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Wednesday, May 8, 2013 - 08:30

The Fed's Magic Number May Signal The End Of The Dividend Boom

Wednesday, May 08, 2013 8:30 AM

With investors clamoring for dividend stocks, companies have responded by instituting large hikes in their payouts, which has led to the doubly good fortune of rising income streams and rising share prices, as I noted a few days ago.

Of course, every major change in the investing landscape must come to an end. Tech stocks were all the rage in the 1990s during the dot-com boom -- until they crashed spectacularly. Housing-related stocks surged in the past decade, culminating in the Great Recession of 2008. And the mania for dividend growth will surely cool eventually (though without the dramatic bang that tech and housing did).

The question for many: When will the dividend era wind down?

If you asked that question a year or two ago, the answer might have been late 2013 or perhaps 2014. After all, economists expected interest rates to start rising by then as the economy heated up and the Federal Reserve took away the punch bowl of low interest rates. (Higher interest rates from bonds and other debt make income-producing stocks, with their inherently higher risk, less appealing.)

But as we head into the summer, it's time for a new view. Thanks to recent Fed comments, paired with underlying economic trends, we can now say that interest rates will stay low -- and dividend-paying companies will remain in vogue -- until at least 2016.

6.5%: The Magic Number
In recent months, the Fed has focused more squarely on the national unemployment rate, specifically calling for a drop to 6.5% before rates rise.

At first blush, last week's monthly employment report, which showed a drop to 7.5%, implies the economy is making steady progress. If current trends hold, then we'd presumably be looking at a 6.5% national unemployment rate by the end of next year -- and the Fed would already be gearing up to start rate hikes.


Source: U.S. Bureau of Labor Statistics (BLS)

Yet there's a good chance we won't see 6.5% unemployment until a year or two after that. That's because millions of discouraged workers (not collecting unemployment or actively looking for work) will try to re-enter the labor force as the job market picks up. When they do, they are likely to swell the ranks of unemployed people looking for work.

The numbers are fairly staggering. Right now, 63.3% of all active adult Americans who are working fall into what the economists call the labor participation rate. That's the lowest measure since 1979, and it has actually risen even as the headline unemployment rate continues to drop.

To put that in context, this measure peaked in 2000 at 67.3%. The difference of 4 percentage points between that figure and the current number may not appear to mean much, but it equates to more than 6 million people.

A sampling of grim statistics associated with last week's monthly employment report:

  • The number of long-term unemployed (out of work for more than 27 weeks) stands at 4.4 million. (Another 7.3 million were unemployed for less than 27 weeks and have a better chance of re-entering the workforce even as employment rates remain weak.)
  • The number of people working part time (but seeking full-time work) increased by 278,000 last month to 7.9 million.
  • In April, 2.3 million persons were "marginally attached to the labor force," according to the BLS. These individuals were not in the labor force, they wanted and were available for work, and they had looked for a job sometime in the prior 12 months. (They were not counted as unemployed because they had not searched for work in the four weeks preceding the survey.)
  • Roughly two-thirds of those people were seen as "discouraged" because they believe no jobs are available for them.
  • The remaining 1.5 million "marginally attached" people had not searched for work in the four weeks preceding the survey for reasons such as school attendance or family responsibilities.

Let's exclude the 1.5 million "marginally attached" people as candidates to eventually rejoin the workforce. Let's also exclude the 7.3 million who are considered to be short-term unemployed. That leaves 14.6 million people who are either underemployed or chronically unemployed.

Now let's look at employment growth trends. Roughly speaking, the private sector is creating 200,000 to 250,000 new jobs per month, offset by about 50,000 jobs lost in the government sector. Let's call it a net figure of 200,000 per month. At that pace, it would take more than three years just to bring half of those 14.6 million workers back into the workforce.

It's crucial to remember that these people will start looking for work well in advance of their ability to actually line up full-time work. And as they do, they will unwittingly push the unemployment rate up as they join the ranks of actively looking job seekers.

You can see this data playing out in the national unemployment rate.

From April 2011 to April 2012, this figure dropped 900 basis points, from 9% to 8.1%, as 2.16 million jobs were created. From April 2012 through this past month, the rate fell only 600 basis points, to 7.5%, even as the economy created 2.19 million jobs.

So robust job growth may exceed 2 million for the coming 12-month period, but formerly discouraged job seekers are likely to keep the unemployment rate from falling quickly.

Even if the unemployment rate falls to 7% by next summer, can the rate then make a quick move to 6.5% as the Fed waits to hike interest rates?

Well, that presumes uninterrupted growth, but it's important to remember that since the end of World War II, the United States has endured 11 recessions -- on average, one every 5 1/2 years. The most recent recession technically ended in June 2009, so there's a decent chance the country will have another recession in the next few years before reaching that 6.5% rate.

Risks to Consider: As an upside risk, the housing construction market can be a major employment driver, so any negative news out of this sector could strongly affect the unemployment rate.

Action to Take --> The key takeaway is that the Fed will maintain very low interest rates for at least a few more years, which is bad news for savers who depend on fixed-income investments, but great news for investors who are spending the time to seek out dividend-paying stocks and funds.

P.S. -- Here's what the "Dividend Vault" could mean for you: tax-free dividends, monthly dividend income, nine years of dividends in one day... Which type of dividend would you rather have? The good news is, you don't have to choose just one. You can learn how to get all three types -- starting as early as next month. Click here for more.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.