The last decade of investing, what you might consider the “post-crisis” period, has served up a tremendous opportunity to forget nearly everything that matters about investing.
Now, before diving into the negative, some positive lessons of the last ten years are in order.
For one thing, the greatest behavioral lesson in the history of investing has been emphatically reinforced: Do not capitulate into panics. The 2008 crisis, recession, and subsequent Q1 2009 market bottom gave human nature every opportunity it needed to act as its worst self. Not only was the pain of the market drawdown immense, but the optics into a turnaround were non-existent. Only the powerful lessons of history (and hopefully steady hand of an empathetic financial advisor) could be expected to keep an investor from capitulating in that abyss of TARP, Lehman, Fannie, AIG, housing collapse, Wall Street debacle, and all other associated events of that market bottom.
But those investors who hung in there – who maintained a coherent asset allocation – who even, lo and behold, rebalanced in the midst of that debacle – were rewarded by the gods who oversee such matters of investment justice. With equities over triple their ten-year-ago price, I would like to think many investors will think twice next time we have a bear market (and God help anyone who actually wonders if we will have such). There’s the most positive thing I can say about the last decade of investing (and it is a doozy).
However, some other fundamental truisms are easily lost in the last decade – what we would be better served to call the “initial recovery” period (the post-crisis period can hardly be called “over” with the Fed balance sheet still $3 trillion higher than it was pre-crisis). For one thing, many investors may not remember that, and sit down for this: Stock prices do go down. Last year’s 2018 return of -4.3% in the S&P 500 represented the first negative year in the S&P 500 since 2008 (though 2011 and 2015 got close). Note what I said: -4.3%. In many years over the last century, a 4.3% drop could practically have been considered “one of the good years.” It barely registers. And yet any look or feel around investor sentiment, and media coverage would have given one the impression it was Black Monday, Black Friday, the Flash Crash, and the return of swing-dancing all rolled into one (note: our country has come back from all but one of those horrific events). Of the 50+ times that markets dropped 3-5% since 2009, each one was made to feel like the return of the black plague when in fact it was the “return of all that is normal in investing.”
In other words, volatility is the norm. Not-volatility is what is abnormal.
We experienced a decade of unprecedented monetary accommodation. Did it drive the entire market recovery? Not even close. Corporate profits drive the recovery because they always do. But does a discounting of the natural rate by which all risk and investment returns are measured drive asset prices higher? Of course (and beware anyone who even pauses in answering that question). And did the expansion of credit (albeit off of the massive credit cessation of 2008) help drive profits? Sure it did. And there is no reason for a bull to deny this! My point is simply that the significant accommodation of the Fed (and central banks across the globe) all within this ten-year time span we are about to conclude created what my friend Jason Trennert of Strategas Research calls the “everybody gets a trophy” era of investing! Put differently, QE1-3 and ZIRP did not create the stock market’s run, but it did help a lot of the weak players make the team.
The first decade of this century, the one that preceded the one we are about to conclude, contains some important lessons from investors, lessons that I freely acknowledge were also out of “outlier” events. A calendar decade of zero percent equity returns is hardly normal, though not entirely unheard of in rolling-ten-year periods. The bookends of the tech crash and the great recession were not just unfortunate, but bizarre in their timing and violence. Nonetheless, they happened, and the math of them ought not be forgotten.
Investors that were periodically withdrawing from a generic S&P index fund throughout the period, even as it declined, were slaughtered. Indeed, withdrawing from any presumption of total return when such total return is negative is how a permanent erosion of capital takes place. It is hard to remember that withdrawing from a negative return environment is a problem when one doesn’t experience negative return environments. But they are normal, far more normal than the last ten years would cause us to believe. And yet, before this magical decade we are about to conclude, or the lost decade that preceded it, we have experienced decade after decade of reinforcement around a fundamental understanding of investing that both capture the upside of the good years and provides mechanical insulation (and opportunity) during the bad years:
Dividend Growth Investing
Throughout the vast majority of the 20th century, investors expected profits from their investment risk in the form of profit distributions known as dividends. Whether an investor wanted (needed) income or just wanted to see their investment assets grow in value via the addition of new money (reinvested into new shares), companies with the muscle, the stability, the business fortitude, and the confidence in their own growth, rewarded investors with a distribution of profits worthy of the risk investors were taking. The dividend marked not only a just reward for the deployment of capital, discounted to an appropriate rate of return, but it signified a company that believed in its own future. Companies paying generous dividends and growing them with regularity had the balance sheet management to do so, and an income statement to match. Free Cash Flow drove dividend growth, and investors reaped the benefits of growing income streams even as inflation eroded the purchasing power of the dollar.
Today, secular low rates have driven down yields, led by the bond yield itself which sits fully 500 basis points below its level of when I was born. And yet the need for income is as real as ever, if not more so. And as for the need to accumulate balance sheet wealth, the almost complete evaporation of company defined benefit plans has put the burden of retirement savings more on individuals than ever before. Such an accumulation of wealth screams for high-quality companies that can be relied upon to steward the company’s assets, to avoid the fatality of excessive leverage, and to innovate so as to protect and stimulate cash flow generation.
There are now, and always will be, extremely exciting companies that do not pay a dividend, yet nonetheless generate incredible returns for investors via stock price appreciation. The argument for dividend growth is not that such companies do not exist. Rather, it is that they are harder to reliably and consistently identify, and of course, that they carry an inherently higher risk. The dividend payment (that is, the growing, steady, responsible distribution of profits to risk-taking shareholders) is a portfolio buffer itself, and it signifies the greatest of portfolio buffers – a company that is well-run, with management aligned with its investors.
The next decade is not likely to look like the one we just had or the one we had before that. But from the 1940s to the 1970s to the new terrain of this tumultuous new millennium, a decade of dividend growth has served investors of all ages and objectives well. The fundamentals matter. Cash flow matters. Quality matters. Dividend growth is the trophy we can all enjoy.
