We can all agree that this year’s continued equity and bond market volatility are not for the faint of heart. The S&P 500 has been in correction mode (a decline of more than 10%, but less than 20%) for more than nine months, falling from its December peak. Bearish market sentiment has driven the NASDAQ down more than 20% year-to-date, including stock prices of some of the big tech companies.* Inflation and the Fed’s raising of interest rates to attempt to tame it, have made for a tough year.
Our Portfolio Model Changes– Dividend- Generating Stocks
As investment advisors, we are not fainting. We are proponents of Diversified Portfolio Theory who strive to make higher allocations to investment styles and industries that we believe will out-perform in this inflationary environment, and beyond. We have, therefore, increased the allocation of our global portfolio models to dividend- generating securities (AMLP, CSCO, DOW, MRK, NYCB, etc.) that we believe are appealingly priced for long-term growth and whose dividends should cushion the downside. Why not collect dividends and get paid to wait for inflation to come down and a market rebound? And why not reinvest dividends and potentially buy additional shares at lower prices? If you are invested in one of our global models, you might view your portfolio as you read this newsletter.
Cows that Give Milk
Stocks with the highest dividends might not be the healthiest. It is important to analyze a company’s stability and and ability to maintain or even raise its dividend. A key ratio to analyze is the company’s Dividend Payout Ratio, or the amount of net income or free cash flow that it annually pays in dividends. Ideally, the Payout Ratio should be less than 50%. One should also analyze a stock’s industry, average corporate cash flow within that industry, and how that industry might perform in our current political-economic environment. Think of a stock like a farmer’s cow. If a cow loses weight but can still produce the same amount of milk until it returns to full strength, then it could be a cow worth buying in both bull and bear markets.
Source: FIDELITY VIEWPOINTS, 09/07/2022
Many investors have become too enamored in investing only in tech stocks. Large Cap Growth US stocks, particularly tech stocks such as Amazon, Apple, Google and Meta, have been market darlings for much of the past decade. Yet, Large Cap US Value, including dividend generating stocks like Merck, *Enterprise Products Partners and Coca Cola, have recently outshined Large Cap US Growth. The iShares Core Dividend Growth Index (DGRO) is down approximately 12% year-to- date while the iShares S&P 500 Growth Index (IVW) is down double, approximately 24% year-to-date.** Energy, Healthcare, Consumer Staples, Financials and Industrials have been the better sector performers whereas information tech has been the worst performing sector in 2022.***
* Enterprise Products Partners makes-up approximately 10% of the Alerian MLP Index.
***Source: Performance 2022 S&P 500 Sectors & Industries (yardeni.com)
YTD Performance DGRO v. IVW (Source: YahooFinance.com)
Dividends Can Boost Returns
Historically, dividends (reinvesting them) have made a significant contribution to the performance of the S&P 500. In a Hartford Funds’ 2020 Insight Study entitled The Power of Dividends, Past Present & Future, Hartford Funds and Morningstar stated that from 1930 to 2019, reinvesting dividends on average contributed 42% to the total return of the S&P 500 Index.
But during the 1940s, 1970s, and 1980s when inflation averaged 5% or higher, dividends produced 54% of the S&P 500’s total return, says Naveed Rahman, co-manager of the Fidelity® Equity-Income Strategy.
Source: Bloomberg Financial L.P., Morningstar, and Fidelity Investments, as of 7/31/22
Each of us feels the effect of inflation in our everyday lives, particularly where it hurts the most, at the supermarket and gas pump. We don’t know how much higher or longer the Fed will raise rates in its attempt to reduce inflation. We also don’t know how much longer the war in Ukraine will rage and how long Russia will manipulate the supply and price of natural gas to generate inflation, a form of economic warfare.
What we do know from the data above and below is that during periods of rising interest rates, stocks of companies generating sufficient cash flow to maintain or raise their dividends, have cushioned the downside. In some periods, interest rate hikes have caused markets to correct in the shorter term, only to eventually rebound to new highs.
S&P 500 Index - The Carter Years 1977-1981
The Carter Years (Jan. 20, 1977 to Jan. 20, 1981): High Gas Prices and 14% Inflation. Sound Familiar?
While history might not repeat itself, let’s analyze the Carter years as an example of a period marked by inflation, much of which was caused by high gas prices. Under President Carter, inflation rose to 7.7% in 1978. After OPEC doubled oil prices, inflation averaged 11.3% in 1979 and hit 13.5% in 1980*. To tame inflation, the Fed increased the Fed Funds Rate from 4.6% in 1977 to 20% in 1981 to reduce borrowing and cool economic activity.** The S&P 500 sank nearly 15% during the first 13 months of Carter’s presidency yet rebounded by more than 40% percent through the end of 1980.***
***Chart Source: S&P 500 Index - 90 Year Historical Chart | MacroTrends
What’s Next for You?
A Portfolio Meeting to try to seek opportunities in this down market?
How long will the Bears outshine the Bulls? When will the war in the Ukraine end sparking a decrease in inflation?
While we can’t predict the above, we can explore the questions below:
• Moo! Do you own enough cows that give milk in all of your investment accounts? Analyzed together, including your accounts that I manage, plus maybe a 401k at work, an old IRA or an inherited account, how much annual dividend income are you generating in total?
• Have your financial goals changed and are you achieving them?
• Please keep an eye on your email to view my “Junk Drawer Approach to Investing?”
Please email or phone me to schedule an in person or Zoom meeting.