Safe investments are safe.
And risky investments are risky.
Sounds right…until it isn’t.
The chief investment officer of one of the world’s biggest funds management firms fears that the US stock market has built a ‘safety bubble’.
That is, the rush by investors to buy ‘safe’ assets has forced prices higher, making those assets overvalued and putting them in bubble territory.
It looks as though those Americans are at it again, creating another bubble. But they aren’t alone. The same game is playing out here. Here’s how to make sure the stock market doesn’t catch you out…
If you’re a long-time Money Morning reader you’ll know we have a simple asset allocation strategy.
We suggest you split your wealth into ‘safe money’ and ‘punting money’. The amount you allocate to each is up to you. It depends on your attitude to risk, the returns you’re after, and the risks you’re prepared to take.
If you’re a low risk investor and you’re not after big returns, you’ll have a bigger exposure to ‘safe money’ than you will to ‘punting money’.
To give you a rough idea of what we consider ‘safe money’, we put cash, term deposits, gold and silver, and dividend stocks into this category.
In the ‘punting money’ category we put growth stocks, other commodities, blue-chip growth stocks and small-cap stocks.
It’s an effective strategy. And it has worked pretty well over the past two years since we started talking about it. However, some of the biggest returns have come from the least likely source…
Two years ago we rightly pointed out that it would be a tough time for growth stocks. We suggested that you only view growth stocks (blue-chip stocks and small-cap stocks) as ‘punting’ investments.
At the same time we told you to have a decent cash buffer and a good exposure to dividend paying stocks. Our belief was that if stocks didn’t go up then at least you would get better-than-the-bank cash dividends.
Owning dividend stocks was good advice. But not only for the reasons we had expected.
As it turned out you did get better-than-the-bank dividends, but you got something else you perhaps didn’t bank on — growth stock-style capital gains.
It’s these major gains that have Seth Masters, chief investment officer of Bernstein Global Wealth Management calling the rise in dividend stocks a ‘safety bubble’.
Masters told Bloomberg News:
‘Many stocks with high dividends don’t have growth potential. Their payout is their primary appeal. Utility stocks, for instance, [are perceived to] have safe dividends. So a lot of people are buying them.
‘Recently they were trading at a 50 percent premium to their historical average valuation. That’s their biggest premium ever.’
We know what he means. We’re looking to put some cash to work in the family retirement fund. Our initial thought was to put it in the stock market…into something safe…into a dividend stock.
But then we remembered that dividend stocks aren’t the safe stocks they used to be. Masters is right, there is something of a ‘safety bubble’ among Australian dividend stocks.
It’s not normal for a safe and boring food stock or bank stock to gain 50% in just over a year. That’s especially so when earnings have risen marginally, or in some cases fallen.
So, does that mean you should avoid dividend stocks altogether? If only investing was that easy…
In short, despite the threat of a ‘safety bubble’, we still believe it’s too early to sell stocks. That means you shouldn’t sell dividend stocks yet either.
We will give you one word of caution: although dividend stocks may not have shifted from ‘safe money’ to ‘punting money’, they aren’t the safe investment choice they were two years ago. So you need to be careful before you buy a dividend stock.
But we don’t want to put you off buying dividend stocks.
Last Friday we showed you a chart that compared Australian dividend yields with dividend yields on overseas stocks. Australian yields are about 70% higher than overseas stock yields.
That’s attractive to foreign investors.
The market has fallen in the past few weeks and so have the share prices of dividend stocks. That should give you the chance to buy dividend stocks at a cheaper price than three or four weeks ago.
Just be aware of the valid warning from Seth Masters. Most dividend stocks are low growth. That means you shouldn’t expect to make a killing on these stocks with capital growth.
But the combination of dividends and even modest capital growth makes income stocks a better over the next 12 months than cash, term deposits or other fixed interest investments.
If you’re happy to take on the higher risk, and you want a bit more than the returns you can get in a bank account or fixed interest investment, then dividend stocks are still a good bet.
Just remember that unlike cash, the value of shares can go down…that even goes for ‘safe’ dividend stocks.
Cheers,
Kris
Join me on Google+
PS. A new feature in Money Morning each day is Money Morning Premium. Each day we’ll take the theme from the main issue of Money Morning and turn it into an investable idea. To gain access to Money Morning Premium you just need to make a small change to your subscription. Click here to find out how…
From the Port Phillip Publishing Library
Special Report: TORRENT SIGNAL 3
Daily Reckoning: Why Europe’s Debt Crisis is Barely Getting Started
Money Morning: Rick Rule: You’re Either a Victim or a Contrarian
Pursuit of Happiness: Why the NBN is Dead Before it’s Begun
Australian Small-Cap Investigator:
How to Make Money From Small-Cap Stocks