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No Bubble for Income Stocks

There is scant evidence that companies are in a cash bind that could interrupt tomorrow's dividends.

The voice, always edgy, was borderline breathless. “Jeff,” began Jack, a man in his seventies from Philadelphia who is a Kiplinger’s subscriber and regular caller, “some of my stocks are bothering me. Ya think I oughta sell AT&T and Verizon and American Electric Power? Whaddya think is going on?” This was on a day when the Dow Jones industrial average fell 106 points (less than 1%). But some of Jack’s stocks and other top-notch dividend payers, including utilities and real estate investment trusts, took far bigger hits.

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Consider: In roughly two weeks, Verizon Communications (symbol VZ) fell from $53 to $48; American Electric (AEP) dropped from $50 to $46; and my favorite REIT, Realty Income (O), tumbled from its all-time high of $55 to $45 (prices are as of May 31).

The proximate causes were the frothy prices of these stocks (they had rocketed in April) and a sudden jump in interest rates. In just a month, the yield on ten-year Treasuries surged from 1.70% to 2.16%. Because rising rates could enhance the appeal of bonds for income-oriented investors, the decline in these scalding stock groups is not illogical, although a government bond paying 2.2% still isn’t competitive with a utility yielding 4% or a REIT at 5%.

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But what shocked me, and surely scares a guy like Jack, is how the retreat of divi­dend payers conjures up so much loose use of the dreaded word bubble. From CNBC to the blogs on Seeking Alpha to brokerage analysts’ commentaries, bubbles are everywhere—dividend bubbles, REIT bubbles, bond bubbles and now a new housing bubble. You’d think that the Nasdaq was back at 5000, inflation was surging, janitors were buying $800,000 McMansions with gains from money-losing Web firms, and Ben Bernanke was set to announce a big hike in short-term interest rates (the ones that are currently near zero).

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Those would be, to quote a sensible definition of a bubble, events that “foster and amplify” wild herd behavior that culminates in a disaster. The original bubble, the blowup of the South Sea Company, lured Englishmen in 1720 to bet their spare pounds in a failed scheme to get rich trading with South America. South Sea shares soared some 800% in months and collapsed even more quickly. The affair led to hostil­ities between Britain and Spain as well as an economic meltdown. How does that correspond to an 8% correction in an electric utility index that, at its peak, was up 18% for the year? Or to a $10 fall in the shares of Realty Income, a growing REIT with secure earnings that began 2013 at $40 and ended May at $45? Folks, it doesn’t.

Don’t panic. Remember, most of you buy dividend stocks for the income and maybe a tad of appreciation. Sometimes, the stocks fall. But there is scant evidence that utilities, property-owning REITs, oil-and-gas pass-throughs and cash-rich industrial firms are in a bind that could result in an interruption in tomorrow’s dividends. I’m a bit more worried about mortgage REITs, which need higher long-term interest rates to recharge their sagging profit margins. But even the biggest of that breed, Annaly Capital Management (NLY), which at $14 is sitting at a four-year low, earns enough to cover its 45 cent quarterly dividend (although the payout may soon fall to 40 cents).

I did advise Jack that if his stocks were making him nervous, he should sell, even if it meant incurring a tax bill on his winners. But that doesn’t mean it’s a good idea to turn into a trader. Are you prescient enough to sell AT&T for $40 and buy it back at $35? And repeat the feat with other stocks?

The more critical issue is whether (to borrow a phrase from the policy wonks) there is an “existential threat” to the future of dividend-paying stocks. In a slow-growth, low-inflation economy in which companies are rich in cash, there isn’t—unless you see bubbles that aren’t bubbles.

Jeff Kosnett is a senior editor at Kiplinger’s Personal Finance.

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