On Thursday, Market Folly ran a piece summarizing the latest newsletter from Trapeze Asset Management, a hedge fund, called ‘Stocks vs Bonds and Risk vs Reward’. I thought the piece was quite interesting in regards to the way a top hedge fund thinks about stocks vs bonds with respect to risk. The money quote for me is:

“It has been argued that, if one takes a longer term horizon to smooth out the fluctuations, equities can be viewed as long-term bonds with an earnings yield in lieu of a bond yield and often with a fixed dividend yield, mostly reliable, mostly growing. In the current environment if one takes, say, a 5-year horizon to even allow for the possibility of an interim double-dip recession with a lower stock market from a poorer outlook for earnings, stocks should still be the preferred asset class in that extended period.”

Read more: http://www.marketfolly.com/2010/09/stocks-vs-bonds-risk-vs-reward-value.html#ixzz0ztqHGwgS

This is the way I think about high quality dividend stocks,as longer term bonds with lots of upside potential. I start with a long term macro-outlook, usually adjusted to the pessimistic side. Then I pick my investment and asset allocation with that in mind. Today my macro outlook calls for another lost decade, i.e. another 10 yrs of zero returns for the S&P 500. What happens in the short term, mega correction – sideways market – etc, is much less important than the endpoint. So, a dividend stock yielding 7% today, with 0% dividend growth, and no change in price for 10yrs, still gives me a 7% annual return. Actually, as I’ll discuss in another post the more severe the correction in getting back to the zero return point in 10 yrs will only increase my returns through the power of re-invested dividends. Plus, I have the upside potential from growing dividends and rising prices in the face of a brutal macro environment, which will keep interest rate low, and have people, especially the graying baby boomers, still searching for yield.
So, for me its a no-brainer – high quality dividend stocks over bonds!