Fight This Feeling a Little More

The S&P 500 soared 25% in 2024, building on a 24% gain in 2023. This marked the market’s strongest two-year streak since the dot-com bubble of the late 1990s.

A rising tide did not lift all boats, though. The Dividend Aristocrats index gained just 6%. SCHD, Schwab's popular dividend ETF, returned 12%. REITs eked out a 5% gain, and dividend stalwarts like Johnson & Johnson, Realty Income, and PepsiCo finished the year in the red.

Dividend investors had their mettle tested as momentum trades had one of their best runs of the past thirty years. Everything from AI stocks like Nvidia, up another 170% in 2024, to Bitcoin, now worth around $100,000 after more than doubling, left many dividend stocks in the dust.

The emotional pull to follow the herd is hard to ignore when fast and easy money is being made. It’s almost as if REO Speedwagon's 1984 hit "Can’t Fight This Feeling" was written for today's investors who can't resist jumping on the momentum bandwagon:

But don't give in. Fight this feeling a little more. Remember what we are fighting for – safe income, income growth that beats inflation, and long-term capital preservation.

 

Our three dividend portfolios have consistently delivered on these objectives. Dividends are cash in hand, resembling regular, growing paychecks detached from the market’s moods. They provide peace of mind, especially in retirement, and reflect a company’s financial health.

Relative to the broader stock market, many quality dividend stocks appear historically cheap. The best time to own a conservative dividend growth portfolio is when no one thinks you need insurance. This strategy looks set up to perform well whenever the next storm hits.

Chasing momentum – buying the market’s winners and hoping prices keep moving higher regardless of fundamentals – works until it doesn’t. And I see mounting evidence that investors have become complacent about risk as they embrace narratives around AI, crypto, and President-elect Trump's pro-business policies.
 

Survey data from the Conference Board recently showed a record share of American consumers think stock prices will rise over the next 12 months – an all-time high by a good margin across data going back to 1987. Households have a record-high percentage of their financial assets in stocks, too.

The options market has boomed like never before as well, with volumes soaring in the riskiest contracts that expire the same day. Retail traders account for a growing share of overall activity and want big payouts now, with little patience for buy-and-hold investments.

Crypto represents another area of froth. I don’t own Bitcoin and won’t get into whether it’s worthless or worth $1 million. But “joke” coins, which should truly have no value, are raking in the cash. My favorite is Fartcoin, valued at nearly $1 billion after its October debut, where claiming initial tokens required submitting your best fart joke.

These flatulent conditions have coincided with the return of so-called SPACs, or Special Purpose Acquisition Companies, which raise money through an IPO to merge with a private company and take it public. SPACs are risky because investors don't know which company they will buy or if it will succeed, but last year they raised several times more money than they did in 2023.

High-yield bond spreads tell a similar story of investors’ tolerance for risk. The average yield on U.S. junk bonds is about 2.9 percentage points above the equivalent yield on much safer government debt. That's the lowest spread since 2007, right before default rates soared.

To be fair, the U.S. economy's surprising resilience justifies at least some of this positive sentiment. A moderate pace of expansion continued last year even as inflation cooled, and analysts expect more than 10% annual earnings growth in 2025 and 2026.

But Wall Street has a tendency to be too optimistic. Much of the market's projected earnings growth is from Big Tech companies focused on generative artificial intelligence (AI), which can help with everything from writing code and creating art to drafting emails and personalizing education.

ChatGPT's launch roughly two years ago triggered an AI arms race. America's tech giants have about doubled their annualized capital spending pace since then, pouring hundreds of billions of dollars into data centers, chips, and other AI infrastructure.

AI seems likely to be the next transformative technology, but it's early days. In many industries, meaningful AI initiatives are just kicking off. It remains very unclear how much revenue there is to be had to pay for all this spending, but that uncertainty hasn't stopped the speculative investment frenzy. No one wants to be left behind.

The top tech stocks dubbed the Magnificent Seven – Apple, Nvidia, Microsoft, Amazon, Alphabet, Meta, and Tesla – accounted for more than half of the U.S. stock market’s gain in 2024 as more investors jumped on the AI bandwagon.

These tech titans have a collective market cap nearing $18 trillion – more than the combined value of major European stock exchanges and about equal to the European Union's annual economic output (GDP). Just seven companies.

The rapid growth of these companies and the high valuation multiples they have sustained have made the S&P 500 heavily concentrated. The 10 largest stocks in the market now account for 40% of the index's market cap, per Charles Schwab senior investment strategist Kevin Gordon.

This high concentration creates risk for investors. The Magnificent Seven are great businesses, but they have to deliver on the hype behind AI.

Compared to past bubbles, the group's 24-month forward P/E ratio of 25 isn't as scary, but the Magnificent Seven's enterprise value (EV) to sales ratio of 8.7 now exceeds the 8.2 ratio observed during the peak of the 2000 tech bubble. Expectations are high, especially given the huge size of these companies.

Put it all together with excitement over lower taxes and fewer regulations under Trump, and the S&P 500 trades at a forward P/E ratio near 22 – well above its average of 15.8 over the last 40 years. Low interest rates no longer justify higher multiples either with the 10-year Treasury now paying 4.6% – in line with its median yield over this period.

By now, I hope you're finding it easier to fight the feeling to chase momentum. This type of market environment is unusual and leaves little margin of safety if anything goes wrong with the economy or developments with AI. It feels like a good time to go fishing.

As we look ahead to 2025, the current momentum trade could keep running. Your guess is as good as mine, but that's no excuse to ignore fundamentals in favor of trends. Making money quickly is never a reason to own stocks.

We do not have plans to make big adjustments to our portfolios, including in response to the Presidential election's outcome. Knee-jerk reactions to these events often don't age well.

Take 2016, for example. Trump’s election odds were only around 20%. After his victory shocked the world on November 8, the best performing stocks that November were in the financials, energy, industrials, and basic materials sectors as investors scrambled to buy companies that would benefit the most from stronger economic growth and higher interest rates and inflation.

However, of the five sectors that initially outperformed the market in 2016, only the consumer discretionary sector did better than the S&P 500 for the nearly four years until Covid hit. Tech was the biggest winner but was largely ignored immediately following Trump’s 2016 win.

You really can’t make any blanket statements about which area of the market will do best under a certain president. It's just not that simple, and I don't believe long-term investors should make trades in their portfolios that are driven only by election outcomes.

That said, Trump's policy proposals involving mass deportations, new trade tariffs, and lower taxes could complicate the Fed's battle with inflation. With price increases remaining stubbornly above the Fed's target in recent months, investors have started pricing in fewer rate cuts this year. Add that to the factors keeping a lid on many dividend stocks for now.

As always, we will do our best to help you navigate this unique environment with ongoing research and Dividend Safety Score updates. We also have an exciting improvement in the works that will help you further assess a company's risk profile – stay tuned.

Thank you for your support of Simply Safe Dividends, and I hope you and your family have a healthy and prosperous New Year!