Sunday, August 05, 2007

Safety Becoming Sexy: An Unappreciated Link Between Housing and Stocks

Yes, the housing market is weak and looking to extend weakness into 2008. Yes, the mortgage credit market is a mess and risk aversion is spreading to other sectors of the market, helping to drag down the shares of financial companies.

Eventually we'll see a floor on the stock market's pessimism. Why? Take a look at PEY, the PowerShares high-yield ETF that seeks out stocks with high yields and consistent dividend payments. With the recent decline, the yield on PEY has risen to over 4.3%. Why? About two-thirds of its holdings--which come from the Dividend Achievers 50 Index--are financial stocks. The decline is creating a situation in which, eventually, some of these issues will become interesting as yield plays.

But that's not the big picture. What we're seeing is the longer-term seeding of doubt regarding the idea of housing as a safe investment/retirement vehicle. Baby-boomers and young professionals who have been resting assured that their home equity *is* their retirement nest egg will increasingly rethink that wisdom. And I don't think stocks will, by themselves, fill the void. Memories of tech market crashes and these sudden market swoons will be too fresh.

So what could provide safe haven? Savings. Dividends. Safety. The generation that blazed their way through the Sixties questioning The Man may yet exit the stage as a group of coupon clippers. Holding onto what you've got will be the grim imperative. Housing was the great bastion of growth *and* safety. For the first time in recent memory, that basic perception is undergoing scrutiny.

Yes, there will still be opportunities in real estate, in sectors and specific markets. But it is the fundamental premise of housing as a source of retirement safety that will be irreparably eroded in many markets. Years from now we'll look back on those TV shows featuring home-flippers and wonder how we missed the signs of a bubble.

Above we see a chart of the dividend yield on the S&P 500 Index from 1970 to the present. We're currently yielding a little over 1.8%, having bottomed closer to 1% at the market top in 2000. I propose that we're seeing a nascent uptrend: rising lows in dividend yields at market tops. That, eventually, will lead to rising peaks in yields, when investors demand more safety for the perceived risk of stock ownership.

We can only get rising yields in one of two ways or a combination thereof: companies raising their payouts or stock prices falling to create attractive returns on existing payouts. With housing gone as a psychological prop to retirees and those saving for retirement, sub 2% yields on blue chip stocks ain't gonna cut it.

I happen to agree with my colleague Roger Nusbaum that there is much more to a well-diversified portfolio than yield. But what's makes logical sense is not always what makes psychological sense. When much seems at risk, safety becomes sexy.