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Dividend Alert - October 2013
October 08, 2013

October 8th, 2013

  • Bad news is good news for cash rich investors

Dear subscriber

As many of you know our investment strategy is to seek out high quality dividend paying companies that are historically undervalued, based on our proprietary yield/value algorithms, in order for us to consider relevant companies for our Dividend Income Portfolio.

I am happy to say that this has worked well since we launched Dividend Income in February 2011. Since then, on several occasions, we were able to purchase shares in a number of (than) historically undervalued high quality dividend paying companies. Since, we have happily added their increasing dividends to our growing cash holding awaiting investment.

However, since mid-2012, with returns on savings accounts and bonds remaining at historical lows, many investors have found the benefits of dividend income investing sufficiently appealing to ‘en masse’ start a rally in high quality dividend paying shares.

It is therefore no surprise that we have not added to our Dividend Income Portfolio since April 2012, as share prices from high quality dividend paying shares slipped away from their historically undervalued levels. In some cases, in April 2013, their share prices were even nearing their historically overvalued levels.

Increasingly, earlier this year, and, at several occasions, I have warned Dividend Alerts subscribers, and, in much more detail our Dividend Income subscribers that, while the majority of the dividend paying companies we are following were not (yet) near nor had reached their historically overvalued share price levels, the sustainability of their share prices were increasingly been driven by ongoing Central Banks' money printing presses rather than the growth in their sales, earnings, free cash flows and dividends.

And, I am afraid we have now passed another milestone . . .

Bad news is good news for cash rich investors

That may sound odd, but if you had sold some or indeed all your dividend paying shares, earlier in April and May, as we did, and, as reported to our subscribers at Dividend Income in advance, you would now potentially be sitting on a tidy sum awaiting long-term investing.

And that moment is fast becoming reality . . .

Private investors who invest for the long term – ten or twenty years or so – should welcome the continuation of the markets’ downward path, due to primarily what’s happening in the USA and its effect on the wider world, in particular the emerging markets.

In fact, if and when this continues, say for a few more weeks, with markets going down another 25% or so, you should be able to start picking up some high quality high yielding shares at (than) historically undervalued share prices.

But which ones?

I’ll return to that in a sec.

As we have explained in an earlier article, our long term stock market cycles specialist expects that this autumn will provide those savvy investors with both the cash and the guts the opportunity to benefit to invest in many high quality dividend paying shares when they are truly undervalued.

Also, according to our market cycles forecaster, following this autumn low we are likely to see a bounce in the markets with higher lows in 2015 and 2018 before the new secular bull market begins in 2018, lasting till. . . Yes you read it correctly: 2035.

You well may now well want to ask me: what will cause a 25% stock market drop?

According to the U.S. Treasury Department, Congress has only until October 17 to raise the debt limit. If it doesn't, the Treasury says it will be down to just a relatively small amount of spare cash that would be gone in a matter of days. The United States of America would then be close to falling off the dangerous cliff of default.

And what then?

My five pence worth of it . . .

Scenario 1

At the 11th hour, the Republicans and Democrats reach a compromise and Congress raises the debt limit to fund the government's operations normally.

Based strictly on history, this is the most likely result. It's what has happened every single time in the past.

The outcome: The stock markets will rise . . . business is back as “usual”. No end to the rampant borrow-and-spend addiction of Congress; no end to the print-and-pump madness at the Fed ... until, that is, bond investors rebel and force a different kind of shutdown (see scenario #5) – but until then: bond Armageddon is again postponed.

Scenario 2

The U.S. government defaults on its maturing debts. Stock markets around the globe collapse.

The fact that both Republican and Democrat leaders haven't really flinched an inch — even in the face of a massive government shutdown — leads an increasing number of observers to believe that they may indeed pursue the same tactic even in the face of a government default.

If they do, and if the president abides by the law, we face the ultimate financial Armageddon for any government — not only the collapse of U.S. government bonds, but also the end to our global financial system as we know it today.

Apparently the deadline for this to happen is mid-November when the USA needs to pay more than $6bn in interest on its Government bonds, with nobody really knowing where it is going to come from . . .

Scenario 3

Congress lets the U.S. government default. But the president overrides Congress, invokes the 14th amendment and forces the government to borrow and spend exclusively by executive order.

This is a tactic that former president Bill Clinton endorsed during the last debt limit battle. It's also one that's now advocated by some Democrats. Stock markets will dip, but consolidate on a lower level.

Scenario 4

The president decides to pay off maturing debts but sacrifices nearly everything else. In other words, the U.S. government, despite its long love-and-hate affair with debt, suddenly reverts to operating strictly on a cash-and-carry basis.

This means that Government bond investors and other debt holders get their money on time. But virtually everything else gets axed. Instead of a temporary government shutdown, a big chunk of the government downshifts into a longer lasting — and far more devastating — semi-permanent shutdown.

The U.S. government, the world's largest employer, goes far beyond the temporary furloughs of federal employees announced last week: It takes the next logical step and start to lay-off hundreds of thousands of federal employees. Industries that service the federal government do the same.

The U.S. economy plunges into a virtually instant depression. Stock markets around the world collapse.

Scenario 5

Global bond investors rise in rebellion, dump their U.S. bond holdings and force a government contraction similar to that of scenario #4.

If this were to happen, it is virtually impossible for the United States government to sell its bonds at virtually any price. There are simply no buyers.

U.S. bond prices will plunge uncontrollably. Interest rates will sky rocket for U.S. Treasury bills. The bond market virtually shuts down, threatening to shut down the entire government — even the entire nation. End result: a world-wide stock market crash.

Is any of this realistic?

Can this happen? Absolutely. In fact, among all the scenarios now before us, scenario 5 is ultimately the most likely. Most of the other scenarios may turn out to be little more than previews that lead to this final outcome.

In that case our cash rich investors will be able to pick up some truly unbelievable bargains.

Until then, it is good to know at what share price levels high quality FTSE350 dividend paying companies are historically undervalued.

In fact, we have already alerted our Dividend Income subscribers with our first buy limit order - still to be completed.

Unique opportunity!

So, by becoming a subscriber now, you will be seeing in advance all my moves to create a portfolio of high quality dividend paying companies purchased when they are historically undervalued, as per our proprietary valuation methodology.

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Till next time.

Steven Dotsch
Managing editor
EMAR Publishers
Dividend Income
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