Streetwise for Friday, August 9, 2019

Each time the evening news holds court with a supposed Wall Street guru opining on the next disaster facing the investment world, a cold shiver likely goes down your spine. Suddenly you dread looking where your portfolio will trade when the markets open the next morning.

You received a dose of this as the White House targeted the Chinese with an unexpected round of new tariffs. Not surprisingly the Chinese government responded with a devaluation of their currency. The net result was a one-day blood bath in the equity indexes.

Now, take a deep breath and relax. Excepting events such as bankruptcy, you are not facing, to borrow the title of Francis Ford Coppola’s 1979 epic war film, “Apocalypse Now.”

What you are facing is referred to as event risk, the occurrence of unforeseen exogenous events with the potential to denigrate the immediate future of a company and/or the overall market. Something we have seen too much of lately.

Unfortunately, event risk is more likely this month than at other times during the year. Why you ask? Because since 1970, August has historically proven to be one of the most volatile and dangerous months of the year. Specifically, up until this year, August has accounted for seven of the 50 sharpest monthly declines in the Dow Jones Industrial Average during that period, with an average decline of 8.9 percent.

Baseless commentary implying that Armageddon is right around the corner can result in even experienced investors giving some consideration to liquidating assets, despite adverse tax consequences and exiting stage left. This is wrong and is exactly the opposite of what you should do. 

Yes, I know Wall Street can be brutal. This is especially true for investors with lesser resources on which to fall back on. And the fact that August has a history of crushing investors’ illusions is not going to make your life any easier.

Event risk also becomes more prevalent during earnings season, although current reporting period has many companies chalking up results that are exceeding consensus estimates. And we will likely see a continuation of that trend when third quarter numbers are reported in October. 

While you cannot prevent exogenous events from affecting your portfolio, positively or negatively, the effects are generally transitory and can be minimized through diversification. 

Purchasing stocks with similar risk profiles can result in extraordinary returns…if Lady Luck smiles down upon you. Of course, the inherent risk is just as extraordinary. If you instead spread your selections across a wider spectrum of companies, your overall return may be lower, but you reduce the probability of a severe setback, regardless of economic circumstances

Diversification is sort of a modern-day alchemy. It has the effect of transforming a heterogeneous group of securities into a portfolio with predictable characteristics. Its secret is simple. The weakness of one security is balanced against the strength of another.

However, even a well-diversified portfolio is subject to some event risk. This is where dividends come into play. A dividend is a distribution of the earnings to you the shareholder. They are real money, not just some entry depicted on a balance sheet. 

As I have said time and time again, ad nauseum, there is no more accurate indication of fiscal achievement in a publicly held company than a trend of rising dividends. And once a dividend is paid, the money leaves the company’s control. Paid dividends are not subject to manipulation or interpretation. 

Because rising dividends generally only come from rising earnings, the result of rising revenues, dividend trends can provide a strong indication as to the likelihood for share price appreciation.

Moreover, dividend yields are closely watched on Wall Street. When the yield on a stock becomes abnormally high, often due to a falling share price, it creates interest, with the resulting increase in demand often halting and even reversing a decline. Without dividends, you do not have this safety net.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.