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Dividends4Life (28.13)

The Current Financial Situation Should Concern Us All

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August 16, 2011 – Comments (5) | RELATED TICKERS: CL , JNJ , KO

After spending a significant amount of time studying the problem, I am convinced the current financial situation should concern us all. No, I am not talking about the recent drops in the stock market. That does NOT concern me.

In normal times stock market declines would excite me and I would hope for another 5-10% drop. I love to buy quality dividend growth stocks when they go on sale. A lower price means a higher yield and more dollars in my pocket.

Recently, I have had some questions that have puzzled me, and as I looked for answers what I found left me concerned. Here are the three questions:

Puzzling Questions
1. Why have U.S. interest rates remained so low?

2. Why have the prices of oil, gold and other commodities increased so much?

3. Why am I paying more for everything, but the CPI is only 2-3%?

The answers I found concerned me. Here is what I learned...

Why have U.S. interest rates remained so low?This is where my journey began. After the 2008 financial crisis and economic melt-down, the U.S. government began printing billions and billions of dollars to prop up struggling companies that were "too big to fail."

As the amount of debt increases, so does risk. To compensate investors for taking on additional risk, interest rates usually rise. In addition, China, our largest foreign debt holder, was publicly displeased with this action and it was widely speculated they would buy less of out debt in the future. Lower demand for debt usually drives the price down and thus increases the interest rate.

The interest rate on U.S. debt did not rise; it actually declined. Why was this happening?

Why have the prices of oil, gold and other commodities increased so much?Rather small events in the middle east were said to be the reason oil was increasing, but it continued up after these events were settled. Oil executives were quoted as saying that the economic downturn had greatly eliminated the demand imbalance, so demand was not driving the price of oil up.

Like oil, gold has seen a steady increase for the last several years. I just casually attributed that to the financial downturn. Isn't that what happens every time there is a jolt in the financial system - gold goes up until everyone calms down then it plummets until the next financial bump in the road?

Gold doesn't appear to be showing any signs of an eminent decline. Why is that?

Why am I paying more for everything, but the CPI is only 2-3%?It is not scientific, but since 2008, the dollars I spent on groceries have grown at a compound annual growth rate of 8.8% and for gasoline over the same period the growth rate is 16.4%. The size of my family has not changed and the miles driven has been relativity constant over this period.

To be fair, I dropped the CPI into the same spreadsheet I used to calculate the above growth rates. I was shocked to see the CPI had grown a whopping 1.7% over this period. This seemed very low. For me, food and gasoline made up a little over 20% of my total expenditures during this period. Again, this is just one data point and not scientific.

Some have claimed that the Bureau of Labor Statistics (BLS) has intentionally tweaked the calculation over the years to keep it low. Some also have claimed that food and energy was removed since it is too volatile. This is denied on the BLS website along with the claim that the BLS has selected the methodological changes to the CPI over the last 30 years with the intent of lowering the reported rate of inflation. Are they protesting too much?

Possible AnswersIn trying to find an answer to 1. and 2., I became concerned that the Treasury's printing presses have never slowed down. If the Treasury is meeting the demand for unsold debt at low interest rates, and filling the gaps created by China and other countries who chose to reduce U.S. debt purchases, it would explain why interest rates have remained so low and why the price of commodities (gold, oil , food, etc.) have risen so much.

This is my area of concern. Printing fake money to solve real problems has never succeed. Germany, Yugoslavia, and many others, have provided textbook examples of the futility of such an exercise - it always ends in a financial disaster!

What to Do?If the the U.S. Government is monetizing the debt, the dollar will continue to fall against other currencies and assets with real intrinsic value such as commodities. Your actions should be driven by how bad you see things turning out.

If you believe it is just a bump in the road, then a more focused concentration on quality multinationals such as these may be the best solution:

Colgate-Palmolive (CL) | Yield: 2.7%
Colgate-Palmolive Company (Colgate) is a major consumer products company that markets oral, personal and household care, and pet nutrition products in more than 200 countries and territories.

Johnson & Johnson (JNJ) | Yield: 3.4%
Johnson & Johnson is a leader in the pharmaceutical, medical device and consumer products industries.

The Coca-Cola Company (KO) | Yield: 2.8%
The Coca-Cola Company is the world's largest soft drink company with a sizable fruit juice business.


McDonald's Corporation (MCD) | Yield: 2.9%
McDonald's Corporation is the largest fast-food restaurant company in the world, with about 32,500 restaurants in 117 countries.

The Procter & Gamble Company (PG) | Yield: 3.3%
The Procter & Gamble Company is a leading consumer products company that markets household and personal care products in more than 180 countries.

If you believe it will be a little worse, exposure to international energy companies may be beneficial, such as:

ConocoPhillips Co. (COP) | Yield: 3.9%
ConocoPhillips Co. was formed in 2002 when Phillips Petroleum and Conoco merged and is now is the fourth largest integrated oil company in the world.

Chevron Corporation (CVX) | Yield: 3.1%Chevron Corporation is a global integrated oil company (formerly ChevronTexaco) with interests in exploration, production, refining and marketing, and petrochemicals.

Exxon Mobil Corporation (XOM) | Yield: 2.5%
Exxon Mobil Corp. (XOM), formed through the merger of Exxon and Mobil in late 1999, is the world's largest publicly owned integrated oil company.

Continuing down the sliding scale, if you believe it will be a little worse with the dollar losing much of its purchasing power consider companies with dividends denominated in a foreign currency:

Canadian National Railway Company (CNI) | Yield: 1.9%
Canadian National Railway Company operates Canada's largest railroad, linking customers in Canada, the U.S. and Mexico through approximately 20,600 route miles.

Philippine Long Distance Telephone Co. (PHI) | Yield: 6.8%
Philippine Long Distance Telephone Co. provides telecommunications services in the Philippines. It operates in three segments: Wireless, Fixed Line, and Information and Communications Technology.

Astrazeneca PLC (AZN) | Yield: 5.8%
Astrazeneca PLC formed via the 1999 merger of Zeneca Group PLC of the U.K. and Astra AB of Sweden, is one of the world's leading drug companies.

Telefonica SA Communications (TEF) | 6.5%
Telefonica SA Communications one of the largest companies in Spain, TEF is a leading provider of telecommunications services in the Spanish- and Portuguese-speaking world.
ConclusionI believe the Treasury has already printed enough money to cause problems in the future. The questions are how big will the problems turn out to be and how long will it take us to recover? It will be interesting to see how interest rates react after S&P's downgrade of U.S. debt last Friday. Little or no reaction will not be a good sign. Interest rates should climb.

Full Disclosure: Long CL, JNJ, KO, MCD, PG, COP, CVX, CNI. See a list of all my dividend growth holdings here.

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5 Comments – Post Your Own

#1) On August 16, 2011 at 8:26 AM, BillyTG (29.41) wrote:

Totally agree about being mega multinationals.  If you're not into commodities/precious metals, and are looking for safety in stocks, multinationals are the safest bet (and probably will have the best returns).  They are a way to hedge against the US dollar, too.

You do realize that CPI is nonsense, right?

Hopefully you have seen this:  http://www.shadowstats.com/alternate_data/inflation-charts

And this:  http://www.shadowstats.com/inflation_calculator

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#2) On August 16, 2011 at 8:36 AM, tmathe85 (52.54) wrote:

My favorite was I went to the ATM and withdrew 100$ in 20s..........never before had I seen such crisp, newly printed monies....:) :) :) and I was like uuhhhh I better go spend this quick! lol

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#3) On August 16, 2011 at 11:49 AM, rfaramir (29.38) wrote:

You stopped too soon. Foreign currencies are just as prone to devaluation as ours is. The dollar index is a *relative* measure of dollar strength against other fiat currencies. The dollar is hovering around the 75 level now, yet has lost 80% of its value since losing convertibility to gold 40 years ago yesterday. That means the others have lost almost as much during that time.

If you believe the situation to be much worse, you should invest in gold, silver, and oil. (You covered oil nicely.) Not just bullion, but mining and streaming companies as well. You might want to focus on those that offer a dividend, too. Not many of mine, do.

(Long CEF, SLW, AEM, CDE, DO, AUY, XOM, GPL, EXK, EGO, TGB, CEO, RBY, AUQ, and IVN)

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#4) On August 16, 2011 at 4:11 PM, dwot (64.59) wrote:

My conclusion about the asset price inflation was debt would have to be devalued because all that debt is someone else's assets and there simply wasn't enough reserves to cover defaults, nor could people reasonably pay back that debt relative to wages, and housing prices would have to come down.

If the CPI had included the cost to buy a house, and weighted to 25% of the CPI I think the figures would have shown the inflation.  Also, I totally agree that essentials are underweight in the CPI.

We ended up with huge price imbalances, but I think a great deal of the monetary expansion already happened with the asset price inflation and prices are tending to go to their historical mean relative to the money supply, so housing has come down and essentials have gone up.  I think deleveraging is actually reducing the money supply, but the money supply out there was so massive, and prices for goods and services had not yet increased to reflect the vast money supply.  Other countries buying up the currency and putting it in storage kept helped to keep prices down. 

 

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#5) On August 16, 2011 at 5:49 PM, davejh23 (< 20) wrote:

"Why am I paying more for everything, but the CPI is only 2-3%?"

Why was the billion price index reporting 10%+ inflation before the individual US numbers were taken down?  Why is ShadowStats reporting 10% inflation?  The 2-3% the gov't reports is a huge lie and is hurting more people than you know.  Ask any senior that hasn't seen a cost of living adjustment in 4 years how far their stagnant income goes today...they have a better handle on inflation than anyone as nearly all of their income goes towards essentials.   

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