Dividends: A Guiding Compass in Choppy Stock Market Waters

At the close of the market on January 27th, the S&P 500 was down 3.1% from its record high on January 15th.  This modest pullback has caused nervousness amongst many investors.

Is this pullback something long-term investors should be concerned about?  We don't think so.  Here's why:

1. Stock Market Volatility is Normal

The market's unbroken march upward in 2013 caused many investors to forget what market turbulence looks like.

With so many forces at work in the stock market, it is difficult for one particular trend to last for a sustained period of time.  The market is positive 7 out of 10 years, but the standard deviation of 20% around the long-term average of 10% would make anything between 0% and 30% normal.  Rarely does the market advance higher without

The ABCs of Dividend Investing: Divi-do or Divi-don't?

Low interest rates have propelled dividend income investing to greater popularity in recent years than at any time in the past six decades.

Despite dividend-investing's recent popularity, many investors still only look at one facet of the power of dividend investing: dividend yield.  These investors point to the fact that dividends have represented 40% of the total return of stocks since 1960 and that many dividend stocks yield more than short-term Treasury bonds.  But that is where they stop, and in doing so, they miss an important quality of dividend investing: dividends are more than income, much more. 

The most important element of dividend investing is the statistically significant long-term relationship between dividend growth and price growth.  Understanding this relationship is the key to unlocking the true power of dividend investing.

Dow Jones 18,000: Here's How We Get There

2013 was a banner year for the stock market.  On December 31st, the Dow Jones closed at an all-time high for the 56th time of the year, ending with a total return of over 27%.  

While stocks had their best year since 1997, the economic news did not seem to support such a dramatic increase in stock prices. 

• At the beginning of 2013, Wall Street estimated 8% earnings and dividend growth for the year. Dividends met expectations, but earnings growth was a disappointing 4.5%.

• Sub 2% GDP growth continued for most of the year, and while the unemployment rate fell, much of the improvement was a result of frustrated workers giving up their job searches and thus no longer being counted in the official unemployment rate. 

• Sequestration hit in 2013, reducing Government spending and dragging down already slow U.S. GDP growth by about 0.5% for the year.

• Interest rates, which are typically inversely correlated with stock prices, increased significantly.  The yield on 10-year U.S. Treasury bonds began the year trading below 1.85%. After the Fed began talking about tapering Quantitative Easing (QE), the 10-year started its upward climb to end 2013 just above 3.0%.

• The Government shutdown in mid-October threatened to derail economic recovery and highlighted growing dysfunction in Washington. 

Why Was the Market Up 25%+?

With so much lukewarm economic data, how could the markets have gone up over 25% in 2013?

HCN: How Do Interest Rates Impact Value?

Market prices are always fluctuating around true fundamental value.  Sometimes, investors become overly optimistic about a particular company or the market as a whole.  When this happens, prices often increase beyond what long-term fundamental growth can justify.  

Other times, an overly pessimistic outlook drives the price of a stock too far down.  At Donaldson Capital Management, we call these kinds of companies “vexed”.  In other words, the market is discounting a stock based upon a current or upcoming headwind.  These headwinds can come in many forms including concerns about future company growth (IBM), legal problems (JPM), or concerns about a particular economic region (AFL).

The market often overreacts to these headwinds, causing these “vexed” companies to be driven below their true fundamental value.  Investors who can see through the short-term doom-and-gloom have an opportunity to purchase high-quality companies at a temporary discount.

One particular company we believe is “vexed” right now is a real estate investment trust (REIT) Health Care REIT, Inc. (HCN).  HCN owns a diverse portfolio of healthcare real estate that includes senior housing communities, skilled nursing facilities, and inpatient/outpatient medical centers.  The price of HCN has dropped by over 29% from highs near $80 in mid-May 2013.

The most obvious reason for HCN’s decline has been the upward hike in interest rates.  An increase in interest rates is negative for REITs such as HCN for two main reasons:

Will the Fed Taper in December?

In May, Federal Reserve Chairman Ben Bernanke mentioned the potential for the Fed to begin tapering their asset purchase program, Quantitative Easing (QE).  Since then, the financial markets have been obsessed with tapering and – more specifically – how it may affect interest rates. 

Many Fed watchers have predicted the Federal Reserve will begin to taper QE sometime in early-to-mid 2014.  After the latest jobs report, there is talk that the Fed may reduce asset purchases sooner rather than later.  

On December 6^th, the Bureau of Labor Statistics released the November jobs report, which showed nonfarm payroll employment grew by 203,000.  The jobs numbers were significantly better than expected and lowered the unemployment rate sharply from 7.3% to 7.0%.

The seemingly good economic news propelled the stock market higher.  That same day, the Dow Jones was up nearly 200 points and the S&P 500 rallied back up above 1,800.

The positive job numbers led many to forecast a QE taper starting at the Fed's last meeting of 2013.  Will the Fed start to taper in December?  Probably not.  Here's why:

The ABCs of Dividend Investing, Part IV: Who Are the ABCs?

After our series of posts titled "The ABC's of Dividend Investing", we received many requests from people asking us to show some specific examples of A, B and C stocks.  We don't typically talk about individual securities on our blog, but we decided to identify a few companies that we own and discuss their dividend characteristics and why we own each of them.

We chose three stocks – one each from our A,B,C sub-portfolios.  For those who have read our posts on the ABC's of Dividend Investing, the features of these sub-portfolios are probably familiar to you.  For those of you that have not, here is a brief summary:

           

What Are the A, B, Cs?

In the early 1990s, we restructured our main dividend investment strategy away from a portfolio focused primarily on high dividend yielding stocks with modest dividend growth into a portfolio comprised of three distinct types of dividend stocks.

B-U-L-L: Anatomy of a Bull Market

Today’s investors have not seen a bull market in a very long time.  Some have never invested through one at all.  The last time we saw a true bull market was in the 1990s right before the technology bubble of 1999-2000 took hold.  The stock market downturn in 2008-09 was more of a shock-fear reaction to the financial crisis than it was the end of a bull market. 

The market is certainly in a bull market today.  We’ve used the acronym B-U-L-L in the past to describe the characteristics of a bull market and help us understand market behavior.