Bernanke’s Boom: Dividends, Leverage, and Why This Time Isn’t Different

by JT McGee

History rightfully pinned the housing bubble on Alan Greenspan and the Fed’s easy money policies of the better part of the 2000s.

The central bank eased and eased and eased, supported by the Consumer Price Index which indicated virtually zero inflation. Meanwhile, a bubble was building – an inflationary bubble in real estate. In case you haven’t heard, that bubble burst.

The CPIs Blind Spot

The Consumer Price Index has a terrible blind spot – and I’m not talking about the commonly criticized problem with food and energy. I’m talking about asset prices.

During the housing bubble build up, the focus on CPI as a measure of inflation ignored the cost of housing. Housing, despite being a large part of consumer budgets, is not included in the CPI – at least not directly.

I think I’ve written about this before, but the CPI is goofy in that it uses “actual and implied rents” to value real estate. Basically, the BLS does what you and I would do to value an annuity, perpetuity, bond, whatever. It starts with implied rental income for property, then discounts that back to the future to arrive at a value for homes.

This method is actually pretty good. Any rational and reasonable person would say that a home should have value equal to the present value of the future cash flows one would receive (or spend!) if it were rented.

No matter how logical this thought process is, reality is not so logical. In fact, there is a very weak relationship between home prices and rents, as you can see here:

Will the Fed Error Twice?

So far, easy money policy has not greatly affected the price of real estate. US home prices are, in the aggregate, staying roughly flat from year to year.

But that’s real estate. It is, for the most part, unlovable. Like an old girlfriend, there are just too many bad memories.

I think what concerns me most is the amount of capital that would ordinary flow into less risky investments like fixed-income securities is now flowing into equities. Case in point: utility stocks are on a tear. Their high dividend yields are, to people accustomed to 2% per year, a godsend in this low-rate environment. Just last week, my dad spoke to a financial planner who admitted that dividend stocks are the new trade. Risk-on for grannies everywhere; investors would rather risk some capital loss for a much higher yield.

Stocks and bonds are real assets, and just like real estate, their valuations will never appear directly in the CPI.

I’ve never seen people so adamant about cash-flowing equities and speculative grade junk bonds. Now, my experience is short, but even a careful survey of history extending before my birth year seems to reflect relatively safe participation in the market by investors. What investors are doing today – participating in mortgage REITs, junk bond ETFs, dividend stocks – would be considered reckless in days gone by.

But for now it’s normal. It’s yield chasing! Granny’s gotta’ eat, yo!

What’s my point?

I never have only one:

  1. Seriously temper your expectations for the market in the future. Each dollar you commit today is not nearly as productive as a dollar committed in September of last year when stocks were cheap. If you enter the market now, do it with the expectation that you will hold for a long time and expect a return at or below the historical average.
  2. Unless you need income, dump dividend stocks. CEOs and CFOs don’t need to cook the books any more to insure a higher and higher stock price. Just add to the dividend and yield chasers will buy it up in a heartbeat. If you are a long term investor you are getting screwed in dividend equities right now because you’re competing with people who are happy with anything >2% per year. There’s a reason Interactive Brokers is advertising portfolio margin at .5% and the dividend discount model is back in vogue. (It’s not because people didn’t know about dividends, or because people got tired of EV/EBITDA, P/E, DCF models. It’s because people are blinded by yield.)
  3. Sidebar: All high-liquidity dividend payers are going to be overpriced. So with the exception of low-liquidity microcaps, I don’t even bother to shop companies that pay a decent dividend any more. I straight up throw them out because I’m not going to find anything that displaces the valuation premium from a high dividend. See stocks like PMD, which I regard as the only high-dividend stock worth a hoot, but only during risk-off panics. Disclosure: Have owned it in the past; will own it again. Just wanted to highlight it because it sells for 18x earnings (pricey for a microcap) in a slow growth industry (drug testing). People are bidding it up to catch yield. Shrewd investors wait for panics a la 2011 Eurozone fiasco to snatch up shares of low liquidity stocks.

  4. Earnings growth is great, but probably just financial maneuvering. Growing earnings from an improved business is one thing. Earnings growth from refinancing or leverage is something any company can do. Don’t blindly accept earnings growth as true growth. I’d love to be a CFO sitting on an upcoming maturity wall of high interest non-callable debt that I can refinance in the next few months. Job security for nothing, baby!
  5. Stocks are bonds. They are. They’re bonds in perpetuity – claims on centuries of forward earnings supposing that the company in question lasts that long. Bond convexity is strongest on the longest maturities. See stocks as a forever bond and you’ll see why higher rates will crush stocks.

Anyway, I’m rambling. The point is that we have a crazy asset bubble going on right now, forward earnings are being propelled by leverage and refinancing, dividends are destroying all value for long-term investors, and the Fed – if it stays focused on CPI – will never see the bubble it’s building much like it never saw the housing bubble.

Proceed at your own risk.

{ 3 comments… read them below or add one }

PK September 26, 2012 at 10:06


I’m glad I’m not alone in panning dividends. Not only are you fighting over a decreasing value, but you’ve got a massive uncertainty in tx treatment at the end of the year. Don’t say you weren’t warned!


JT McGee September 26, 2012 at 12:01

I’m not yet concerned about tax treatment. As far as valuation premiums – yeah, I really don’t think you’re going to compound your wealth that fast in dividend stocks. I’m not buying a single company that pays a hefty yield, and I hope they stay off the dividend radar so that I can continue to buy at a discount price.

When I want to exit? Well, that changes the game! Dividend up because then I’m guaranteed a premium.


Sergey Kazachenko September 29, 2012 at 13:41

The home price is determined not only by the future rents, but also by the prevailing mortgage rates. You could say the interest rates are irrelevant because they are used both on the acquisition of the property and on discounting the future rents, but this is not so. Rents typically change much less than prices. The beginning of the run up in the 2000s was the market’s logical response to Greenspan/Bush lowering interest rates after the dotcom crash, in fact pumping up real estate was directly stated as a goal. Of course, then we got the bubble with no-doc subprime loans, etc…


Leave a Comment


Previous post:

Next post: