SPX Dividends and the Lost Decade

OK... so maybe "decade" isn't strictly accurate but it makes for a catchier headline. Unless you were so drunk that you couldn't see straight in the last two days - a prospect I must concede is entirely possible and/or warranted, all things considered - you would have seen that SPX is now at levels not seen since 1997. If you looked a little harder, you could probably have found some cheerleading-type articles saying that yields have never been better, market will recover, stocks are the bomb, etc, etc. Typically, these articles come unadorned with charts and tables and this usually is a sign that there is a bit of elision going on. Or maybe I'm just too skeptical.

My targets here are those that claim that the dividends reaped in past decade would have more than made up for any capital losses and in fact the returns would still have been decent. The first question that requires answering is: Returns compared to what? The gold-standard zero-risk investment is (or at least was) US Treasuries. Since the year 1997 has been mentioned so often, I'm going to use that as my entry point here. For those that want to play along at home, you should download the SP500EPSEST.xls file from the link on the right. I'll also reference some interest rates you can find in the St. Louis Fed database also linked on the right.

Here are the starting conditions: On December 31, 1996 SPX stood at 740.74 and the interest rate on the 10-year treasury pegged in at 6.54%. Let's make some gross simplifications and a few assumptions.

1) Purchase of 1 share of SPX for 740.74

2) Purchase of 740.74 worth of 10-year treasury yielding 6.54%

3) Dividend re-investment in SPX each quarter.

This last point is done because I believe that most people - or at least most buy-and-holders - probably just do the DRIP approach with their mutual funds. So now we have two plans: SPX vs. Treasury.

So at the end of the Q1/1997, the dividends were $3.61 and SPX was 757.12. This means that 0.0048 shares were acquired for a new total of 1.0048. This was then used to acquire dividends in Q2/1997, which were paid at a rate of $3.87/share which translates to $3.89 in dividends to reinvest and acquire another 0.0044 shares with SPX at 885.14 to bring the total owned to 1.0092. And on and on and on up until today, when you would own 1.2233 shares at SPX closing value of 773.14 for a total value of $945.82.

For the years until the treasury matures, it will throw off $50.41 in interest each year until it matures. At that point, to make this comparison easier, the accrued value is re-invested in a 2-year treasury. The interest rate on the 2-year at that point (1/1/07) was 4.8%. The total of $1274.80 would be re-invested at 4.8% simple interest. This produces a total value of $1397.19.

Hmm... so I'm clearly not getting something here. All the risk of the stock market for a lower return? Now, I was not educated in finance and perhaps my math is wrong but I'm pretty sure that the risk-reward equation is supposed to reward risk with a higher return. Excel's INTRATE function produces a rate of 2.31% on the SPX investment when the same formula returns a rate of 7.38% for the Treasury plan. And to add insult to injury, the SPX investment plan doesn't even keep up with CPI inflation. Don't believe me? Click through to BLS CPI Inflation Calculator and find out for yourself. Entering in that $740.74 investment in 1997 dollars produces a value of... $974.47 in 2009 dollars for a real-dollar LOSS. Granted, the real-dollar gain in the Treasury plan isn't glamorous but at least it's a positive number.

Now, the current rates on the 1o-year are an atrocious 2.799%, so the Treasury plan isn't exactly a viable strategy going forward from here. At least barring a wave of deflation that I'm thinking most of us don't even want to ponder. However, I am extremely skeptical of people using the Q4 dividends and the tanked SPX value and producing yields in the 3's. How on earth can you make the assumption that dividends will not fall further? Have balance sheets suddenly gotten stronger in the last two months? Looking at the past work and charts on dividends that I put up, it's pretty clear that it takes quite a bit of EPS degradation to knock dividends down a significant amount. But, look close at some of the charts of reported and operating EPS on this blog and you'll see that the forecasted EPS levels for 2009 look more like 2002 levels for reported EPS and 2005 for operating EPS. A quick look at the dividends from that era show a large difference. I'm not sure this gets bridged but I'm not exactly optimistic that the current yield will be maintained.

One can argue that these are anomalous times and you'll see all sorts of people who want you to invest your money through their service telling you that this is a great time to buy stocks at their brokerage. Just remember, there are real pitfalls to the buy/hold/re-invest strategy and the simple little chart should be plenty to illustrate that.

Ashes to Ashes...

OK... did you mentally sing "funk to funky" or fill in the more somber "dust to dust"? That question sounds a lot like one of those queries on a personality test that purports to tell you something profound but the results instead read like a horoscope out of the Sunday paper. But the title was chosen deliberately.

In the last few months I've read a few stories about assigning blame and generally at least some of it has been laid at the feet of the Fed and their too-loose monetary policy. To be more specific, their absolute refusal to "take away the punch-bowl" to use the most favored phrase. And it's probably true. As usual, here's a chart - this time of the Fed Funds rate. For reference, the data set begins on July 1, 1954 with a Fed funds rate of 0.80% and the last update is 0.18% on 1/15. Interesting and kind of symmetric in a way that appeals to my sense of order.

It certainly supports the premise that the Fed was unwilling to tighten policy since Volker was in charge. Since his tenure each time the rates were cut, they are never subsequently raised back to the level prior to the cuts. One could argue that the Fed has become more supine to the Executive or generally just wants the good time to keep on a-rollin'.

Now, waaaaay back before I started reading about any of this stuff in relation to markets and trading I had a basic academic/political interest in national debt and what-not. If you look back at 1954 as the US emerged from WW2 with some fairly substantial debts, the national debt to GDP ratio in 1954 was 73.3%. (Trivial aside: this number peaked at 121% of GDP in 1946.) In late 2008, this number was... ~72.5%! I must admit, I do like coincidences even if they don't really mean anything.

So moving forward, will we see a return to progressively tighter policy at the Fed? I guess that depends on how much of the money currently being shoveled into the fires of the financial sector manages to remain unburnt and floats off into the broad economy to reappear as inflation. On the flipside, will it even matter as rates are forced upwards because nobody (or at least fewer somebodies) wants to buy the debt? That's perhaps a more ominous possibility. It feels like this could be a great entry point to explore a rich topic but it will have to wait for another post.

Source: St. Louis Fed FRED data

T-Bills, T-Bills and more T-Bills!

A few months ago, in the comments over at Calculated Risk, Nemo started wondering just how many T-bills were being issued by the Treasury and also suggested that adding some charts to illustrate the horrors of issuance would be nice to have. I thought that was a pretty good idea too and decided that perhaps I could actually contribute something to the discourse beyond snark and bile. Over the next few months, I would wait for the Treasury to issue the monthly update and then I would update my spreadsheets. Since then, I started writing things here, so it seemed like a logical place to post them now. The chart to the above-right is the net t-bill issuance since April 2008. All told, between April 1st and December 31st, the Treasury issued $3.37T worth of t-bills. Fortunately, they did manage to at least retire some of them and the net issued as of December 31st was $1.866T. And that $1.866T is all due between January 1st and December 17th, 2009.

The treasury market is not really an area I know too much about and the following two charts are here more for sake of completeness of picture than anything else. The first contains small yield

curves over time. The second shows the falling yields across the curve moving towards the end of the year.

What does this all mean? I'm not really sure but I suspect it means that I don't want to be Obama or Geithner. Further, can the treasury market really digest $1.866T in issuance between now and the end of this year? Or is there another plan for all of these bills? Mr. Jansen at Across the Curve has made a few comments about this topic and today he notes about a failed 10-year Bund auction.

If all of this debt must be rolled, and if any stimulus package must necessarily be deficit spending, what are the impacts on yields? Once again, it should be an interesting year.

Sources: US Treasury - Monthly Statement of the Public Debt