in favor.At Tuesday’s close, the S&P Dividend Aristocrats index of large companies with a history of increasing dividends each year had risen 15.9% so far in 2013, versus 14% for the S&P 500. Moreover, over the past month, as companies have reported first-quarter earnings, a curious trading phenomenon has arisen. Shares in the 10 largest companies in the S&P 500 have become less correlated with one another, the usual pattern as individual companies’ earnings reports drive their stocks in different directions. But shares of the 10 largest companies in the dividend index have been marching in lock step with each other more.

That might be a sign that some investors aren’t differentiating much between stocks so long as there is a history of dividend growth. One reason why: There has been an uptick in the number of bond mutual funds that now hold stocks in their portfolios.

Trouble is, these investors are used to the more stable world of bonds. They often aren’t prepared for the volatility often seen in the equity arena.

That could lead them to overreact, exacerbating swings in stock prices. A glimpse of the type of dislocations that can occur seems to have happened last week with shares of Pitney Bowes PBI +1.50% . The postage-meter maker slashed its dividend, an unsurprising development given the steady decline in first-class mail volume. Its shares, though, fell nearly 16%. They have since largely recovered almost all of that drop as less dividend-minded investors apparently saw some value.

Companies, meanwhile, have been stepping up dividends. Even though a bunch of payouts were shifted to the fourth quarter to avoid higher taxes in 2013, this year’s dividend payments from companies in the S&P 500 should easily surpass last year’s, says S&P Dow Jones Indices analyst Howard Silverblatt.

Indeed, given that investors are so enamored by dividends lately, it seems like a no-brainer for companies to pay out even more. Especially if doing so can help boost their share price, lowering their cost of capital. Making matters even more alluring, they can cheaply borrow money for dividend payments from yield-hungry investors in the bond market.

It’s really a wonderful setup, with investors and companies alike getting exactly what they want. Until, that is, the day arrives that the Fed decides to start withdrawing support for the bond market.

That could drive bond yields higher, really upsetting the apple cart.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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