The Case for Boring Dividend Stocks in a Growth-Hungry Market
There is much to rejoice about in December. The possible end of rate hikes is at the top of the list for investors as the latest readings on the economy and inflation showed signs of slowing. This shot the S&P 500 higher by 9% in November and sent bonds to their biggest monthly gain since the 1980s, according to Bloomberg.
The consumer price index (CPI) measures the average change over time in the prices paid by consumers for a market basket of goods and services. The core CPI, excluding volatile food and energy prices, increased by 4% in November, coming in below expectations and marking the smallest rise since September 2021, per CNBC.
Source: CNBC
While work remains to be done fighting inflation, the downward trend in the chart above looks encouraging. Meanwhile, the economy continues to show signs of cooling but not tipping into recession – the so-called soft-landing scenario many investors have wished for.
At risk of being overzealous, traders are now pricing in not only the end of the hiking cycle, but interest rate cuts next year from the Fed, the European Central Bank (ECB), and the Bank of England (BoE). The chart below shows the latest betting line, courtesy of Reuters.
Source: Reuters
Rate-cut fever brought back the risk-on trade that has dominated markets throughout most of the post-pandemic timeline (outside of a temporary reversal in 2022).
Crypto currency Bitcoin has rallied over 30% since late October. Junk bond ETFs in November enjoyed their biggest monthly inflow for the sector on record. And, of course, the technology sector led the broader market last month with a gain of nearly 13%.
Dividend stocks benefited from the rising tide as well, but not to the same degree. Most of the popular dividend ETFs gained “only” around 5% to 7% in November. Defensive sectors, such as utilities and consumer staples, trailed further behind with returns of 4% to 5%. These bond-like areas largely tracked the fixed income sector’s gain.
The stock market’s insatiable appetite for growth stocks has pushed this part of the market to uncomfortably high valuations compared to value stocks, which include many dividend payers. Earlier this fall, one of my favorite portfolio managers, Bill Nygren who runs the Oakmark Funds, shared an interesting measure of this gap (emphasis added):
This idea that, at the right price, growth can be a value is terribly confusing to those who treat growth as the opposite of value. The opposite of cheap isn’t growth; it’s expensive. So instead of looking at growth versus value, we look at low P/E versus high P/E. A convenient way is to rank order the S&P 500 by P/E ratio, comparing number 50 to number 450. Currently, the 50th lowest P/E stock sells just over 8 times earnings, and the 50th highest sells at 60. So, the highest priced stocks are about 7 times more expensive than the lowest priced. Over the 30-plus years we have data, the P/E ratio averages about 4, bouncing between 3 and 5. (So, if there are 50 stocks below 10 times earnings, there are 50 over 40.) It was meaningfully higher only one time – when it hit 9 times at the end of the internet and tech bubble in 2000.
When we compare the 50 lowest ranked companies by P/E ratio on the S&P 500 today to the ones that made that list in previous periods, we don’t observe any decline in business quality. Therefore, considering both the relatively high price of the higher P/E companies and the solid business quality of the lower P/E companies—we believe that low P/E stocks today present a better hunting ground than they normally do… That’s why the Oakmark Fund today looks more like a traditional value fund than it has in a long time.
How will the story end this time? Your guess is as good as mine. But I share Bill’s sentiment that many of today’s growth stocks have an unusually high bar to climb over.
Hiding out in time-tested businesses that generate great cash flow, maintain conservative balance sheets, have stable long-term outlooks, and trade at reasonable valuation multiples provides comfort during these times, even if the market has paid them less attention (e.g., dividend ETF flows are near a record low in 2023).
Nothing has changed or will change with our investment approach. We’ll keep sticking with quality companies we understand. We’ll avoid temptations to chase price momentum or speculate about where interest rates and the economy could head. No one knows.
Just before a trend changes, there will be maximum agreement by experts and others that the trend will not end. That should make any investor a little nervous as market pundits begin to sing in unity that the tightening cycle is finished, and a soft-landing is imminent.
Rather than get swept up in the market’s ever-shifting sentiment, you should build and maintain a dividend portfolio with expectations that a recession or deep bear market will happen at some point in the future. That’s a given. But it shouldn’t make you live in fear.
When you know the companies you own and why you own them for the long haul, tuning out the noise becomes easier. Your portfolio’s rising stream of dividend income can act as a guiding light as well, decoupled from the market’s ups and downs.
Of course, we will do our best to help you as well. Every piece of research we publish and all the website features that we improve are intended to make it easier for you to generate safe income, preserve capital, tune out noise, and enjoy retirement with less worry.
All our work is done in-house so you can trust it – no fancy AI, ChatGPT regurgitation, or corner-cutting contractors with no skin in the game. We care deeply about delivering a quality product that is insightful, a joy to use, and something we are proud to stand behind.
As we head into the festive season, I'm particularly thankful for your support. Working on Simply Safe Dividends is an incredible privilege, especially as we embark on our 9th year.
It's been a rewarding journey that I know is built on your support and referrals. The trust you place in us by choosing our service is something I never take for granted.
I hope you enjoy the holiday season, and I look forward to continuing the journey together in 2024. As always, please feel free to reach out if you ever have any questions or suggestions for us to consider as we improve the site.
Thanks for reading,
Brian Bollinger President & Analyst, Simply Safe Dividends
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