Anxious Investors Throw Out the Good With the Bad ? Investing Daily

Anxious times trigger fearful responses. So it?s no wonder that when stocks fall, many investors sell first and ask questions later, if indeed at all.

Dividend-paying stocks used to occupy a place in the investment hierarchy that excluded them from such shenanigans. In fact, the only time a high yielder really took a hit was when there really was a cut in the payout. At that point, the healing would begin and the seeds of inevitable recovery would be sown.

No industry epitomized that underlying strength like utility stocks. Time and again, sector stocks would be knocked on their back by tough regulation, poor investments or even operating disasters. Each time, management?often a new team?would put the pieces back together by repairing relations with regulators, while cutting debt and operating expenses. Eventually, balance sheets were repaired, earnings and dividend growth restored and stock prices recovered.

The most recent recovery for utilities followed the 2001-02 bear market meltdown, which left the Dow Jones Utility Average (DJUA) off nearly 60 percent from its highs, with two-dozen companies either in or on the brink of bankruptcy. It took a few years to fix the damage, and some, such as the former Aquila/UtiliCorp, never fully made it back. But by early 2005, the DJUA was breaking out to a new all-time high. And by early 2008, the index was 340 percent higher than its late-2002 low.

The battered utilities of 2002 had certainly taken a hit as businesses, many from trying to copy the model of the vanished Enron. On that basis, it would have made good sense to sell many of them when signs of a real breakdown became apparent in late 2001.

Selling is something that I failed to do enough of during that period. Fortunately, utilities? formula for recovery was a relatively simple one. And so long as companies did systematically cut debt and operating risk, their recovery was in the bag. In fact, utilities are obviously the strongest they?ve been as businesses in decades, demonstrated by how they weathered the Great Recession of 2008-09.

The New Volatility

Not even utilities, however, are immune from the new volatility that?s gripped dividend stocks in general the past several years. That?s partly a rational response to the fact that there are now so many companies paying dividends in industries not traditionally known for that.

Producing energy and other natural resources is, for example, an exceptionally volatile business, where earnings follow prices up and down. Rising prices provide the wherewithal to pay out more. But when prices drop, cutting dividends is the preferred course to borrowing more or reining in business plans.

Over the past several years, however, we?ve seen an unprecedented number of corporations, master limited partnerships and other entities that produce energy begin paying massive dividends. Some such as Linn Energy LLC (NSDQ: LINE) have hedged their exposure to energy prices for many years into the future, limiting the impact of earnings volatility. Others, however, have little or no such protection.

As a result, when energy prices do drop, investors treat energy producers?even those hedged like Linn?as though dividend cuts are on the way. And the same is true of producers of everything from coal to wholesale electricity. The sharp drop in the price of power, for example, has caused investors to dump more price-sensitive fare such as Exelon Corp (NYSE: EXC), even as they?ve gravitated to mostly or entirely regulated electric utilities like Southern Company (NYSE: SO) as safe havens.

Going up the risk/yield spectrum, reactions are progressively more extreme to real or perceived threats to earnings. Pipeline stocks have come to be considered nearly as safe as regulated utilities. But a drop in energy prices and the hint of a possible change in taxes have been enough to knock prices of many master limited partnerships for a loop this month, just days after many announced robust third-quarter results and in fact raised distributions. In fact, that applies to several whose payouts yield nearly 10 percent.

Communications was once a monopoly. Today, it?s a fiercely competitive business increasingly dominated by the largest players, AT&T (NYSE: T) and Verizon Communications (NYSE: VZ). And there?s nothing like a fearful market to roil an entire sector, including the big boys.

AT&T shares, for example, are more than 12 percent off the peak they hit in late September, despite reporting very solid third-quarter numbers since. High-yielding rural communications companies have fared far worse, with investors assuming wipeouts await even those that continue to post very strong numbers.

Dominant Psychology

The magnitude of those moves suggests something else is at work in the dividend-paying stock universe: growing fear of a reprise of the 2008-09 crash, or something even worse.

As long as that?s the dominant market psychology, we can expect more of this kind of volatility. In fact, it could well increase in the coming weeks, as the Jan. 1 deadline for Washington to resolve the fiscal cliff and avoid a recession approaches.

As I?ve written here on numerous occasions, a repeat of 2008-09 is extremely unlikely for the simple reason that there?s not nearly the degree of leverage now as there was prior to that crisis. Corporations have used record-low corporate borrowing rates over the past three-plus years to eliminate near-term refinancing risk as well as slash interest costs. If conditions freeze up, they can simply delay borrowings, and in fact force investors to come to the table to buy.

Similarly, households have dramatically cut debt, and even overall government deficits are at their lowest level relative to the economy since 2006.

Put another way, everyone is hunkered down expecting a collapse. There just aren?t enough people leaning in the wrong direction to really incite a panic.

That suggests the next move for the market is actually going to be positive. And the most likely catalyst is a deal on the federal debt that calms frayed nerves for the near term and builds confidence by establishing some framework for getting the nation?s financial house in order. That was the case in 1993, and the results were positive indeed.

There are plenty of indications now that all the American economy needs is a friendly push to set all that money that?s been injected into the system the last four years to work, firing up growth. At that point, the problem is likely to become inflation, which few are looking for now. But the near-term benefit will be a crisis averted, and stocks are likely to take that very favorably indeed.

On the other hand, if Washington lawmakers fail to reach a deal, and spending cuts and tax increases kick in, investors should expect additional selling?including dividend-paying stocks with long-held reputations of stability. With a repeat of 2008 unlikely, however, it will be time for buying, not selling.

The key is to make sure your dividend-paying companies have the reliable revenue and lack of near-term debt refinancing needs necessary to weather tough times. As long as that?s the case, they?ll always recover from a spill, and eventually move on to higher highs.

The bottom line: Whether it?s doom or boom ahead, pay attention to whether companies are supporting their dividends, while maintaining strong balance sheets and plans for growth. Discerning companies? success at those tasks will enable you to get the most out of the market?s next ascent, or ensure your portfolio can endure a downturn. And keep in mind that the best buys may be the stocks that have fallen the most in the current turmoil.

Source: http://www.investingdaily.com/15934/anxious-investors-throw-out-the-good-with-the-bad

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