It should be no surpise considering today's uncertain economic and political environment that investors have been flocking to dividend-paying stocks. Historically, stocks that pay steady dividends tend to perform better during challenging market environments. As the European debt crisis continues to rattle markets and fears of a global economic slowdown persist, investors have been finding safety in predominantly large-cap, defensive stocks with attractive dividends. Additionally, with interest rates at historic lows, dividend stocks offer a much higher yield versus short-term debt instruments for investors who are willing to accept some equity market risk.
We have been hearing the pundits praise the benefits and appeal of dividend-paying stocks for over a year now but it hasn't been until recently that we have seen it manifested in the actual price action of the stock market. We conducted our own analysis by examining the performance of all S&P 500 stocks with a dividend yield of greater than 2.75% versus the overall performance of the S&P 500. From August 31st through November 30th, the 140 stocks in the S&P 500 with a dividend yield greater than 2.75% had an average return of +3.64%. The average return for the S&P 500 during that period was +2.30%. And that performance is price appreciation only, so including dividends will only make the relative returns of the 2.75%+ dividend-paying stocks even more impressive.
To illustrate this, we have generated a chart of these higher paying dividend stocks Download Dividends. An examination of the relative price action (the bottom line in the chart) shows the surge in performance since September. With such a disparity in performance, it looks like the pundits are finally putting their money where their mouths have been as dividend stocks have become a leadership segment of the market.
Today we share an excerpt from our recent Q3 letter to investors to provide some insight on our current bullish market perspective despite a turbulent and uncertain economic environment.
The pessimists seized control of the equity markets during the 3rd quarter assisted in large part by news of the ratings downgrade of US debt, the financial problems in Europe, and the prospect of a global economic slowdown in growth. For the quarter, the S&P 500 Index dropped 15% while the average U.S. Stock Fund fell 19%. Foreign investors also experienced a lack of investor confidence as the Morgan Stanley EAFE Index declined 20%. Bonds were the “place to hide” as the Barclay’s Aggregate Bond Index climbed 3.8%.
While the current “mess” falls on the third anniversary of the Lehman Brother bankruptcy and mortgage crisis, many conditions are better today than they were then. In fact, many of the monetary conditions are more favorable now. Not to be overlooked, corporations are flush with cash and liquid assets, and have much greater capacities to absorb an uncertain economy today.
Although the extreme volatility has put even the most resolute bulls back on their haunches, we are not one of them. A lot of negativity is currently baked in to the equity markets. In our opinion, investors who sell now are likely to be left stranded on the sidelines when the market begins to recover. Bull markets are often sparked by a single rally so powerful and so fast that many investors fail to react in time. This happened to many of them when the market rebounded sharply in 2009 after plummeting the year before.
It was late October and dark in the early morning as I entered Boston’s newest and highest skyscraper, the Bank of Boston. I walked through the lobby to the far end of the elevator bank and pressed the button to the 37th floor, the penthouse. There were two massively opposing 12 foot high oak doors at the office entrance. Above the doors, in gold leaf, it read Clark Dodge & Co, at the time a very prestigious firm. But one that was about to go out of busines, because it was 1973.
Opening the large brass lock I stepped onto a stone slate floor covered with oriental rugs. Above was a large chandelier some 20 feet high. Walking past dark paneled walls, I stared at my desk in the distance. In the top drawer was an unopened pay envelope. The prior day’s dread was coming back. I psychologically had been unable to open it.
The rising sun coming out of Boston harbor forced me to realize that this was a new day. Sitting at the desk, I opened the envelope. The check was for $13 and change. It was my entire September commission check! I decided to save it as a reminder of how quickly everything can change.
Many stocks which had been over $100 in 1972 were selling for $50 by the end of 1973. Little could anyone imagine that by the end of 1974 some stocks would be $5! Such was the speed and viciousness of a bear market. Markets, then as now, can move at speeds which we cannot get our minds around.
The 1960s were the “Go Go” years in the stock market. The federal government’s policy of “Guns and Butter” (Viet Nam and The Great Society), plus union demands, had created accelerating inflation. By 1972 just 50 stocks were rising. They were called the “nifty fifty; the “vestal virgins;” “the one decision stocks.” It really didn’t matter what one paid for them ... at least according to the acolytes. They would always earn their way higher. The overriding “big picture” from 1947 on had been equity. However, strong inflation and a weakening economy eventually crushed the stock market in 1973-1974.
In 1982 interest rates peaked and there was an explosion in private and public debt which was to last over 35 years. In the process, debt became many times the size of the stock market. This led to almost all financial institutions being managed by fixed income “Masters of the Universe” … bond traders. They created a pyramid of debt structures, real and synthetic, which finally crashed in 2008-2009.
Unlike 1973-1974, the 2008-2009 stock market experience had nothing to do the stock market. Stocks were sold because they were the only asset class with a liquid and visible (honest) market. Debt contraction is a deflationary experience. Stocks in the future will be the only asset class of choice.
FRANCIS PATRICK BOLAND
10-16-11
The 3rd quarter marked an inflection point for the stock market as the long-term leadership sectors gave way to new emergent themes. The following table helps illustrate just how much the market leadership shifted during the quarter as we compare the 1-year performance of each sector through 6/30 vs its respective Q3 performance.
| Sector | 1-Year | Q3 |
| Energy | 51.7% | -22.2% |
| Materials | 38.8% | -25.4% |
| Consumer Discretionary | 38.0% | -13.3% |
| Industrials | 35.6% | -21.5% |
| Telecom | 33.5% | -18.1% |
| Health Care | 25.9% | -10.6% |
| Info Tech | 25.9% | -8.2% |
| Utilities | 18.5% | +0.4% |
| Financials | 11.0% | -22.9% |
| Consumer Staples | 5.3% | -5.0% |
With the S&P downgrade to US debt, the sovereign debt crisis, and no improvement on the unemployment front, it is probably no surprise that investors switched from offense to defense in the 3rd quarter as the best performing sectors were those that are defensive in nature and cyclical sectors were damaged the most. Time will tell whether this is just a short-term blip for the market or something worse, but for now its important to be aware that a leadership shift is taking place.
It's been a tough few months for the stock market but things could be worse. While the S&P 500 has declined roughly 12% from its peak in early May, the price action overseas makes the grass look a lot greener on this side of the pond. While we struggle domestically with high unemployment and uneven economic data, foreign markets continue to deal with those and a host of other issues, the most notable being the European sovereign debt crisis.
The most widely accepted index to measure foreign market performance is the MSCI EAFE Index. It seeks to provide investment results that correspond generally to the price of publicly traded securities in the European, Australasian and Far Eastern markets. A look at the performance of this index demonstrates just how bad things have been overseas. While the S&P 500 is -2.5% on the year, the EAFE index is a staggering -11.9%. The attached chart demonstrates the relative performance of the EAFE vs. the S&P 500, highlighting both the long-term and notable short-term underperformance since May. Download EFA
Despite the many headwinds we face here in the United States, it is clear investors continue to find relative value in our stocks versus those abroad. Let's hope that trend continues.