By: Sheila Morgan
As we head into the third quarter, we, as investors are faced with a mosaic of uncertainties that we’ll examine together. The Federal Reserve (Fed) took its most hawkish stance against inflation yet, by raising interest rates three-quarters of a percentage point. With the anticipation of getting inflation under control, the Fed initiated its vigorous quantitative tightening policy, the largest initiative since 1940. This is a contractionary policy that reduces the level of liquidity, money supply, and the level of economic activity in the economy. However, its policy has put further downward pressure on most asset classes. Meanwhile, macroeconomic themes continue to mount about the future direction of the U.S. economy. Consumer confidence is sharply lower, economic indicators are pointing to slowing growth, and the possibility of a recession is on the rise.
A rising interest-rate environment has caused U.S. equities to sell off as their valuations have come under pressure. Pure growth stocks that do not pay a dividend, continue their relative underperformance, while high-quality dividend stocks with strong fundamental valuations continue to deliver relative strength in the first half of the year. Dividend stocks are like the Hondas of the investing world. They are not particularly the poshest cars at first glance, but they have a lot of substance when you look deeper under the hood.
Typically, in periods of heightened risk aversion, dividend stocks become respected for their stability relative to the overall stock market. During cycles of market volatility, they can provide support to portfolios when a stock’s price depreciates. Many of our clients’ own stocks that are dividend aristocrats. Dividend aristocrats are S&P 500 companies that have increased their dividends every year for at least twenty-five consecutive years.
Examples include Clorox, Church & Dwight Co. Inc., Target, McDonald’s, and Lowe’s, to name just a few of the quality dividend stocks in our clients’ portfolios. The S&P 500 is down twice as much as dividend aristocrats.
Going back to 1960, dividends contributed approximately 84% of the total return provided by the S&P 500. In every recessionary bear market over the past 50 years, high-quality dividend stocks have outperformed the overall market. Dividends can provide a dependable source of income into retirement years and for investors
looking for an income stream without having to sell their underlying investments. Dividend stocks typically have a lower beta and are less volatile than the overall stock market, thereby reducing risk.
It’s possible the stock market isn’t taking a full account of the weakening in the labor market and the broader economy. I don’t foresee spectacular growth in certain segments of the market. The strong performance of lower-quality stocks is providing the market with a false sense of confidence in the health of the economy. It only takes one negative catalyst to send the stock market lower. Over the next few months and arguably into 2023, I expect economic growth will not be particularly robust. The culmination of monetary and fiscal policies enacted over the past few years to stimulate the economy, along with our excessive national debt levels, will accelerate inflation. As additional interest rate hikes are imminent in the foreseeable future, dividend stocks have the potential to offset inflationary pressures and thrive in a slow growth environment.
In the long run, dividends deliver strong long-term returns regardless of the market cycles. Dividend investing is not as simple as selecting the highest-yielding stocks or ones with fastest short-term dividend growth. We remain confident in our fundamental analysis and the dividend investment strategy we approach with every one of our clients’ portfolios. As always, we are happy to discuss and answer any questions or concerns our clients may have, as we navigate the markets’ peaks and troughs together.
If you have any questions about portfolio advice and management, give us a call or email us at info@portfolioadvisor.com.
