Dog Days of Summer: The Highlight Reel

In this Sunday’s letter given we’re in the depths of the so-called ‘Dog Days of Summer’, we wanted to reflect on what has been an action packed last few months and determine if any of the events dominating headlines should alter our course as dividend oriented income investors. Despite being the summer, a lot has been going on; from Greece shutting down its stock market and banks (for 5 weeks!) to 3 crashes on a single day: (1) NYSE Glitch, (2) United Airlines Outage and the Chinese Stock Market meltdown, to the Puerto Rico muni bond crisis, where the slow motion events finally climaxed.

Let’s dive in.

After Prime Minister Alexis Tsipras shut Greece’s banks and its stock market over the weekend, it was natural for markets around the world to sell off – uncertainty is almost never an ‘buy’ accelerant. This who-knows-how-this-will-resolve-itself crisis is like all others in that a sudden spark sets off a storm during which investors run for the hills. On June 29th, yields on 10-year US Treasuries fell by more than 5%, reflecting demand for investments that are perceived as ultra-safe.
Dividend-paying stocks aren’t Treasuries, of course, so there was no stampede into those stocks in the aftermath of the Greek news. In fact, many of the most popular dividend payers lost value, in line with the rest of the market. As Ben Graham would say, Mr. Market came to work depressed that day. But as what typically happens after investors catch their breath and gain perspective, it’s likely that dividend stocks will bounce back. While a hit to the European economy as a result of a “Grexit” from the EU is likely to affect the earnings of established American dividend payers, it’s likely A) short lived and B) nearly immaterial. Most long standing dividend-payers (the ones we like) are stable companies that have survived, prospered and paid dividends through recessions, economic crises and assorted panics. They will continue to do this despite the ongoing saga in Greece.

NYSE Glitch
In the long run, and even in the short run, the crash at the NYSE won’t mean much for investors. Yes, it shows how vulnerable we are to computer outages in general, but on Wednesday, July 8th, trading continued on other exchanges, of which there are about a dozen, and on institutional marketplaces known as “dark pools,” of which there are about 20. This market fragmentation is good in the sense that buying and selling can continue even if an important trading node goes down. Whether the fragmentation is of any other benefit to retail investors is another story.

When zooming out from the day to day of market headlines this will be a non-event in the life of a long term dividend investor.

Anyone remember the “flash crash”, back in May 2010? Didn’t think so.

United Outage
The system failure at United Airlines probably had more of a personal impact than the NYSE stumble. Thousands of passengers were delayed across the country, with crowds quickly making O’Hare, LAX and other United hubs look like Times Square on New Year’s Eve.

While this event made headlines given it happened on the same day as the NYSE glitch and therefore suspicion arose that the events might linked, it turns out they were unrelated, and therefore nothing but noise to us as investors.

China’s Stock Market Meltdown

Investors saw the value of their shares tumble about 30% in the past month (after a meteoric rise since last fall). The government was taking the typical steps of blaming the mess on short sellers and foreign banks rather than admit that it’s likely a natural evolution of the easy credit policies that have feuled the speculative buying frenzy. Yet if history is any guide, once the air starts coming out of the bubble, we’re in for tough times. And those tough times won’t be limited to the Mom and Pop Chinese investors who’ve lost their savings. We wrote about our concerns about this back on July 12th in a piece titled, “The Greatest Fool”.

Dividend investors — first cousins to income-seeking bond buyers — can take a lesson from Puerto Rico’s roiling of the fixed-income market.
Friday, 31st July was the last day for the Puerto Rico Public Finance Corporation (PFC), a subsidiary of the commonwealth’s Government Development Bank, to pay $58 million to bondholders before it, and therefore Puerto Rico, was in default. Such an event was the first time that a state-like entity had defaulted on its bonds since Arkansas in the Depression year of 1933.

Puerto Rico’s bonds are what’s known as moral obligation bonds. Devised by John Mitchell (yes, the one who became President Nixon’s Attorney General) for New York Governor Nelson Rockefeller, issuers of moral obligation bonds are not legally required to pay principal and interest to bondholders. But in order to satisfy investors, they establish a reserve fund that is intended to meet any debt service costs the issuer is unable to make.
In the equity world, of course, there is no legal obligation to pay dividends in the first place, nor is there an obligation to continue paying dividends or to increase the dividend. Investors know this, which is one of the reasons why equity investing carries a risk premium.
But while they have no legal responsibility to pay shareholders a dividend, many corporations feel a moral obligation to share profits with owners on a regular basis. And as we know, many corporations — such as Johnson & Johnson (JNJ ), Procter & Gamble (PG ) and numerous utilities — take pride in their dividend-paying tradition and enshrine dividends in their corporate culture. They believe they have a moral obligation to pay dividends and they take that responsibility very seriously.
Intricacies of the muni bond market aside and how it contrasts with that of the dividend investing world, in the long run, the Peurto Rico fiasco will be yet another non-event in the lives of a steadfast, long term oriented dividend investor.

Despite a number of headline grabbing stories in the markets the last few months, including Greece, multi-crash days and Puerto Rico, we’ve said it once and we’ll say it again, it’s noise. While it’s always good to be informed about the happenings in the world and positioned opportunistically, none of these three events change our course or our desired destination.

Stay tuned for next week’s members’ correspondence as we look to make an addition to our famed Best Dividend Stocks list.