Sunday, November 04, 2007

The Value/Dividend Bubble is Deflating

For the past few years the stock market has been suffering from a strange imbalance. On the one hand, value stocks and dividend-paying stocks are more popular than ever. This popularity is made obvious by (1) the relatively high P/E ratios of value stocks relative to growth stocks, (2) the amount of money invested in value and dividend funds relative to growth funds, and (3) the amazing run-up in prices of value and dividend stocks relative to growth stocks between late 2003 and early 2007. REITs and other real-estate related stocks were among the favorites due to their dividend payments, and they experienced a correspondingly large run-up in price.

But this value and dividend rally has occurred at a very strange time, because dividend payments - the very things that make dividend and value stocks valuable - have been disappearing. Since the peak of the tech bubble in 2000, corporations have been phasing out dividends in favor of stock buybacks. As a result, the yield of the S&P 500 index today is a near-record low 1.7%, well below the historic minimum of 3%. Even dividend-paying stocks are barely paying dividends today; the Dow Jones Select Dividend Index (ETF: DVY) only sports a 3.2% yield.

So why have value and dividend stocks outperformed growth stocks during the very time when they are producing the least income for investors? The only answer can be that we are in the middle of a value bubble, and I suspect that corporate buy-back money (which normally would have been paying dividends) has helped to drive up prices of cash-producing companies. Recent events have me convinced that this bubble is - if not bursting - at least deflating.

Stocks known for their dividend-paying advantages have been gradually veering south of the S&P 500's performance this year. In February REITs and financial stocks began to underperform, and they are now down more than 20% relative to the S&P 500. In May, the bulk of dividend-paying stocks followed as a group, and they are now down 12% relative to the market. Finally the entire value half of the market started slipping in June, and today it is already 10% behind the growth half.

I can't predict how long or how far this dividend "peel-off" will go, but I'm betting that growth stocks will be mostly unaffected since (1) growth investors aren't looking for dividends and (2) growth companies have less extra cash relative to their stock price to use for price-inflating buybacks.

Update January 22, 2008:

Duh! Growth stocks eventually succumbed along with every other group of stocks around the planet. I should have realized this might happen ... even though the bubble of 2000 was mostly growth and tech stocks, value stocks also participated in the subsequent bear market decline.

No comments: