Time to Reconsider Your Dividend Rates?
The ride that the stock market has given us over the past weeks has had all the thrills of a great theme park roller coaster. It started with the slow tick, tick, tick as our political leaders did little to resolve the debt problem. Then we had quick and furious drop after the S&P downgrade. You couple this with a wonderful quick bounce back up, followed by a rapid decline followed by some sharp right and left hand turns. The parents are about to toss in their cookies and the kids are smiling with their hands up in the air. The ride still has a while to run, but this is all that it is, and it is a temporary wild ride.
No doubt many members are looking to get out of the market for the safety of an interest rate deposit at their friendly credit unions. Actually, even at the very low rates that credit unions have paid for deposit accounts, credit unions may actually be doing members harm by encouraging them to jump off the roller coaster of the market into a deposit IRA account. I never consider leaving the comforts of a roller coaster car mid-ride.
One should question whether credit unions are doing the right thing by continuing to payout out excessive dividends in light of the Federal Reserve’s announcement that it will keep the fed funds rate at close to zero into 2013. Credit unions have a true asset-liability management problem if they are overpaying for CD’s without proper loan demand. The investment options going forward are just not there to justify attracting hot money. A major weakness and threat to a credit union's future is the bias of elderly board members. They may be mispricing dividends rates because they are voting with their pocket books.
Dividend rates offered by all institutions are going to have to get lower. The traditional relationship between the 10-year Treasury and short-term rates indicates a 10-year Treasury rate going down almost a point to between 1.25% and 1.5% to be in line with its historic relationship. With limited lending prospects and limited investment options, credit unions are going to have to suffer the ire of silver-haired CD commandos whose sole purpose in life is to get a quarter of a point higher rate on their maturing CDs once they have checked the obituaries and found their names missing.
Real asset-liability management is balancing the relationship with assets and liabilities. If you cannot find an appropriate asset to invest your members' money, than you should not over pay for the liability. Your best service to your members is to not encourage a wrong- minded decision during your members' thrilling ride. You should do them a real service and give them a perspective on markets and the future.
If you look back to 1987, to get a perspective of a real market crash, you will understand that today we are fascinated by the headline numbers, but we are nowhere close to the 1987 Tower of Terror drop.
In August of 1987, the year-to-date increase in the Dow was about 44%. In 2011, we were about 9% year to date. The market clearly got overpriced in 1987. By any reasonable matrix, the 2011 market was fairly valued. The one-day drop on Black Monday in October 1987 was about 22%. This was a record one-day decline. Over the last two weeks, we have been able to achieve a less than impressive 16% decline. Between October and the year-end 1987, the market moved back up and closed up for the year. There is a very good chance that this will happen this year.
Much of the problem with the 1987 crash was that it was pre-Internet and electronic processing. The wave of selling was so great that many sell and buy orders could not get executed. Today, the trades are executed electronically. Most are done without human interference. In 1987, you had to use a land line and reach a haggard broker. Today, you generally use a click of a mouse. The reality about today is that many insiders have increased their buying of their own companies. In 1987 the 10-year Treasury rate made it a very safe place to hide.
It is also interesting to note that in 1987, the 10-year Treasury was increasing to almost 10%. Today, the yield is declining even after the debt downgrade. What does the market know about American debt that Standard & Poor’s seems to not see? The relationship of the 10-year Treasury to the yield on the S&P 500 is indicating a very bullish market signal. You have a choice. You could choose an investment in a safe bond with a negative actual yield or a quality S&P 500 company with a potential for growth and a 4% dividend.
What does it all mean? It seems to me that if we get the worse that 1987 has to offer, we will be fine. If you consider that today’s market is a moment in time event, we will be fine. It is very likely that today is much like a wild roller coaster ride that we are in the middle of.
Funny thing about a roller coaster ride is that you end up at the same spot in a pretty short period of time.
Bill Brooks is a certified financial planner with CU Prosper.
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