“Financial oppression” and dividend-growing stocks

Lyle Stein - September 01, 2011

“Financial oppression” is a new term coined to describe today’s economic times – a time when governments set interest rates so low investors can’t maintain their standard of living. The only antidote? A dose of high-yielding equities

Over a year ago, noted Morgan Stanley analyst Arnaud Mares coined the term “financial oppression.”

According to Mares, financial oppression describes the situation whereby governments set interest rates so low that investors can’t maintain their standard of living. As of late, central banks around the world have driven yields on government debt below the level of inflation, in effect confiscating the hard-earned savings of the frugal in an attempt to maintain the spending of the profligate.

As anyone with a savings account knows, returns on cash investments have been driven to virtually nil. The 2.2% yield on 10- year Canada debt is now 50 basis points below Canada’s current inflation rate. In the US, the gap between inflation and bond yields is even wider.

Chart One shows US yields on 10-year debt (dark blue), three-month T-bills, (light blue) and CPI inflation (grey) since the early 1950s. With the exception of the episodic oil shocks of the 1970s and 1980s, yields on long debt exceeded yields on t-bills, and both typically exceeded the rate of inflation.

The financial crisis changed that relationship. With t-bill yields at nil since the middle of the last recession, and 10-year bond yields at 2%, financial oppression is the natural result in a country where inflation is running closer to 3%.

Financial oppression is not going away any time soon

Financial oppression is not going away any time soon. The US Fed has said short-term interest rates will stay at current levels for the next two years

The Fed’s QE2 bond purchasing program was a move to drive three- to five-year yields down in an attempt to save the housing market. Now a QE3 program is being contemplated to drive down 10-year yields.

Compounding the low-yield oppression felt by North American investors is a wall of money from sellers of European debt who are looking for the perceived safe-home of US Treasuries. The result, a US 10-year yield of 2%, makes little investment sense, especially as all governments strive for growth.

For over 70 years, Leon Frazer have maintained that the best source of return is a growing dividend, and the best place to get a growing dividend is from the shares of well-capitalized companies.

In today’s low-yield environment, Leon Frazer portfolios are typically yielding well north of 3%, and over 50% of our portfolio holdings have provided dividend increases since the beginning of 2011.

As savers, we would like to see yields rise to the average 3-5% levels seen over the past seven decades. Getting back to those yield levels will require either inflation (anathema to bondholders) or growth (a boon to shareholders).

In either case, stocks win. Recent market forces have driven equities lower on the fears of an economic slowdown, with bonds being the beneficiary because of their perceived safety of principal. We do not believe bonds are as safe as the market perceives and view higher-yielding equities as the preferred investment.

CHART ONE

ADAPTED FROM LEON FRAZER MARKET PERSPECTIVES, SEPTEMBER 2011

 

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