Why Weak Economic News Might Be Good for Stocks

As we mentioned in last week's article, we are providing our most current outlook on global economic growth.  We will update our projections periodically to reflect our latest views.

Economic indicators have been very confusing for investors.  “Good news” about economic growth has been perceived by the markets as “bad news”, as it could lead to reduced monetary stimulus from the Federal Reserve.  In this article, we will identify some key economic information and separate each point into good news and bad news, then come to a final consensus as to our specific views about the economy and how it will impact stock market growth moving into 2014. 

1. Slow Economic Growth

Economic growth in the United States has been mostly flat coming out of the recession in 2008-09.  In the 2^nd quarter of 2013, real GDP growth was a mere 2.5%.  The economy has been “muddling along” for quite some time.  We anticipate slow economic growth will continue into 2014. 

Driving the Bull: Dividend Growth Pushing the Market Higher

Now that the government shutdown is past us and the debt ceiling has been pushed out for the near term, we thought it would be an interesting exercise to share with our readers some recent research that we have done in attempting to identify which types of stocks are doing the best in the current bull market.  

S&P 500 Total Return Analysis

The stock market has had a strong run since 2009.  Over the last 12 months, the S&P 500 is up approximately 25%.  We broke the S&P 500 companies down into quintiles of 100 stocks each and ordered them according to largest to smallest in 4 different fundamental categories including sales growth, earnings growth, dividend yield and dividend growth.  We then calculated the total return (dividends and capital appreciation) for each quintile over the last 12 months.

So Goes the Dividend, So Goes the Stock

The Government shutdown and looming default deadline are consuming the majority of headlines.  Our stance remains unchanged: we believe U.S. politicians will eventually reach a deal.  For more details, you can read last week’s article here.

Rather than join the ongoing government shutdown discussion, we want to take a step out of the short-term gloom-and-doom to look at what impacts long-term stock market growth or decline: earnings and dividends.

Our statistical models show dividends to be a highly significant predictor of long-term stock prices.  The chart below shows the basic correlation between nominal dividends paid and the S&P 500 index price over the past 20 years.

Government Shutdown & Default Fears Could Create Opportunity

Portfolio Changes

The strong bull market over the past 5 years has driven a handful of our companies’ valuations to fair or even over-valued in our statistical models. These stocks have done very well for our clients, however, there is a time to take profits and we believe that time is now for some of these companies. As a result, we are in the process of selling a few positions in favor of stocks with better long-term outlooks.

Government Shutdown: This Too Shall Pass

As we have been describing in weekly blog posts, the tailwinds are - in our mind - good for stocks.  Those are:

1. When the dust clears - interest rates are going to stay low.  We projected they would stay around 2.5% to 3.0% and that has held true.  The 10-year Treasury is now trading close to 2.6%.  Low interest rates will continue to push investors into stocks.
2. The economy continues to muddle along, which is a modestly good thing for stocks - as it prevents bubbles from forming and also keeps the Fed engaged in stimulative monetary policy.
3. Year-end earnings and dividend growth projections continue to hold in solidly positive territory.  According to Yardeni Research, 2014 earnings growth is now projected at 11.3% and 10.2% in 2015.

The most obvious headwind of today’s market is the Government shutdown and looming debt ceiling debate.  We spent the majority of our time in the Monday meeting going through the different scenarios that may play out.