The Sleep-Well-At-Night Investing Strategy
Nowadays, I approach the morning newspaper in my driveway with trepidation, as if it were a ticking time bomb. I wonder: what fresh hell will greet me on the front page today?
Investors seem to share my feeling. Wall Street’s most widely followed indicator of volatility, the CBOE Volatility Index (VIX), has been routinely trading above its average level prior to the outbreak of the coronavirus pandemic.
Often referred to as the “fear index,” the VIX has been trading in a range of 25 to 30 over the past few weeks, compared to an average of 15 to 20 before the pandemic began to whipsaw markets in February.
Wall Street’s reaction to events is increasingly unpredictable, as underscored on Wednesday when traders adhered to the adage of “sell on the news.”
Members of the Federal Reserve’s policy-making arm, the Federal Open Market Committee, yesterday indicated that the overnight rate would remain near zero through 2023. The multi-year extension of ultra-dovish monetary policy is ostensibly a desirable outcome. But in response stocks mostly fell, because the implication of the Fed’s move is that the economy will remain weak for a long time.
Stocks seesawed between green and red Wednesday. The Dow Jones Industrial Average eked out a gain of 0.13%, the S&P 500 fell 0.46%, and the tech-laden NASDAQ declined 1.25%. The VIX jumped nearly 8%.
Pre-market stock futures Thursday were trading in the red, with the Dow and S&P 500 both pointing to drops of about 1% and the NASDAQ a drop of about 2% at the open.
Let’s step back from the nail-biting ups and downs of the market to examine an asset class that can help you beat volatility and sleep soundly at night: dividend-paying stocks.
Now’s an opportune time to increase your portfolio’s exposure to dividend-paying stocks in general and the Dividend Aristocrats in particular.
The Dividend Aristocrats are considered by some investors to be “boring.” These stocks don’t get a lot of fawning coverage by the carnival barkers on CNBC. And yet, this type of asset class confers a combination of growth, income and safety. If that’s boring, sign me up.
With a market correction lurking around the corner, you should pare back your growth stock holdings and elevate cash levels. That said, quality dividend-paying stocks still have a lot to offer. Unlike bonds, stocks offer potential dividend growth and share-price appreciation.
The so-called Dividend Aristocrats always provide fertile ground for income investors. But you don’t have to be an income investor to love these stocks.
“Steady Eddy” investments…
To earn the honorific Dividend Aristocrat, a company must typically have raised dividends for at least 25 years. More precisely, the company needs to have a managed dividend policy that increased its dividend every year for those 25 years.
These dividend powerhouses constitute the S&P 500 High Yield Dividend Aristocrat Index, an official index of the 50-plus highest dividend yielding stocks in the S&P Composite 1500. This Aristocrat Index is maintained by Standard & Poor’s, which every December updates the list of companies that make the grade.
By its very nature, a Dividend Aristocrat tends to be a large and stable blue-chip company with a strong balance sheet. Many of these companies are familiar names that produce household brands.
Because of their strong balance sheets and financial wherewithal, the Dividend Aristocrats tend to weather market ups and downs. These “Steady Eddy” investments should keep your portfolio on an even keel, despite the coronavirus-induced recession.
During the financial crisis in 2008, the Dividend Aristocrat Index fell 22%, whereas the S&P 500 fell 38%. That’s just the sort of shelter you need as risks mount in the coming months. During the pandemic-era rally, the stock market bulls that have been ignoring the disconnect between fundamentals and valuations are in for a rude awakening.
However, short-term performance is only part of the case for high-quality dividend stocks. Performance should be measured over a minimum of three years, preferably longer.
The Dividend Aristocrats Index has outperformed the market by over a full percentage point annually over the last 10 years, with lower volatility (see chart).
The U.S. economy’s rebound from its pandemic low is starting to sputter, which makes dividend-paying stocks smart bets now. You should rotate away from momentum “story stocks,” such as the over-hyped Internet darlings, toward reasonably valued dividend-paying stalwarts that offer stability.
When our investment team judges the merits of a dividend stock, we always look for 1) healthy payout ratios; 2) plenty of cash on hand; and 3) earnings growth. This caliber of dividend payer demonstrates greater resilience during economic uncertainty.
One sector known for paying robust and sustainable dividends is the utilities sector. Investors who seek both growth and downside protection should increase their exposure to utilities stocks.
Where else is your money safe, growing and paying you income? Not in Treasury bonds. Their yields are at their lowest in history.
Corporate bonds are riddled with default potential, and CDs and money market funds barely keep up with inflation.
Income investors covet the high dividends from utilities. These businesses tend to be stable, generating growing dividends and stock price appreciation over time. Utility stocks add ballast to a diversified portfolio.
As politics at home and abroad descends into chaos and the world’s two largest economies continue to pursue a mutually destructive trade war, you should focus on companies that provide essential needs.
Electricity is the epitome of an essential need, which explains why the operating results of the utilities sector have greatly outperformed the S&P 500 during this year’s recession.
Second-quarter 2020 corporate earnings per share (EPS) growth for the S&P 500 was -31.7% on a year-over-year basis. The top performing sector in Q2? Among the 11 sectors of the S&P 500, the Q2 EPS growth of utilities came in first at +9.2%. The sector’s earnings outperformance is on track to continue for the rest of 2020 and into 2021.
For the best utilities stocks to buy, click here now. These companies are cash cows that generate juicy double-digit yields, year in and year out. If you’re looking for sleep-well-at-night investments, these stocks are for you. They’ll help diminish your dread of the daily news.