Peace Dividend Cut Alert: Important Warning To Passive Income Investors (2024)

Investing Group Leader

Since the fall of the Soviet Union and the end of the Cold War in the early 1990s, the global economy has undergone an unprecedented period of economic growth and prosperity thanks to the rise of globalization, a dramatic reduction in trade barriers, and rapid technological advances. However, this "peace dividend" appears to be on the verge of ending, warned U.K. Defense Secretary Grant Shapps recently:

Now is the time for all allied and democratic nations across the world to ensure their defense spending is growing. Because, as discussed, the era of the peace dividend is over.

In this article, we will discuss the stock market - and particularly the dividend stock - implications of this geopolitical trend and share how we are preparing our portfolio for this potential seismic shift in the global economy.

Peace Dividend Cut Alert

As Secretary Shapps stated:

In five years' time, we could be looking at multiple theaters involving Russia, China, Iran, and North Korea. We find ourselves at the dawn of a new era. The Berlin Wall is a distant memory and we have come full circle, moving from a post-war to a pre-war world. An age of idealism has been replaced by a period of hard-headed realism. Today, our adversaries are busily rebuilding their barriers. Old enemies are reanimated. New foes are taking shape. Battle lines are being redrawn. The tanks are literally on Europe's Ukrainian lawn. And the foundations of the world order are being shaken to their core. We stand at this crossroads: whether to surrender to a sea of troubles or do everything we can to deter the danger. I believe that, in reality, it's no choice at all. To guarantee our freedoms, we must be prepared.

Clearly, the world is growing increasingly dangerous, and therefore investors can no longer operate on the assumption that peace and free trade across the globe will continue indefinitely.

The possibility of China invading Taiwan presents a particularly significant risk to the global economy and stock market, as it could potentially lead to World War 3 and at a minimum a likely global depression.

This is because Taiwan plays an incredibly important role in the global semiconductor supply chain. Given that semiconductors are the technological backbone of so many modern products, an invasion would lead to immediate and severe disruptions in the global economy, impacting economies far beyond Taiwan like the U.S., Japan, Germany, and several other European nations. Moreover, the Chinese economy would face major shocks from the disruption to the global semiconductor supply chain, not to mention the likely severe sanctions from the United States and Europe.

It should not be surprising to expect that global stock markets, particularly in the U.S. and China, would crash. Moreover, the Rand Corporation estimates that a war involving China and the U.S. could reduce the U.S. GDP by at least 5%, likely plunging it, China, and much of the world into a depression.

Ramifications For Dividend Investors

What does this mean for dividend investors? At a minimum, it means that we need to be mindful of the very meaningful chance that a major global conflict could erupt in the next 5-10 years, likely dealing a major blow to global economic growth, including the leading economies of the United States, Europe, Japan, South Korea, and/or China. As a result, businesses that are sensitive to economic downturns and/or with large exposure to China are likely to suffer the most in such a scenario, and there will undoubtedly be many dividend cuts in the wake of such a conflict breaking out.

For example, some of the dividend stocks that will likely be the most adversely impacted will be:

• Business Development Companies (BIZD) like Ares Capital (ARCC) and Main Street Capital (MAIN) which - despite their impressive track records and the fact that a substantial portion of their investment portfolios are in senior secured debt - are almost fully invested in smaller, highly leveraged, and more economically sensitive businesses and will likely suffer immensely during a severe recession in the wake of a major global conflict.
• Alternative asset managers with large exposure to China and heavily leveraged private, particularly Blackstone Inc. (BX), though the other major players like KKR & Co. Inc. (KKR), Brookfield Asset Management Ltd. (BAM) Brookfield Corporation (BN), and The Carlyle Group Inc. (CG) will likely suffer too given that heavily leveraged private equity may suffer
• Multinational dividend stocks with significant Chinese exposure, such as Apple Inc. (AAPL), 3M Company (MMM), The Coca-Cola Company (KO), Leggett & Platt, Incorporated (LEG), PepsiCo, Inc. (PEP), and McDonald's Corporation (MCD).
• Major miners like Rio Tinto Group (RIO), BHP Group Limited (BHP), and Freeport-McMoRan Inc. (FCX), who are heavily dependent on Chinese demand.

However, it is important to keep in mind that the entire stock market (SPY) will likely crash, impacting virtually all dividend stocks (SCHD) in the process. As a result, in addition to ensuring that they are not overly exposed to the aforementioned dividend stocks, dividend investors may find it prudent to do the following:

• Ensure that any funds invested in public markets are not needed for at least 5, and preferably closer to 10 years to allow the market plenty of time to recover from any major shocks due to the breakout of a major war.
• Invest in securities with low correlation to public stock markets, such as lower-risk bonds (BND) to benefit from any flights to safety and steep rate cuts by central bankers in an attempt to prop up the economy in the wake of a war breaking out as well as short-term treasuries (SGOV) to give them plenty of flexibility to respond opportunistically to a market crash.
• Invest in companies like Virtu Financial, Inc. (VIRT) that profit from sudden spikes in market volatility.
• Invest in safe havens like gold (GLD)(IAU) and possibly Bitcoin USD (BTC-USD) that tend to benefit from periods of growing geopolitical and macroeconomic uncertainty. Blue-chip gold miners with low geopolitical risk such as Agnico Eagle Mines Limited (AEM) and Newmont Corporation (NEM) may make for decent investments in this scenario as well.
• Last, but not least, investing in military-industrial complex stocks like General Dynamics Corporation (GD), RTX Corporation (RTX), L3Harris Technologies, Inc. (LHX), Lockheed Martin Corporation (LMT), Palantir Technologies Inc. (PLTR), and Huntington Ingalls Industries, Inc. (HII) could also provide a hedge as these stocks would likely see booming demand and profits in such a scenario.

Investor Takeaway

As Secretary Shapps has made clear: the era of the peace dividend is over and - should a bad-case scenario play out - income investors may be confronted with a plethora of literal dividend cuts. As a result, we believe that it may be prudent to diversify portfolios now while the opportunity still exists to ensure that portfolios are not overly betting on peace continuing indefinitely.

With SPY at all-time highs right now, it is evident that Wall Street is basically pricing in a little to no chance of a major war breaking out in the next decade. However, a growing number of leading government officials in the U.S., Europe, and Asia are voicing concerns that put the chances of such a scenario playing out at a much higher percentage than Mr. Market seems to think at the moment. As a result, we think that preparing for such an event enhances the overall risk-reward profile of a dividend portfolio.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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