Investors are starving for income like never before. Most recently, retirees, insurance companies, pension plans and others are tossing caution to the wind and desperately reaching for yield wherever it can be found. Based on history, this will not likely end well.
This summer has marked a new low in yields and a corresponding new wave of investor desperation. After the surprising U.K. vote to exit the European Union, interest rates plunged throughout the globe. Government bonds – about $12 trillion worth – now trade at negative yields. No modern-day finance textbooks discuss the notion of investors literally paying a government for the right to lend them money. Yet, this is the upside-down world of finance in which we now live.
Dealing with this world of low interest rates has pushed investors to seek alternatives to owning high-quality, low-yielding bonds or CDs. As a result, traditional income-oriented stocks, such as utilities and telecom companies, have surged about 20% in just the first seven months of this year. These are astounding returns for companies operating in slow-growing industries. Nonetheless, investors today view 3% dividend yields as mouth-watering. There appears to be very little fear of paying too much for these dividends. There should be.
Let’s put the current price of utility and telecom stocks into some historical perspective.
Currently, investors are so happy to receive their dividends that they have now bid up utility stocks to nearly 20 times their annual earnings. During my career, it has not been uncommon to see utilities trading about 30% to 50% lower than they do now. It is a basic fact of math that any return to normalcy – even a move in the direction of normal – will wipe away many, many years of the dividends these investors so craved. It takes a lot of years of dividend payments to make up for a 30% drop in the stock price.
It is ironic that Warren Buffett’s warning that investors “pay a very high price in the stock market for a cheery consensus” has been so turned on its head. Four decades later, it is now investors’ un-cheery consensus about ever being able to earn enough income on their money that has led them to ignore Buffett’s advice. Whether it is optimism or pessimism that leads investors to pay too much, the outcome will be the same. You should review your own portfolio now for any hints of desperate thinking.