Some international funds worth perusing

International markets seem to have awakened after a long, long nap. These funds have excellent returns and positive alpha — which means they have done better than might be expected, given the risk they take.

Bear in mind that you’re taking on stock-market risk as well as currency risk, which is one reason why I don’t generally advocate huge international positions. But if you’re in the market, this is a decent place to shop. And, yes, there’s a paywall here, but it’s for a good cause.

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Awash in cash

People who like dividend stocks might find that technology stocks are the type of stocks that they like.

For one thing, they have enough cash to buy several small European countries. “Companies have enough money to do whatever they want, and that’s before potential reparations” from the tax bill, noted Howard Silverblatt, senior index analyst for S&P Dow Jones Indexes. And how. All told, about $1.8 trillion is cooling its heels on corporate balance sheets, and much of that is on tech balance sheets. Here are the 10 companies with the biggest cash stashes:

Apple has another $195 billion in “long term investments” on its balance sheet, which skeptics might label as “pretty darn close to cash.”  And overall, IT is the second-largest dividend payer, behind financials.

Why does IT have so much cash, aside from being immensely profitable? One reason might be that IT went through a near-death experience in 2000-2002, and they have learned the lesson that cash is your best friend in hard times. (Banks, which have gone through several near-death in the past 50 years, never seem to learn that).

Another is that IT companies rely on innovation to survive, and innovation doesn’t come cheap. Either you have to hire top people (and pay them well to keep them) or you have to pay up to buy innovative companies. That requires cash, too, although having an extravagantly valued stock price is good, too.

What’s interesting is that many of these stocks aren’t insanely priced. Apple sells for 14.4 times its estimated 12 months’ earnings, and pays a 1.45% dividend, too. Cisco sells for 14.4 times earnings and pays a 3.0% dividend. Oracle pays a 1.48% dividend and sells for 15.3 times earnings. Only Facebook, which sells at 26.8 times its expected earnings (and doesn’t pay no stinking dividend) fits the profile of the gunslinging tech company of yore.

(The two biotech companies in the chart, Amgen and Gilead, also rely on heaps of cash to continue innovation, are cheap, and pay good dividends. Coca-Cola is, well, Coca-Cola).

During the 2007-2009 bear market, and for some time thereafter, technology was the sector with the highest dividends, precisely because it had the cash on hand to do so. Banks were too busy staving off bankruptcy. For investors who like dividends and dislike bankruptcy, large-cap IT seems to be a reasonable bet.

Naturally, there’s an ETF for that: The First Trust NASDAQ Technology Dividend Index Fund (TDIV), which currently yields 2.14% on a trailing basis. The fund doesn’t have the sizzling returns that an all-tech fund has — it’s up a mere 21% this year, vs. 36% for the technology sector — but that’s not why you buy a dividend fund. Assuming these companies don’t waste their money on something foolish, like buying several European countries, they could be a good long-term investment for dividend investors.

Taxes and the urge to merge

Tax reform, in whatever final shape it takes, is likely to put lots of money into corporate hands. While these companies already have lots of cash — a record $1.8 trillion in nonfinancial companies in the Standard & Poor’s 500 index — giving them more cash may give them an incentive to actually, you know, spend it. I talk about one likely option in my latest column, here. 

On another topic, the Baby Boom Generation spans the years 1946 to 1964. There’s a big difference between the early Boomers and their younger siblings: If you were born in 1946, you came of age with the Beatles, the Vietnam War, Lyndon Johnson and Richard Nixon. If you were born in 1964, you grew up with The Clash, gas lines, Jimmy Carter and Ronald Reagan. More importantly, older Boomers are more likely to have pensions and more likely to have taken a beating from the past two bear markets. Younger Boomers? They probably don’t have pensions, they face soaring college tuition costs for their children — and some will retire just as the Medicare Trust Fund runs out of money. You can read about it here.

By the sweat of your brow

“By the sweat of your brow
    you will eat your food
until you return to the ground,
    since from it you were taken.”

One of the enduring mysteries of the U.S. tax code is why the system is harder on those who earn their income by the sweat of their brow as opposed to those who get money from their investments.

The tax code’s main purpose, of course, is to fund the activities of the government, and Americans have been having a lively discussion about the proper scope of government activities and how to pay for them for more than 200 years.

Over the years, however, the tax code has been used to encourage certain behaviors and discourage others. In its current incarnation, for example, we give deductions for contributions to some retirement savings accounts, because that’s a good thing. We levy tax penalties on early withdrawals from retirement plans, because that’s often a bad thing.

There are plenty of things to argue about with these types of tax incentives. What is curious, however, is the favorable treatment of investment returns over ordinary income. Currently, for example, employment income is taxed at a maximum 39.6%, while long-term capital gains are taxed at a maximum 20%.

Ostensibly, the lower tax rate for capital gains – the difference between your purchase price and sales price on a winning investment – is to encourage investment. As such, it has some merit: Congress cut the capital gains rate from 28% to 20% in 1982, and the stock market took off. (On the other hand, Congress returned the capital gains rate to 28% in 1987, and the stock market generally rallied until 2000).

Nevertheless, we as a nation tend to encourage hard work and look down on those who work as little as possible. And here we come to a paradox between the admiration for hard work and the tax code. Consider this comparison of two people, each with $300,000 in income, presented by Ben Steverman of Bloomberg.

Our first taxpayer is an emergency room surgeon. The other plays video games all day, thanks to his inheritance.

twogus

Now, as with all things taxable, there are some important caveats here. One is that under current law, if the heir’s parents gave him his capital in their will, the estate is liable for taxes under estate tax law. (Heirs don’t pay estate taxes.) That said, it’s unlikely that the parents paid estate tax: It doesn’t kick in until $11.2 million for a couple and $5.6 million for a single individual. About 11,300 estate tax returns were filed for people who died in 2013, of which only 4,700 were taxable, fewer than 1 in 550 of the 2.6 million people who died in that year, according to the Tax Policy Center.

This is largely an investment blog, so it’s useful to point out that lower corporate taxes in the new tax bill means that companies are more likely to increase dividends, buy back stock, or increase merger and acquisitions. All told, it’s hard not for investors to like the bill, because it will help returns from the money you earn while you sleep. But we’re a country that admires hard work. In the end, however, even with a tax break, those who earn their living by the sweat of their brow still wind up paying more.

 

The Three Percent Solution

When I was growing up, we had a lot of cats. I don’t mean three or four cats. We usually had upwards of ten, all descended from a single calico named Caroline. My parents underestimated both the gestation period of the common house cat, as well as the neighbors’ interest in adopting kittens, no matter how tri-colored and adorable. I thought little of it: I liked cats, and still do, and to me, having 10 or more cats in the house was perfectly normal. It wasn’t until I was older that I realized how peculiar that was.

One of the peculiarities of the past decade – and it’s been a singularly peculiar decade – has been the exceptionally low level of interest rates. The average yield on the three-month Treasury bill the past 10 years has been 0.38%, according to the Federal Reserve. And that figure is inflated somewhat by the first 12 months of the series, when three-month T-bill yields averaged a whopping 2.14%. After that, the three-month bill yielded an average 0.18%. (For purists, this is the market yield, not the discount yield).

For anyone who has been investing the past decade, 0.18% seems about normal. Money market mutual funds, whose yields track the short-term T-bill, have yielded next to nothing – and sometimes actually nothing – for much of the past decade. The same is true for bank CDs. But this is not normal. The average yield for the three-year T-bill since 1934 is 3.5%. If we want to get rid of the very highest and very lowest yields, we get a typical yield of 3.18% over that 83-year period.

Why is this important? For large swaths of the nation’s history, you could get a yield of 3% or more by taking virtually no risk. But for the past decade, that 3% yield has been entirely elusive. To get even a modest 3% yield, you had to take unprecedented risk, either by investing in dividend-producing stocks, or by investing in corporate bonds.

Barring some unforeseen disaster, the period of rock-bottom rates is over. From October 2009 through October 2015, the three-month T-note yielded an average 0.07%, as the Fed kept rates low to stimulate the moribund economy. Today it stands at 1.26% and, should the Fed raise rates as expected, will rise to about 1.5%. Analysts widely expect the Fed to raise rates another half percent or more next year, bringing T-bill rates to about 2% to 2.25%.

While this is still low by historical standards, it holds some interesting implications for long-suffering savers. First, a 2.25% riskless yield could be enough to dull investors’ interest in dividend-producing stocks. Currently, the Standard & Poor’s 500 yields 1.9%. While companies are flush with cash – and get more so should corporate tax rates fall – a 1.9% yield is not a terrific reward for stock market risk when T-bills are sitting at 2.25%.

Yields on bank CDs are already rising. The highest yielding nationally available one-year CD, offered by online bank Banesco, weighs in at 1.75% with a $1.500 minimum, according to BankRate.com. Goldman Sachs Bank USA offers a one-year CD at the same rate. A five-year CD from Capital One 360 yields 2.45%, but it makes little sense to lock in for five years when rates are rising.

Money fund rates are rising as well. Vanguard Money Market Prime (VMRXX) currently sports a 1.20% yield. And Bankrate.com lists three bank money market accounts with yields of 1.5%. (Bear in mind that bank money market account yields are set by the bank, while money market accounts are set by the market).

Investors who decided to seek a bit more yield by investing in short-term bond funds may want to rethink that strategy. Vanguard Short-Term Bond Index fund (VBISX), for example,  has gained 1.39% the past 12 months, including reinvested dividends. Its 12-month yield is 1.54%, indicating that investors have taken a modest loss on principal. If the Fed continues to raise rates, investors will get higher yields, but also increased principal losses.

If you’re a long-term investor with reasonable risk tolerance, there’s nothing wrong with investing in a stock fund that aims for high or growing dividends. Members of the Standard & Poor’s 500 stock index have record amounts of cash, the economy is growing, and they may get even more cash through proposed corporate tax cuts. And several funds offer a convenient way to buy dividend stocks. T. Rowe Price Dividend Growth (PRDGX), for example, has gained 17.35% the past 12 months and offers a 1.4% yield. Fidelity Dividend Growth (FDGFX) has gained 16.13% the past 12 months with a 1.47% yield. Vanguard Dividend Growth, alas, is closed to new investors.

If you’re simply looking for income, however, and you’re worried about the stock market, you may soon be able to put some of that worry to rest by going to cash. Any reasonable portfolio needs exposure to stocks for long-term growth, so don’t sell everything. But if you want to raise a little cash, you’ll get a bit more reward than you have for most of the past 10 years. And that’s one thing about our current investment climate that actually isn’t peculiar.