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    The real threat to our economy is how fast wallets are closing

     

    There is one thing worrying me about the economy these days. It’s not the fact that China is having problems taking a second breath between economic sprints. It’s not Europe and their big fat debt they keep feeding like an overweight cat. Nope, what bothers me about the economy right now is the possibility of seeing all these wallets closing at the same time.

     

    The only thing that can kill an economy in a capitalist world is a lack of liquidity. Cash is like blood going through your veins, if the heart stops pumping, the whole body collapses. If the Fed stops pumping money into the system, will the economy crash?

     

    You don’t know what I’m talking about? Here’s a recap of what is going on…

     

    Fiscal Cliff, Debt Ceiling and the FED

     

    2013 will be a year of great debate between the Republicans and the Democrats. They will have to argue on how to completely solve the fiscal cliff. If they can’t find a solution, major spending cuts doubled with tax increases will hit the economy like a train. That’s a recession scenario right there.

     

    The other great debate is the debt ceiling. Over past decades, Governments have increased the US debt ceiling (the amount of debt the country is allowed to borrow) several times. The latest episode happened in 2011. Still, we are now back at the table to discuss the same issue. The first meetings happened at the end of February. If no long term solutions happen, there will be another series of spending cuts to make sure the US Gov doesn’t break the ceiling again.

     

    On their side, the FED continues to print money like there is no tomorrow. They are injecting billions, read trillions, into the economy with bond buyback programs called quantitative easing. Wall Street is reassured each time Ben opens his mouth to say that interest rates will stay low and the FED will keep pumping money into the market. The big bulls of Wall Street only want to hear that more money is coming in, they don’t really care if it’s good or bad for the Government.

     

    The Government Is Not The Only One To Put The Brakes on Spending

     

    The Government is not the only one putting the brakes on spending. On both sides of the border, we see consumers slowing down with their credit cards. Americans have started to save money since 2009 and their financial situations are getting better. However, this doesn’t mean they will open their wallet again. Since the American consumer counts for 70% of the US GDP, we absolutely need his enthusiasm for the economy to continue rolling.

     

    In Canada, we don’t have Government debt problems yet but we surely have a huge issue with consumers. They are so under water that they don’t even see the earth where they can land. Sooner or later, they will have to slowdown with their credit cards. They will either do it because they realize they are in trouble or they will be forced to do it when the cashier returns their card saying the transaction is refused. In both cases, this will hurt the economy.

     

    Recession, Stagnation, Where to Find Growth?

     

    When I look at global markets, I have a strong feeling that economic growth will be pretty close to the stagnation level. I think we will avoid talking about the R word but won’t be ecstatic about the markets either.

     

    Nonetheless, the stock market is not related to the Government’s balance sheet nor the typical consumer bank account. This means that we will still have a great year in the markets and the first two months have proven it.

     

    If you have energy, cyclical stocks and “pure growth oriented” stocks in your portfolio, chances are that they will lag a little bit in 2013. Spending cuts will affect cyclical markets (especially if they increase taxes!). I would probably stay away from weapons and defence industries since the bulk of the cuts will happen in the military budget. They had great years in the 2000s, but I think the party will end soon for those companies.

     

    My bet would be on cash and stable businesses. I recently wrote a piece about the food sector (click here to read it) showing how well it has done since the beginning of the year. I think that companies with strong dividend policies and low dividend payout ratios will be among the most popular stocks.

     

    Investors are looking for steady income and bonds are not providing what they are looking for. As long as we see a stagnated economy, interest rates won’t go up. Therefore, the next item on the list for steady income is dividend stocks. I currently don’t believe in a dividend bubble since stocks are undervalued. But 2013 could probably be the year when the bubble will start growing faster.

     

    What do you think? Do you think the economy will get back on track this year? What about your portfolio, do you think that dividend stocks will be among the big winners for 2013?

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  •  

    Are companies rushing their year-end dividend to avoid the fiscal cliff or is it just a last kiss goodbye to their payouts?

     

    For the first time in 20 months, funds invested in Dividend ETFs are droppping

     

    For the first time since many years, several companies are paying an special dividend before the end of the year

     

    We are not Halloween, and yet we talk about Death… Dividend’s Death?

     

     

    I’m taking a quick pause from my utilities dividend growth stock series to talk about the possible impact of the fiscal cliff. I don’t know if you have noticed this, but there are a lot of companies rushing their payout before the end of the year. In their announcement, they specifically mention that this exceptional ex-dividend date and dividend payout are prior to January 1st with the only goal of avoiding the possible new tax treatment on dividends in 2013.

     

    Companies such as Oracle, Cisco, Seagate Technology, Wal-Mart, etc are paying their “regular” dividend in advance while other companies such as Wynn Resorts & Tyson Foods are paying a special dividend before the fiscal cliff. At the same time, companies who refuse to get in line and pay their dividend prior to 2013 like GAP will be penalized by the market and see their shares plummet. Do companies and Wall Street Golden boys know something small investors don’t? Are they planning on cutting their dividend after the fiscal cliff? Or is it the death of dividend growth?

     

    Fiscal Cliff in Numbers

     

    To answer these questions, we must understand what the fiscal cliff is. The Fiscal cliff is a combination of measures that will drastically increase the Government revenues and cut its expenses.

     

    The revenue increases will come from the maturity of a series of special tax reductions that were enacted during the Bush Government.

     

    The expenses cut will come from a series of arrangements decided by congress in 2011 in order to decrease the debt level.

     

    The problem is that the combination of both measures creates a “hole” in the economy equivalent to 3.7% of the USA GDP. So unless we see incredible economic growth in 2013, we are heading directly into another recession. Being in a recession is one thing, but what concerns folks the most is the tax increase detailed as follow:

    Fiscal Cliff Explained

    The tax increase will mainly hit high income households along with capital gains and dividend payouts in general. I’m not a tax expert but I read that dividend income currently taxed at 15% could go as high as 38.6%. That’s more than 20% less in your pocket for every dollar received in dividends!

    How the Fiscal Cliff Influences Dividend Growth Stocks

     

     

    We all know that the main goal of any CEO of any public company is to keep the share value as high as possible and to generate profits. If the share value is up, it’s good for both investors and the CEO ;-). We also know that several stocks attract investors with their dividend growth policy. For example, what has been the point of holding JNJ for the past 5 years (stock value is +3.13% but dividends increased by 45% during the same period) besides its ever growing dividend payout? None.

    JNJ GraphIn a historically low rate environment, solid blue chips have slowly replaced a part of bonds and certificates of deposit in the fixed income portion of a portfolio. It seems like a good way to buy a stock that will be relatively stable over time while paying a dividend that is taxed less. What do you think would happen if the reason why you hold a stock is impacted by a tax increase of 23%? You might sell the shares and look elsewhere for another investment opportunity.

     

    Stocks May Hold Off On Their Dividend Growth Strategy

     

    We recently talked about a potential dividend bubble due to the fact that investors were rushing into dividend paying stocks to compensate for low interest bonds. The word quickly spread and several companies started to increase their dividends and adopted a dividend growth policy in order to get on the train and attract more investors. I’m not making this up, check out this chart showing the huge dividend burst that happened upon the dividend tax cut to 15%:

     

    Dividend tax rise fiscal cliff

    So maybe the fiscal cliff is not the end of the world and dividend investing is not dead. However, strong dividend growth stocks might be hard to find if several companies hold off on their dividend growth policy. Instead of increasing their dividend increases year after year, they might keep their money and use it for other projects.

     

    We Are Not Done Yet With The Fiscal Cliff

     

    Back in April, I discussed the pros and cons of Obama rising taxes on dividend. I’m obviously not a fan of the situation but it might not be as catastrophic as we think. There are still a lot of companies that will continue to pay dividends. On the other hand, nothing has been settled yet and the Government could still continue to debate throughout the beginning of 2013 as the taxes will be applied during the year but most likely paid in 2014..

     

    So there is still hope that the dividend tax won’t be hiked to 38% and that stocks will continue paying great dividends!

     

    What’s Your Take? Are You Afraid of the Fiscal Cliff?

     

    Dividend investors prefer to receive cash right now instead of playing on a potential company growth. But if the dividend payout is taxed too much, there might be a loss of interest towards dividend investing.

     

    Do you think that dividend investing will be dead upon the fiscal cliff?

     

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    Disclaimer: I hold shares of JNJ & STX

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  •  

     

    Sometimes I wonder if financial journalists know what they are talking about – the FED printing money, really?

     

    Do you believe that the FEDis the only institution that evolves in a closed world separate from real economic data and without expertise? Do you believe that Ben Bernanke is not as smart as a 5th grader? When you read the financial news, I start to believe that journalists think so!

     

    I’ve read numerous articles about the fact that the FEDis printing money like there is no tomorrow through their set of Quantitative Easing measures (aka QE1, QE2 and QE3). At the end of summer 2012, the FEDannounced a third round of QE by buying $40B of mortgage back assets on a monthly basis (read more on QE3). Bernanke was accused by many of printing more money and eventually pushing the States into an uncontrollable inflation spiral. When you think about it: The FED is injecting $40B per month into the markets. Where do they find the money if they don’t print it? At first glance, it seems that Bernanke is not smarter than a 5th grader after all… but, thank God!, the reality is more complex.

     

    How Quantitative Easing Measures Work In theREALWorld

     

    In the real world (this is what matters, right?), theFEDis not depositing $40B into someone’s bank account each month. It’s not “real money” but rather a way of playing with accounting books to facilitate liquidity (read; more credit facilities for consumers) and add pressure to long term bonds (which results in pressure on mortgage rates to stay low). As you can see in the chart below, this part of the system works well:

    30 yr treasure rates vs QEIOU System

     

    As I mentioned earlier, QE is not real cash in a bank account. It’s working like an IOU system:

     

    #1 The FED buys mortgage back assets from a bank. Therefore, in the books, the bank can release its weight as it doesn’t hold the illiquid (and most probably under water) mortgage assets on its books.

     

    #2 In exchange, the bank doesn’t receive cash.  The money from the mortgage backed asset sale is deposited at the FED. This allows the bank to switch an illiquid asset from their books to solid cash. The interest in theFED bank account is paying more than regular money market. This is why the bank will keep it there.

     

    #3 The Bank now shows an improved balance sheet. With the mortgage backed assets gone, the bank shows a stronger balance sheet and is able to lend more money at better rates to consumers. It’s like capitalizing banks without “real” money.

     

    #4 The money in the market is coming from banks to consumers. So theFED is not printing money, its only facilitating the banking industry to provide credit to its consumers. Since 70% of the USGDP comes from internal consumption, it is crucial to help US consumers to continue to buy goods.

     

    There is No Printing Money but there is a lot of Burning Money

     

    Another factor that most people tend to forget is the fact that we are currently burning a lot of money in the US at the moment. How can we burn money? Here’s how it works:

     

    In a “normal” situation, you have a mortgage on a house that’s worth more than its debt. So you buy a house at 100K with a mortgage of 80K. Each time you make a mortgage payment; you drop your debt and automatically create equity in your house. Therefore, the day that your mortgage is paid down to 70K, you can still borrow back the 10K equity you’ve built on your house. If you are lucky, the house now worth 110K and you have 20k equity ready to be used (or abused ;-) ).

     

    But right now the situation is different. You bought a house at 100K with a mortgage at 80K. Housing market has been so bad that your house now worth 50K. So even if you have paid 10K on your mortgage, you are still “under water”. Your balance sheet is showing a 50K asset with a 70K debt attached to it. You are still in “negative equity”. So each time you are paying down your mortgage, you are taking away this money from the system as you are not creating equity. This is what we call money burning.

     

    Since there are millions of mortgages in this situation, there are millions being burned at the moment? So creating liquidity on the banks’ balance sheet in this situation is not that bad!

     

    Monetary Mass is Relatively Stable

     

    Everything you read here could be confirmed or destroyed by someone else like any other theory. But I think I’m pointing in the right direction since there is a key metric that doesn’t lie: theUSmonetary mass.

     

    The monetary mass is the sum of all US dollars that “exists”. When we look at the money supply, we can see that it’s increasing but not like there is no tomorrow either:

     

    monetary base

    For this reason, I’m not too pessimistic about hyperinflation. As long as the monetary mass is stable, we shouldn’t have to fear inflation.

     

    What Truly Concerns Me is Obama

     

    I’m not American, I didn’t vote and this blog is not about politics. In fact, I don’t really mind if Obama or Romney is the President. What concerns me is the fiscal cliff that is looming ahead and while the President is a democrat, the congress belongs to the republicans. With a neutral opinion, I just don’t think it’s a good fit since both parties have a very different way of seeing the economy right now.

     

    The fiscal cliff is arrives in January 2013 when several spending cuts and tax increases are going to happen (including taxing dividends!) if a solution is not found. So the problem is not being a democrat or a republican at this stage. The problem is that both parties will have to walk hand-in-hand towards in the same direction to find a solution. This is where I see the problem happening. They do not seem to get along very well at the moment.

     

    My concern is the following: while both parties argue on which way to turn, do you fear that we will jump in the cliff before they decide to avoid it?

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