2 Dividend Stocks To Thrive In The Forest Fire Economy (WPC & VZ) (2024)

What Forest Ecology Can Teach Us About The Economy

The economy is like a forest.

Yes, seriously. I have long been interested in the similarities between economics and forest ecology. Bear with me. I know this sounds like an esoteric topic, but it does have implications for investing.

In my October 2019 article "Emergent Order Vs. The Fed," I talked about how ecosystems in nature exhibit a spontaneous order not so different than what we find in the economy and markets. The words "economy" and "ecosystem" share the same Greek root word oikos, meaning "house." While "economics" means "house management," the word "ecosystem" refers to the various connected parts forming the house.

Economics, then, can be thought of as the management of ecosystems. Ecology, on the other hand, is the study of ecosystems. While external intervention is assumed in economics, it is assumed in ecology that there will be no external intervention.

In nature, external human intervention, even well-intentioned, often disrupts balance and order and thereby has deleterious effects.

If the goal is a normally functioning ecosystem, the most effective and natural way to achieve that is often simply to leave it alone. Don't interfere with the natural functioning of the ecosystem. Don't try to help, because attempts to do so more often result in net harm rather than net benefit.

...Ecosystems have natural rebalancing and self-healing mechanisms that can correct many shocks and anthropogenic interventions. We simply have to let them operate.

The core point of that article was that the Federal Reserve lacks the kind of knowledge of or control over the economy that is often attributed to it.

Central bankers can no more control the outcome of the economy solely by adjusting interest rates than an ecological wizard could control the health of the Amazon rainforest solely by adjusting the supply of rain.

In an April 2020 article titled "Recessions Are Like Forest Fires: They Shouldn't Be Stopped" (one of my favorite pieces of writing), I described the natural cycle of creative destruction that forest fires facilitate.

In coniferous forests, leaves, deadwood, and overgrowth build up on the forest floor over time, stifling new plant life and eventually leading to a decline in vibrancy. Fires, however they start, clear this dead overgrowth carpeting the forest floor, releasing the microbial nutrients trapped within it back into the soil, thereby simultaneously making room for and enriching new plant life.

This process has happened again and again and again throughout history. Ravenous fires that seemed to utterly destroy forest ecosystems actually led to their ultimate renewal and rejuvenation. The new life that emerged from the devastation was stronger and more vibrant than what came before it. Some plants, such as the wild lupine, have evolved to depend on regular fires to clear out overhanging foliage that would otherwise starve them of sunlight.

For decades, however, it has been the policy of well-intentioned humans not to allow forest fires to take their natural course. There are few forest fires today that humans don't strive to put out as quickly as possible.

Of course, it's understandable that people would want to prevent property damage from fires, but the stifling of forest fires has gone far beyond that.

Over time, this policy has led to excessive buildup of floral detritus on forest floors, which basically acts as kindling and fuel for even bigger and more dangerous fires in the future.

As the following infographic shows, since 1990, the number of wildfires has dropped considerably, but the number of acres that burn in wildfires each year has steadily risen.

Source: Visual Capitalist

Despite fewer individual outbreaks of fire, each one has gotten worse on average over time.

Here's a recent video put out by Vox explaining how decades of stifling forest fires has made them worse:

Notice that the heroes of this short video are the Native American tribes who have long held the policy of allowing forest fires to burn with minimal human intervention. They seem to understand, in a way that highly educated modern ecologists seem not to, that the destruction wreaked by the fire contains within it the seeds of renewal and rejuvenation.

What strikes the contemporary observer as unmitigated ruination is actually a natural process that has played out in forest ecosystems for millennia.

Putting Out Fires In Our Financial Ecosystem

I believe recessions are like forest fires in their capacity for creative destruction. Likewise, I believe external intervention into the economy from governmental forces causes a buildup of detritus of unproductive debt, zombie companies, and malinvestment that diminishes GDP growth and causes worse crises afterward.

I know these are controversial beliefs, but there is ample evidence for them, in my estimation.

In the financial ecosystem in which we live and do business, the government and central bank have continuously attempted to stifle recessionary forest fires for decades. Take, for instance, the Fed's dramatic lowering of interest rates at the onset of each recession going back to the early 1990s.

When rates hit zero, the central bank introduced "quantitative easing" — government bond buying — as a method of dumping more water on the fires of a weak economy. It has taken more and more of this type of "water" to have an effect, if it has an effect on the economy at all.

The federal government, likewise, has opened the hoses to spray fiscal "water" on the economic fires whenever they arise. Notice that in the wake of each recession going back to 1990, the government has answered by spending more money (through automatic stabilizers and intentional stimulus spending alike) and thus increasing the fiscal deficit.

The corresponding buildup of economic detritus is clear to see during times when governmental agencies are pouring billions of dollars of "water" on our financial ecosystem in order to stifle existing "fires" or prevent new ones from breaking out.

I could point to rising debt levels, increased market concentration, surging stock buybacks (during periods of high stock valuations), and expanding wealth inequality as examples of unproductive detritus on the "forest floor" of our economy, but I've discussed those issues at length in "The Monetary Death Spiral."

Instead, I will simply point out the correlation between monetary easing (water dumped on the fire) and the buildup of zombie companies. Through 2016, the Fed had monetary accommodation on full blast. Then, in 2017, it began to slowly nudge interest rates higher. Shrinking its balance sheet of government securities began in early 2018.

Backing away from monetary fire-stifling had the unsurprising effect of reducing the share of zombie companies in the economy for two years in a row.

Source: Federal Reserve

Then came COVID-19, along with its fiscal and monetary fire suppression the likes of which have never before been seen, and zombie companies began proliferating again.

Also consider the way in which these fire suppression efforts exacerbate wealth inequality, which increases political tensions and support for growth-subduing populist policies while scarcely increasing consumer demand.

Image Source

As explained by the Federal Reserve Bank of San Francisco, a rising stock market (fueled by fiscal and monetary accommodation) increases inequality because most stocks are owned by the top 10% and especially the top 1% of earners.

Like allowing floral detritus to build up on the forest floor, diminishing the multiplication of new life, fiscal and monetary policies seem to be suppressing economic growth and dynamism.

In a July 2021 article on why "The Macroeconomic Case For Disinflation Remains Strong," I explain:

Despite the Fed pumping ample reserves into the banking system, banks find themselves increasingly unable to grow their total loan books. At least, they can't grow their private sector loan books.

In spite of the money supply rising over 10% YoY and US bank credit increasing by over 19%, total commercial and industrial ("C&I") loans on the books of commercial banks are almost back to their level from before the pandemic began.

I offered three reasons why this is the case in the previously mentioned article:

1. Because more debt in the household, consumer, and corporate sectors (collectively, the private sector) reduces borrowers' creditworthiness and willingness to take on additional debt. The more assets or revenue streams that are already secured by debt, the less additional debt a borrower can take on.
2. Because more debt in the private sector raises the risk premium for loans, and yet the Fed's aggressive monetary policy combined with competition among banks for scarce creditworthy borrowers makes interest rates on loans unattractive to the banks.
3. In an economy that is fundamentally hobbled by over-indebtedness, unproductive government spending, zombie companies, aging demographics, etc., there are simply fewer productive loan opportunities available to be made.

We see this clearly when comparing the growth of the money supply compared to bank loans and nominal GDP.

Source: SOM Macro Strategies via Dividend Cafe

David Bahnsen attests that you can "throw as much money in bank reserves as you want, it doesn’t promote nominal GDP growth, and it doesn’t promote loan growth. You cannot make people consume or produce – only economic incentives can."

In other words, the very visible and undeniable rebound in consumption coming out of the pandemic has not resulted in a boom in the kind of business expansion that would permanently grow the economy.

Instead, as consumers have cleared shelves, businesses have simply repaid emergency loans and credit lines. Rather than use this unique period as an opportunity for permanent expansion, businesses on the whole have treated it as a one-time event, after which the world would return to its pre-pandemic state of normalcy.

That pre-pandemic state, mind you, was characterized by lower and lower bank loan growth in each successive economic expansion.

Source: Strategas Research via Dividend Cafe

Lower and lower bank loan growth has played a major role in disinflation (lower and lower CPI rates) over the past few decades, and it is likely to do so again if and when a new supply chain equilibrium is reached.

Two Dividend Stocks To Thrive

In an environment of low GDP growth, low inflation (which will likely return eventually), and increasing economic reliance on ever-greater fiscal and monetary "fire suppression" efforts, two kinds of stocks in particular have benefited:

1. High-growth, innovative tech companies (e.g. ARKK, VGT, VUG, IVW)
2. High-yield, indebted dividend payers

The first category is outside my sphere of competence, but here are two debt-utilizing high-yielders for your consideration.

1. W. P. Carey Inc. (WPC)

• Dividend Yield: 5.4%

WPC is a diversified net lease REIT, with properties mostly in North America (63%) and Europe (35%). Its net leases stipulate that tenants pay for all or most property-level expenses, including real estate taxes and property insurance. Almost half the portfolio is in industrial real estate, but WPC also has sizable office and retail exposure.

Source: WPC Portfolio Overview

Another benefit of WPC is that 99% of its portfolio enjoys contractual rent escalations, and 61% have CPI-linked rent bumps. This should provide protection from inflation for as long as it remains elevated.

I've written more about WPC's fine qualities here and here.

2. Verizon Communications (VZ)

• Dividend Yield: 4.9%

In Q3, VZ's debt increased by a whopping $36 billion to $141.6 billion as the telecom giant invests heavily in its infrastructure network in preparation for 5G. I suspect this plays a large part in VZ's underperformance this year.

But in my estimation these investments should pay off over time while continuing to produce a gusher of free cash flow to pay out VZ's safely covered dividend.

Source: VZ Q3 Presentation

In the first three quarters of 2021, FCF was $17.3 billion. And in Q3, operating revenue (excluding the recently sold Verizon Media) was up 5.5% YoY, while adjusted EPS of $1.41 grew 12.8% YoY.

Year-to-date, total operating revenue was up 6.4%, and net income surged 31.2%. Meanwhile, VZ has only paid out 45% of FCF YTD, which gave room for the 15th annual dividend raise of about 2%.

At 9.7x estimated 2021 EPS, VZ looks attractive for yield-seeking investors.