July's Stock Surge: Don't Lose Perspective

The market’s gloomy mood reversed abruptly in July. The S&P 500 blitzed higher by 9.2%, delivering its best monthly performance since November 2020 and cutting its year-to-date loss to about 13%.
 
A better-than-feared earnings season helped spur the rally. Of the 56% of S&P 500 companies that had reported second-quarter earnings as of August 1, more than half topped analyst estimates – above the long-term average of 47%, according to Bloomberg.
 
Meanwhile, softening economic data and falling commodity prices provided some hope that inflation is peaking.
 
For example, the latest report on America’s gross domestic product showed that the economy contracted for two quarters in a row. And the Dow Jones Commodity Index, a broad measure of raw material prices across the energy, metals, and agriculture and livestock sectors, has retreated 15% since early June.
 
If inflation has peaked and begins retreating towards the Fed’s 2% target, well below the 9.1% rise logged in June, then perhaps a recession can be avoided as central banks tone down their pace of interest rate hikes designed to rein in prices by slowing demand.
 
But whenever I’m tempted to speculate about the economy, I recall the two laws of economics. First, for every economist, there exists an equal and opposite economist. And second, they’re both wrong.

Markets and economies are driven by too many complex, intertwined variables to forecast their short-term direction with any consistent accuracy. While I’m skeptical that policymakers will be able to tame inflation sufficiently without the economy experiencing greater pain, my opinion has little influence on how I manage a portfolio for the long term.
 
Reading too much into the market’s performance any given month can lead to trouble as well. In June, we received emails from several investors wondering if they should change the composition of their retirement portfolios in response to falling stock prices.
 
Right on cue, the market surged in July. And now cash-heavy investors may feel some FOMO (fear of missing out) as they ponder whether the bottom is in. Perhaps we are headed back to the days of lower interest rates and slow but steady economic growth. 
 
Both types of emotional responses to price volatility are natural human reactions, but they are equally dangerous. The market should serve you, not instruct you. Speaking at Berkshire’s annual shareholder meeting in 1997, Warren Buffett put it best:
 
“Ben Graham used the example of Mr. Market… Just imagine that when you buy a stock, in effect you’ve bought into a business where you have this obliging partner who comes around every day and offers you a price at which he will either buy or sell… That’s a huge advantage. And it’s a bigger advantage if the partner here is a heavy-drinking manic depressive. The crazier he is, the more money you’re going to make. As an investor, you love volatility.”
 
Keeping perspective about what you own – a slice of a real, operating business – makes it easier to tune out the market’s noise. Underlying fundamentals drive a company’s long-term success, regardless of where stock prices head any given month. If the businesses we own do well over time, our performance will turn out fine if we paid reasonable prices for most of our investments.
 
The debate about whether a recession is imminent, as most CEOs believe, may not be resolved for months. As recession sentiment oscillates, the stock market’s volatility could remain elevated.
 
Rather than try to time market turns, we will remain focused on what we can control: owning quality companies with entrenched market positions, healthy balance sheets, and predictable cash flow from which to pay sustainable dividends.
 
These defensive-oriented businesses generally did not keep up with the market’s rally in July, which was led by more speculative companies. In fact, reflecting the market’s renewed appetite for risk, high-yield bonds enjoyed their largest one-month rally in over a decade, per Bloomberg.

Looking ahead, we expect diversified portfolios of quality dividend growth stocks to perform relatively well if economic growth further decelerates and more investors seek safe havens. 
 
While the three model dividend portfolios we actively manage are designed to deliver higher dividend income each year, we believe companies may favor more conservative dividend increases in the year ahead in response to uncertainty created by the slowing economy.
 
As always, we will continue monitoring the evolving landscape. And if we ever deem a Dividend Safety Score change prudent for a company within our coverage universe, we will email our analysis to members who hold the stock in their portfolios.

Thank you for reading.

Sincerely,

Brian Bollinger
Simply Safe Dividends

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