Dividends matter.

Lowered tax rates on dividends make them matter even more.

I get all that, but chasing yield in stocks is an interesting phenomenon these days. Many advisors are suggesting that now is the time to buy stocks that pay dividends. They say it’s a safety thing and that if the market pulls back, you’ll at least get the benefit of some income. Personally, I think this is nonsense. I can understand this comment back in 2000 to 2003 when the market was in a steady decline. I can especially understand it in 2003 when the dividend tax cut was put in place. I can even agree that it was a good thing to do as earnings picked up and dividend payouts increased along the way. I can also understand how you might want yield from stocks when money market rates were declining or sitting at about 1%. But now? That I cannot understand. Just pull up any of your favorite dividend stocks and most of them will have probably increased about 100% since 2003. Make it easy on yourself and pull up a 10-year chart of the IShares Dividend ETF (DVY). At the beginning of 2003, it was trading around $40 and now it’s at $70 (a 75% gain). How much reward is left and how much risk is there?

In early February, GM cuts its annual dividend by 50%. Prior to that, many people were being told to buy GM for the high yield (8%) and because Kerkorian was investing. Neither of those turned out to be longlasting. However, an investor that bought GM the day before the dividend cut and held until today would still have made a bunch of money, but their dividend yield would have gone way down. The only reason for the gain is $7.50 of appreciation in the share price, but if you were buying just for the yield, it’s not good. Just as a price increase like GM’s can rescue you from a dividend cut, a negative change in the share price can rapidly eat at your total return. So if you insist on buying a dividend paying stock, you better make sure that the share price at least holds constant.

One of the things I looked at was the current dividend yield for many of these stocks versus their 5-year historical average yield. Most of them are less today than the average and that is a warning sign. I also don’t find many of their valuations to be cheap relative to their historical averages and that’s saying a lot because dividend paying stocks are typically considered to be in the “Value” category. Lastly, money market rates are pretty high right now and if adequately insured, the deposits have no “principal risk”. If you already own a dividend stock, I am not advocating that you sell it. You need to evaluate so many things and the most relevant one is the historical yield on your purchases. If you bought a stock 5 years ago at $40 and it is now paying you a $4 annual dividend, I’d feel great about having a 10% return. It would be tough to sell that stock and reinvest the proceeds in something equivalent.

There are several factors to analyze a good dividend paying stock and the web or your financial advisor can help you with those. But here are some of the things I evaluate:

• Size of yield (high yields may be pricing bankruptcy risk or dividend cut risk)
• Current yield vs. 5-year historical yield
• Earnings per share vs. Dividends per share
• Free Cash Flow per share vs. Dividends per share
• Expected Earnings Growth Rate vs. Expected and Historical Dividend Growth Rate
• Forward PE vs. Historical average PE

If you are a member of HEDGEfolios you can easily sort the EVALUATE section by using the Income criteria box and select “All Yields” to find stocks that pay a dividend (about 1500 of the HEDGEfolios universe) or dig deeper by selecting Low, Mid or High Yield. You can also get a bigger picture of the Income stocks by selecting ANALYZE - STOCKS and scroll down to the Income section. Banks, Utilities, REITS, Telecoms, and Consumer Staples are pretty common sectors to find stocks that pay a dividend.

I think dividends are great and yet, hearing these blanket statements about buying them right now is questionable to me. As I said, that was excellent advice about 4 years ago, but I think it’s dangerous advice today. If rates decline further and the yield curve remains inverted, we are probably heading to a recession. Typically, these “widow and orphan” dividend paying stocks were looked at as safe bets for weak economies. If the hard landing appears, I don’t think many of them will be spared just as the old AT&T was not spared in 2000. If the economy starts to strengthen, rates will increase and money will come pouring out of these stocks to fund investment into the capital appreciation offered by growth stocks. I seem to be on my own with this opinion but dividend yields are not high enough for me to offset the risk that the share price will get whacked. If you are looking for yield, money market rates are much more liquid, have no principal risk (if insured) and the money market rates of about 4% are superior to the average S&P 500 dividend yield of 2%, even after paying the incremental taxes. In the words of a smart friend of mine, I don’t dislike dividend stocks, I just dislike bad dividend stocks. When you hear someone pushing you to buy a stock because of its dividend, you have a lot of work to do to make sure that the stock is good before the dividend matters.

Yesterday, Bernanke spoke and people listened. The bears heard some of what they wanted to hear and the bulls heard some of what they wanted to hear. That’s not so surprising because Chairman Bernanke has done a great job “talking his book” and he gives just enough hawk squawk with an equal dose of dove love. None of it really changes the current market momentum and that is the way it should be. For as long as the market is predominantly bullish, anything he says will likely be spun into supporting the bulls. When the market was struggling as he took over last spring, he could do no right. Remember that?  Back then, I referred to him as the Whipping Boy for the market.  Every time he spoke it was not good enough for the bulls and since the market was bearish in May to July when this was going on, it didn’t change the downward trend then either.  Market bad = Ben bad.  Market good = Ben good.  That’s the way my cynical eyes see it.

But yesterday was classic “talking your book” from the new master.  When Bill Gross of Pimco makes an odd comment, he is often accused of talking his book and trying to position the gazillion dollar portfolio he runs.  The same thing happens when a fund manager spouts his “favorite names” on CNBC or Bloomberg or wherever else he can pitch his crap.  Ben is just doing the same thing on a bigger scale - his book just happens to be named “Goldilocks” and his portfolio is the famed soft landing economy.   If I didn’t know that the first edition was actually printed in 1837, I might assume that Ben was the original author of Goldilocks.  Whenever he speaks we get a mixed message of a weakening economy but optimism of a recovery or his mixed message of lesser inflation but being uncomfortable with risks of higher inflation.  Like many things in life, the more you say it the more it seems true.  With the beige book release today, it is clear that his talk yesterday was right out of its pages.  After all, beige is a shade of gold!

It was only 32 days ago that the market was rocked by the GDP numbers. Remember that? According to all happy talk today, the upward revision we got this morning is a big reason for the “huge” 0.5% move in the S&P 500. If it wasn’t so sad, it would be funny. Do people really believe these numbers? If they believe them, do the numbers mean anything? I guess they do matter to people that must be a lot smarter than me.

Just remember this is a gift that keeps on giving. On October 27th, we got the 1.6% GDP number for the 3rd quarter, but that was just the “advance” GDP. The advance estimate, got revised upward today to 2.2%. Yippeee! It’s bad, but not too bad. Maybe by the time the next and “final” revision comes on December 21st, it will be less “badder.”

It appears that this iterative process of market reaction to the same lousy data has identified the exact point (plus or minus a few bps) where we fear recession (the old 1.6% GDP) and where we are convinced there is no recession possible (today’s 2.2%). Since the concensus estimate of economists prior to the October 27th release was 2.1%, any number less than that would have been a negative surprise and that is what we had. Based on all this info, my guess is that the ideal GDP is somewhere between 1.6% and 2.0%. There you have it. Any GDP that fits snuggly in that range, but preferably closer to 2.0% will be “just right.” Maybe we should rename GDP so it actually stands for Goldilocks Determined Product.

Last week’s list of UP signals that I was optimistic about really stunk. I guess it shows how tough this market is getting for the longs but it is more than a bit frustrating for me to underperform the S&P over any time period. Here is a summary of the performance of last week’s list as well as the two prior ones I put up. All figures are through yesterday’s close (11/28/06) and based upon an equal-weighted portfolio of buy-and-hold positions.

11/21/06 27% winners out of 108 signals with a portfolio loss of 1.55% vs. S&P 500 loss of 0.98%

11/07/06 62% winners out of 201 signals with a portfolio gain of 1.90% vs. S&P 500 gain of 0.51%

10/24/06 69% winners out of 178 signals with a portfolio gain of 5.35% vs. S&P 500 gain of 0.70%

Transparency is very important to me so you will always get a blunt assessment of my performance on this site. At times, it may seem that I am too proud of myself and at other times, it may seem like I am too tough on myself.  To me, it’s all the same so I leave it up to you to interpret.  Regardless, the older lists did better than the las week’s list and significantly outperformed the S&P 500. That was then (good) and this is now (bad). While it is important to give positions time to turn into winners, it is critical that you don’t tolerate ones that may never make it. I took a look at the charts from last week’s list and still feel confident in most of them, but my patience is already thin. Yesterday I put up a smaller list of 41 stocks and I will update that performance in a week. Hopefully by then, the 11/21/06 list will be in the black.

Commentators, analysts, portfolio managers et al on financial media are frequently pointing investors to the Large Cap sector as a safehaven for a potential decline in the market. Months ago, they finally started suggesting that it was now safe to get into Large Caps and the multi-year Small Cap run was over. But at that point, the idea was that there were excess gains to be found in the biggies and now the spin is that they are safer than Mid Caps or Small Caps. Which story is correct? Is either rationale a good reason for putting money into Large Caps right now? Whenever I see the same recommendation for different purposes over such a short time, I get a little nervous.

Members can go to the EVALUATE section and select Large Caps from the Size criteria and you will see what I am talking about. Non-members can either register for a FREE TRIAL or just look at the summary data on the ANALYZE - STOCKS section or take my word for it (not as good of a choice!) You will see that almost exactly 50% of the 397 Large Caps have DOWN signals with 119 of 200 given in the past 4 weeks. During the same period, only 45 UP signals were Large Caps. Clearly, my opinions are not consistent with most of the smarties advising the investing public.

So I decided to analyze further and look at the actual charts of the Large Caps to see if I was missing something. Of the 199 Large Cap UPs, I see most of them as closer to a top than a bottom. The average gain of the UPs was about 15% and the average position was held for 14 weeks. That just doesn’t sound like a good entry point for new positions to me. However, when I look at the DOWNs, many of them are just beginning the negative trend with an average decline of 2% and an average hold period of 7 weeks.

Based on looking at all the charts and related time / performance statistics, I still disagree with the majority of Large Cap enthusiasts. I am not saying that there are no good positions to be had in the biggies, but it isn’t a “sure thing” like you may be hearing elsewhere. Entry positions are unique to each stock and you should evaluate each one independent of what style or size criteria is being hyped on any given day, week or month. If Large Caps were exciting candidates for either safehavens or capital appreciation opportunities, I would be seeing something like 75% UP signals in this category with gains less than 5% and holding periods less than 4 weeks. That is not the case, but I will be sure to let you know when (or if) I ever see a particular style or size criteria that looks overwhelmingly strong or weak. Until then, please don’t chase after Large Caps just because they are Large Caps.

Since mid-September, my posts have become increasingly bearish, I cast my first “Bearish” vote on the TickerSense poll the first week of November, I began suggesting you should start working on your “sell list” on Halloween, and yet, the HEDGEfolios Timing Indicator has maintained a bullish reading despite sliding towards a crossover. It left me feeling very disjointed and inconsistent at times because I don’t like to contradict the timing indicator. Finally, I can report that the timing indicator switched to a bearish bias this week. The now-ended bullish signal was given on July 10, 2006 and generated a 10.65% return on the S&P 500 during those 5 months. Hopefully, your portfolios did as well or better.

I am not calling a victory here as I am much too humble to pretend that I am smarter than the market. There is a lot of risk right now to being wrong (in both directions.) This market has been amazingly strong and each pullback in recent memory has been small and been bought. There is a strong risk to that happening again so be careful about trying to short at these levels. There are many reasons why investors and portfolio managers want to ride out the rest of this year and I don’t want anyone to disregard that influence. On the other hand, I would be more inclined to sell individual stocks when the time is right and park the proceeds in a money market account. I keep providing reiterations of UP signals that I think are still going to head higher despite my negative tone, but those “short lists” are getting shorter and shorter. Putting new money to work at this time is very difficult.

This week’s signals were tougher than usual and I was not very “thankful” about this Thanksgiving’s extra challenge. The light volume was not helpful for trying to read charts to say the least. I left a lot of UP signals on the chopping block - kinda like the President pardoning the national turkey. Unfortunately, based upon what happened yesterday, I wish I had been more aggressive. Regardless, this week I gave about 10 DOWN signals for every 1 UP signal and that is an extreme ratio. Oh well, like I said earlier, we might get a bounce here and in some ways, I will be happy for it. You can count on me taking higher prices as a nice opportunity to make up for missing a bunch of DOWN signals this week. Unless something tells me otherwise, I expect to sell the rallies and I don’t think I will be alone.

For all the VIX lovers out there - did the sub-10 reading cause you to get out before yesterday? Are you going to look at the higher VIX and decide that it’s still time to get out? I doubt it. What level would it have to spike to before we will start hearing how it’s so high that we have to buy? Historically, the upper limit was about 50 but since the VIX methodology was changed in 2003, the bands have changed. Now it appears that it is 10 (lower band) and 20 (say 18-20 on the upper band). As I wrote last week, this indicator is dangerous and there are so many other things to follow for longer term market moves.

I have heard that investors are just taking profits and I think that is permabullshit ( a related post is on its way on this topic ). Something else is at work. There has been an absence of buying for weeks and it’s finally being obvious to people who have been too busy falling in love with higher prices.

Yesterday was so tough that I thought I’d see how many UP signals were worth mentioning.  I thought it might cheer you up to hear me being bullish, if only about a handful of stocks!  As I noted the last time, each successive week I go through this exercise I end up with a smaller group. That is just one of the reasons I think this market is getting tired. But….there are always stocks to buy, it’s just harder to find them when the market doesn’t go parabolic. I am not saying these are sure winners, but I like the way they have held up and am optimistic that many of them will outperform the S&P this week.   Note that many of the stocks on this list did not go up yesterday and are losing signals so far.  The usual disclaimers apply and for good reason - it’s getting ugly out there. Remain vigilant about your portfolio and please tighten your tolerance for pain. Good luck this week.

AVD, BRW, CALC, CHRW, CRR, DESC, ESCL, ESST, FBR, FFEX, GB, GNTA, GTOP, HYGS

INFS, IVC, LMLP, LNCR, MED, MRTN, MTCT, NBR, NEM, NGS, NT, ORGN, PDC, POP, PRLS

PTA, PTEN, SALM, STJ, SYPR, TEVA, TRFX, USG, USS, UTI, UTIW, WFII

It seems so easy to pump a stock these days.  I am not going to accuse anyone, but I find it a little obvious that all someone needs to do to move a stock higher is to publish a “wish list” of potential targets for private equity firms and sneak your preferred name onto it.  As I have written in the past, I am never impressed by analysts that put out speculative crap for one bandwagon or another.  I don’t like it when a whole sector is bid up if one company happens to be acquired by another public company.  But these days, that isn’t happening as much so the same group of analysts are now directing their “research” at the flavor of the day, private equity deals.   I know I cannot stop anyone from speculating, but it’s just not the way to find good investments.  If investors decide to buy Barnes & Noble because CNBC says they are a target for going private, I don’t hold out much hope for positive returns in their portfolios.

Some people cannot help themselves and short sellers are no exception. It’s so tempting to try to take advantage of a down day and pile on some shorts. Unfortunately, a little restraint here would be beneficial. I know it’s been a long time since May gave us a small window of opportunity for the shorts and I imagine that they are desperate for some gains, but I am hoping they let this play out and not be so short-sighted. The permabulls are out in force today with the usual comments that this “pause that will refresh” is “not unexpected” because its just a “little bit of obvious profit-taking.” Blah Blah Blah. As you know from my bearish tone the past three months, I have also been waiting for some downward action. But now is not the time to make a quick buck on the negative. It was one day. One day that MAY be the start of a sustained trend, but I am never certain of one-day trends for obvious reasons. In my opinion, the best time to put on shorts is after a series of mostly down days because these periods last long enough to make some real money and cover without much stress. Today is not one of those days and each time this market gets fed with a new round of short covering, it just makes it tougher on the “dark side” of the trade. So I’d like to see what happens if the bulls are left to their own devices and have to put more money on the long side to stop this negative move. If the market has gotten as top-heavy as I think it has, they’ll be the ones giving the bears a Santa Claus rally. For all you bulls - I am not hoping that you’ll fail here, but that is my bet. If you prove me wrong, I hope you do it because the market is truly as strong as you think it is and not because you get another lift from the shorts.

Some of the best days to run screens are the worst days in the market.  Whenever I find a daily or weekly period that makes a significant reversal to the prevailing trend (like today) I spend a lot of time looking for opportunities.  Last week, was also a great time for me to sift through stocks because of the low volume that was systemic since Tuesday.  If the market has abnormally low volume for the week, I screen for any stocks that came within 10% of average volume for the preceding 4 weeks.  If the stock was trending higher prior to last week and it managed to maintain normal volume with an upward price move, that is usually a stock I want to watch.  The same goes for stocks heading lower.  Any stock that trades actively in a dull week is not dull.  The simple screen that I like to use on down days like today is any stock that heads higher, regardless of volume.  I know it’s a basic divergence tactic, but the KISS principle works well on extreme days.  Unless it’s an obvious contrarian play (like a homebuilder going up when rates go down unexpectedly), any stock that bucks the trend of the market deserves additional attention.  If you are not selling today, you should be looking for stocks to buy - maybe not buying them but identifying them is a little easier on a day like today.