Categories
Income Investing Wealth

Dividend Growth vs Median Wage Growth

In case you haven’t been paying attention, most people are broke as fuck. The days of middle class growth and prosperity ended a generation ago.

Need proof? Look at real (real = adjusted for inflation) median household income in the United States. For years it was declining. Median real household incomes were flat from 1999 to 2016.

This seemingly simple measure is a driving force behind many of the recent societal shifts across America and much of the developed world. This is because while the economy has grown, the average Joe has been left behind. The wealth created by the overall economy didn’t simply evaporate – instead it went to a select few.

The 1%.

The owners of capital.

Labor has been shortchanged for a generation and people are looking for answers. This is precisely why far-left and far-right views are growing in popularity. Both wings of competing political parties offer radical solutions (and scapegoats) to their constituents who – driven by desperation – eat it up. The same situation has occured many times throughout history, often with tragic results.

Luckily, real median household incomes have started to improve. Still, the experience over the past 20 years has been horrible.

On average, despite a couple good recent years, real household incomes in America have grown by 0.53% each year this millennium! Compare that to average real GDP growth over the past 20 years of roughly 2% (which is already on the low side, historically).

Now compare real median household incomes and real GDP to real dividends paid by the S&P 500. The chart below shows real dividends per share for the S&P 500.

On its own this line doesn’t provide much information to evaluate against real household incomes or real GDP. The chart below, however, shows year-by-year growth in S&P 500 real dividends.

The average annual growth in real dividends this millennium: 5.14%.

5.14% vs 0.53% growth in real income growth (dividends vs. wages) is a massive difference. Especially if you compound this over 20 years as you can see below.

At 5.14% annual growth, $100 of annual dividend income grows to $272.

At 0.53% annual growth, $100 of annual wage income grows to $111.

That’s 145% more income for the person who derives their income from dividends. This clearly shows that the owners of capital (shareholders) have far outperformed the providers of labour (workers) over the past 20 years. And this doesn’t even count the capital gains on shares during the same period.

So who would you rather be?

This is the reason why many people have chosen to transition from providers of labour to owner of capital by saving and investing heavily. The aim is to accumulate enough capital to replace labour income with dividend income + capital growth. It’s the path many use escape the rat race.

Categories
Income Investing Investing

Stock Market Performance During the Great Depression

Many people point to the US stock market performance after the 1929 crash as evidence that stocks can go nowhere for decades.

The argument usually points to the chart below, which shows the Dow Jones Industrial Average failing to retake its August 1929 peak until November 1954. In other words, people make the argument that someone investing in US stocks at the 1929 peak would have had to wait until November 1954 just to break even.

This is false.

The above chart shows the commonly used Dow Jones Industrial Average – an index based on price-returns.

What people completely miss is that investors would have received dividend payments during this entire period. Below, I adjust market returns to include dividends.

According to the calculation below, when including reinvested dividends, an investment at the 1929 peak would have returned on average 5.58% per year ending November 1954. That’s equivalent to a cumulative total return of just under 300%.

While it’s true that the buy-and-hold investor would have ridden a financial rollercoaster along the way, even the worst market timer would have done OK if they simply invested a lump sum and did nothing.

Source: DQYDJ

Of course, it took time for dividends to compensate for price declines. It wasn’t until 1945 that investors started to experience a positive total return. That’s still a long time to wait – and still implicit evidence that stock markets can take a long time to recover.

However, the stagnation narrative is significantly undermined, as this shows it took far less than a quarter-century for the worst market timer to break even.

The above examples show a worst case scenario – someone who’s only decision was to invest at the peak of a stock market bubble and then sit on their hands. This isn’t a realistic scenario for most of us.

Most people invest periodically (i.e. not all at once) as they stash away savings over time. So the more realistic illustration would show how someone performed if they started investing in 1929 and added to their investment over time.

The following chart shows the portfolio value for someone who spread their investment over a 40 month period, starting at the end of 1929. In this example, the person invests a total of $20,000. As you can see, their account is positive (i.e. above $20,000) from the end of 1933 onward.

This more realistic scenario again shows the myth of secular stock market stagnation narrative is largely misleading.

Data from Robert Shiller
Categories
ETFs and Funds Investing

Should Canadian Investors Hedge US Dollar Exposure?

After constructing a well-diversified portfolio of Canadian and US companies – using a combination of individual stocks and ETFs – you look at your portfolio’s currency exposure and wonder: “Should I hedge or not?”

I believe there are reasons for and against hedging US dollar exposure, many of which investors fail to consider.

Most investors incorrectly base their decision to hedge US dollar exposure on their view of the US dollar. While it makes intuitive sense that if one is bullish on the US dollar they’d want unhedged exposure, I believe this is the wrong way to execute on this view.

Some Canadian investors might have 30, 40%+ of their equity holdings allocated to a diverse basket of US companies. They’ve committed a lot of time to ensure individual exposures aren’t excessive and spread across a range of sectors to reduce the risk of one individual weak holding making a significant impact on portfolio performance.

Yet, after all that careful effort they leave their entire US equity position exposed to a single factor: the US dollar. While there may be some nuances (e.g. some US companies will benefit from a weak US dollar), a decline in the US dollar would negatively affect the entire 30, 40%+ US equity position. This is a massive overexposure to a single risk factor.

By leaving a large portion of a portfolio exposed to a single factor investors are taking on significant risk. Many people fail to recognize this.

Historical Canadian dollar performance

If you were to ask Canadian investors during the mid 2000s about US stocks, most would say they stay far away. Why? Because during that time the Canadian dollar appreciated significantly against the US dollar, wiping out investment returns. At that time, currency risk was at the forefront of their minds because they had just experienced its painful effects. Between 2002 and 2007 (a 5 year period!) the Canadian dollar appreciated roughly 60% against the US dollar.

Note: Many investment practitioners argue that CAD/USD is a wash over the long run. The chart below shows that today’s level is close to where it was almost 30 years ago. What this argument fails to appreciate is that not all investors have a 30 year time horizon. An investor with a 5 year time horizon (note that many investors behave like they have 1 year time horizons) would have either experienced a massive tailwind or a massive headwind due to USD exposure. Not a gamble people should take as they approach real-world liabilities, like retirement. Also, the argument that CAD/USD is a wash over the long run erroneously assumes that exchange rates are mean-reverting and deviations are temporary. This is false.

Nobody knows where the USD/CAD exchange rate will head over the long run. Smart people have great guesses, but nobody truly knows. And it’s quite possible that CAD appreciates considerably again, for one reason or another. My point is the risk still exists and it always will.

By leaving a large portion of a portfolio exposed to a single factor investors are taking on significant risk. Many people fail to recognize this.

As with everything in finance and investing, there are multiple considerations. Nothing is black and white, and currency exposure is one of those things.

USD performance during crises

While overexposure to a single risk factor should be avoided in all portfolios, some exposure to the US dollar – due to its safe-haven status – does provide a portfolio cushion in times of crisis.

The chart below shows the level of CAD/USD during the recent crash. From December 2019 to March 2020, the Canadian dollar depreciated roughly 10% against the US dollar. This means that Canadians holding unhedged US assets would have benefited from a buffer.

Below, I’ve shown the performance of two TSX-listed US equity ETFs during that time period. Both are Vanguard S&P 500 Index ETFs, but VSP is currency hedged while VFV is not. You can see how the unhedged version of the ETF declined about 10% less than the hedged version, due to US dollar exposure. A similar narrative played out during the 2008 financial crisis.

So should I hedge or not?

Personally, when given the simple option I hedge. But overall, I might only be about 50% hedged.

My US exposure is attained using a combination of ETFs and individual stocks. Because it is much more time consuming to create my own hedges (e.g. using FX derivatives) my individual US stock holdings are unhedged. However, most TSX-listed US ETFs offer hedged and unhedged versions. In those cases, I buy the hedged ETF.