Thursday, July 23, 2015

The Stock Market & Its Master

We’re just past the midway point in 2015.  So far, stocks have had a fairly underwhelming year. The S&P 500 has returned right around 4%, which is on pace to hit the lower range of what we predicted to start the year. The Dow Jones average is only up by 1.5%.

If you break the S&P 500 down into its components, you’ll find a more sobering story.  Nearly half of all stocks are in negative territory for the year.  A full third are down by 5% or more.  As a result, the average mutual fund has underperformed the S&P 500 by roughly 3% year-to-date (source: Morningstar).

Dividend stocks have been hit especially hard.  The perfect storm of a higher U.S. dollar, modestly rising interest rates, and collapsing oil prices have all hurt dividend stocks.  Both the Dividend Achievers Index and High Dividend Yield Index have struggled to stay positive for the year.

What's a Dividend Investor To Do?

We’ve been following the same dividend growth strategy for more than 20 years.  Over those years, we’ve seen dividend stocks outperform and we’ve seen them underperform.  In recent years, dividend stocks have been in favor as investors seek to find income.  In 2015, however, they’ve been out of favor.

We periodically fine tune which rising dividend stocks are in our portfolios based upon our market outlook.  However, we have seen that over a long period of time, dividend growth stocks generated higher than average market returns with more income and less risk than the market.

The Dog & It’s Leash

To illustrate what we mean, let’s consider a dog tied to his leash.  There are times when the dog will bound ahead of its master.  The dog cannot get too far ahead, however, because the leash will eventually yank it back.  There are also times when the dog will stand still while its master walks ahead.  This can only last for so long.  Once the dog falls too far behind its owner, the leash will yank it ahead again.

The same concept applies to dividend stocks.  There are times when the price of a stock bounds ahead of its dividend, creating an overvalued situation. There are other times when the dividend pulls ahead of the stock price, creating an undervalued situation.  There are other times when the dividend and stock price are moving along with each other, creating a fairly valued situation.

Dividends are the masters of price.  Prices are not the masters of dividend. Our research shows that dividends can predict roughly 90% of the movement of stock prices over the long-term.

To find out what the future of dividend stocks looks like, all we need to do is look at what companies are doing with the dividend.  If dividend growth is weak, we can expect future stock price growth will also be weak.

Dividend Growth in 2015

In 2015, dividend growth has been anything but weak.  With a good portion of dividend hikes already in, the stocks in our portfolios have grown their dividends significantly.

  • If end-of-year projections come in like we expect, Cornerstone stocks will have grown dividends by 10.8% in 2015 compared to last year.
  • Capital Builder dividends will be up 14.7% over 2014. 
Dividend stocks haven’t been the place to be in 2015, however, that will reverse at some point in the future.  The best thing we can do during times like this is to follow the dividend.  If dividend growth continues to be strong, we know prices will eventually take care of themselves.  We can’t know how long the master will outpace the dog, but we can know that the dog must eventually catch up to its owner.

NOTE: All data current as of 7/21/2015