For the past week, first the Dow Jones Industrial Average ($INDU) and then the Standard & Poor's 500 Index ($INX) have been bouncing around the Nov. 20 lows for this bear market. One day they close just below those levels -- 7,552 for the Dow industrials and 752 for the S&P. The next day, they close just above them.
They call this process "testing the lows." If the November lows hold, after holding in late January, the stock market will be another step closer to marking the bottom that comes before a recovery.
If the Nov. 20 lows don't hold, investors will be looking at another leg down in what is already one of the worst bear markets on record. The S&P is already near its April 11, 1997, low of 738. Go through that, and the next stop is the 640-to-650 range, where the index spent more than six months between February and September 1996.
That's scary. Especially because there's no guarantee that even the 1996 low will mark the ultimate bottom.
Despite that -- no, because of that -- this is an ideal time to build a core portfolio in dividend-paying blue chips. Especially if you're closer to the beginning than the end of your investing career. And especially if, rather than loading up all at once, you use dollar-cost averaging -- and reinvest your dividends -- so that you get the best price on some what you buy.
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Why dollar-cost average into these stocks now? Because the data from those really, really monstrous bear markets, the ones that accompanied the Great Depression, show that investors who bought dividend-paying blue chips and reinvested the dividend did just fine in the bear markets that lasted from 1929 through 1942.
Stock prices plunged during that period. The price of the Dow industrials plunged 87% from August 1929 through June 1932. Stock prices hadn't recovered much even 10 years later. In April 1942, the Dow industrials were down 74% from their August 1929 level. The Dow wouldn't see its 1929 price again until 1954.
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That huge difference is a result of the way that an extended downturn in stock prices magnifies the power of dividends.
First, dividend yields go up as stock prices go down, so in a bear market an investor gets more dividend for each invested dollar. For example, Intel (INTC, news, msgs) paid a yield of 4.64% on Feb. 24. That's more than double the stock's 1.95% yield on Nov. 3, 2006. Some of that increase in yield is due to increases in Intel's annual dividend from 40 cents a share in 2006 to 56 cents a share in 2009, a 40% increase. But the bulk of it is a result of the drop in the stock's price to $12.57 a share this month from $20.51 in November 2006. Because of that plunge in Intel's price per share, each dollar paid by an investor buys more yield.
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No bottom yetStocks won't bottom until more companies default on their debt. Take a look at navigation-products maker TomTom to see why big debt and falling revenue can be a toxic combo. (Feb. 26, 2009)
Second, falling stock prices during a bear market turn a strategy of reinvesting dividends into a supercharged form of dollar-cost averaging. An investor who reinvested the 2006 dividend of 40 cents a share in November 2006 would have wound up with, roughly, an extra 50th of a share. An investor who reinvested the 2009 dividend of 56 cents a share in February 2009 would have wound up with an extra 25th of a share. The longer the downturn keeps stock prices low and dividend yields high, the more powerful this compounding effect is.
So, yes, this bear market is scary. And, yes, it's impossible to tell when stock prices will bottom. But if you have a long time horizon -- 10 years or more -- this is a great time to buy dividend-paying blue chips. And that's especially true if you're a beginning investor.
Continued: 5 blue chips to consider
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