Beware! Reaching for Yield has Never Been More Deadly

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Did you know the Dubai stock market has been crashing?

The Dubai Financial Market General Index fell from a high near 5,400 on 5/6/14 to below 4,000 this past week.

It now sits near 4,200, down over 20% in under two months.

The selling in the Middle East has affected specific Middle East focused ETFs like the iShares MSCI Qatar (NASDAQGIDS:QAT) and the iShares MSCI UAE (NASDAQGIDS:UAE), but the WisdomTree Middle East Dividend Fund (NASDAQGIDS:GULF), which holds almost 50% banks, is down over 10% in price since May with more of its holdings exposed to the Dubai selling.

The Dow Jones Middle East & Africa Index (DJI:^DWMFST) has fared much better, weighted more heavily in Africa than the Middle East, but not everything has escaped the damage.

Another ETF with supposed Middle East exposure is the SPDR Emerging Middle East and Africa (NYSEARCA:GAF), however a look at its prospectus reveals it holds zero exposure to the Middle East and as a result its price has barely been affected by the Middle East's price decline.  GAF's exposure is extremely concentrated, with 93% of its holdings from South Africa, which has largely helped it avoid the ramifications of the selling elsewhere.

Yield Chasing = Bad

Even after falling 15%, GULF's dividend yield still remains under 3%, a great example of how chasing yield in this low rate environment can be extremely dangerous.

A yield of only 3% does very little to protect you when the underlying asset falls such a large amount (in this case over 10% thus far).  This is one of the key differences between a bond and a stock and why stock dividends should not be compared directly to bond yields.

With a bond you are typically guaranteed a return of your principal.  A stock contains no such guarantee and GULF is a perfect example.

If you bought GULF in April or May, your yield was less than 2.5%, but the current decline has wiped out over four years of dividend gains, in only two months!

The reality of the situation only gets worse as one chases yields closer and closer to a top in price.  This point was a topic discussed in our April 2014 Profit Strategy Newsletter article entitled, 'The Most Crowded Trade Ever' when we focused on the extremely low bond (and dividend) yields.

But in GULF's case a price decline of 10% isn't the end of the story.

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Price Rising but not Dividends = Even Worse Yield

The chart below shows that even though GULF's price has been rising the last three years, the amount of dividends paid out has actually been falling.

GULF 6-25-14

In 2012 GULF paid $0.66 of annual dividends.  In 2013 this shrank to only $0.56 in annual dividends.  After its recent June distribution, it looks as if 2014 will only pay $0.54 of dividends to holders (a yield at current prices of only 2.5%).

Even though price has been rising, the amount of dividends paid have actually been declining, having a negative effect on yield.

It Gets Worse

In 2012, when $0.66 of dividends was being paid, GULF could have been bought for under $16 as shown by the chart's bottom section and price history.  This means investors in 2012 received a minimum yield of 4% (at its low price point, yield was above 4.7%).

In 2013 GULF traded for an average of $18 but only had a yield of 3.1%.

By May, at GULF's peak in price of $24, it yielded just 2.3%.  Now its price trades 15% below that level, but yield is still below 3%.

This means it will take those investors who bought GULF because of its 2.3% yield in May over six years now just to breakeven, assuming price stays the same as it is today.  If price falls further, it will only increase that breakeven time.

Buying stocks, ETFs, bonds, or anything else solely based on yield is not a viable strategy.  The price paid must always be a portion of your decision making process as return of capital is never guaranteed.

As the GULF example shows, it may take you more than a few years to recover your losses through dividends alone as price risk out-trumps dividend yield.

In the ultra low yield environment we currently are in, this is exacerbated and even more important of a concept as a 20% decline in price takes much longer to recover from than a similar 20% decline that occurs when interest and dividend yields are higher.

If you are yield chasing, buyer beware, as a sizable price decline can more than offset any expected gains in dividends through time.

The ETF Profit Strategy Newsletter follows the stock, bond, commodity, and currency markets to keep our subscribers ahead of the markets.  Right now there is an extreme push for yield, but investors should not forget that one sizable market correction can wipe out all those expected future dividends.  This has already occurred in Dubai already negatively impacting Middle East ETFs.  What market is next?

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Bonds

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