VYM: Inflation Has Improved Its Timeliness

seekingalpha04-11

Vanguard High Dividend Yield Index Fund ETF Shares has delivered robust returns since I last wrote about it at the end of 2023.Despite the large price rallies, the VYM fund is even timelier now in my ...

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Richard Drury VYM has become timelier now My last article on the Vanguard High Dividend Yield Index Fund ETF Shares (NYSEARCA:VYM) was published a few months ago (on Nov 29, 2023, to be exact). In that article, I argued that: A) value funds were out of favor, both in the U.S. and internationally; but B) I preferred VYM due to its better growth prospects, better profitability, and lower fees. Indeed, VYM has delivered robust returns since then. The chart below shows the total return of VYM in comparison to an international value fund, iShares International Select Dividend ETF (IDV), and the overall market as approximated by the Vanguard S&P 500 ETF (VOO) since then. As seen, VYM has a total return of 14.74%, closely matching that of VOO. In contrast, IDV has a total return of 8.01%, very respectable but lagging VYM by a large gap. Seeking Alpha Usually, a working bull thesis tends to defeat itself. As prices rally, valuation expands, and risks escalate. However, in this case, my thesis is that VYM is still a good BUY. Actually, I think the new inflation data (quoted below from this SA news) has made VYM even timelier than last November: The Consumer Price Index climbed 0.4% in March, the same increase as in February, and exceeding the 0.3% rise that economists expected. That indicates that the hot readings in January and February may be more than a \"bump\" on the path to inflation heading toward the Federal Reserve's 2% goal. In the remainder of this article, I will elaborate on the role of inflation on value stocks and explain why I see VYM as a good hedge. VYM’s role as a value fund But first, let me first justify why I view VYM as a value fund. The fund’s indexing methods are quoted below from its webpage: VYM summary: VYM seeks to track the performance of the FTSE High Dividend Yield Index, which measures the investment return of common stocks of companies characterized by high dividend yields. It provides a convenient way to track the performance of stocks that are forecasted to have above-average dividend yields. It follows a passively managed, full-replication approach. And the FTSE High Dividend Yield Index largely consists of stocks of mature businesses, as you can tell from the next chart below. Its top 10 holdings are dominated by sectors like banking (JPMorgan Chase & Co. at 3.48%), staples (Procter & Gamble Company at 2.45% and also PepsiCo, Inc. at 1.66%), healthcare (Johnson & Johnson at 2.68%, Merck & Co., Inc. a1.97%, and also AbbVie, Inc. at 1.94%), etc. These are sectors where most value stocks are often found. Source: ETF.com The next two charts provide an additional data point showing that VYM is a value fund. The first chart illustrates the price ratio between VYM and VOO. The second chart, taken from Goldman Sachs, shows the relative performance of value compared to growth stocks. You can see that the VYM/VOO price ratio behaved in a pattern that is very close to the data provided by Goldman Sachs between 2010 and the present. Seeking AlphaGoldman Sachs Growth, value, and inflation After establishing VYM as a value fund, now let me get back to my first reason for remaining bullish on VYM: it is still at a large discount relative to the overall market despite the large price advancements since my last writing. As seen in the next chart, VYM now trades at a P/E of 15.93x, far below the overall market’s P/E of ~23.9x. Yet, its profitability measured by ROE is on par with the overall market (~16% vs. the overall market’s 17%). Source: ETF.com Secondly and more importantly, because of the persistent inflation mentioned earlier, I think VYM has become timelier now than when I last wrote about it. Let me start with a historical perspective of the role of inflation on value and growth stocks. The next chart is also taken from Goldman Sachs, and my key takeaway is this (as quoted from the report): A look at cyclical inflection points shows that the two secular trends of dominance of one style over the other—1970-2007 for Value and 2007-2020 for Growth—contain bouts of outperformance of the other style. Since January 1970 there have been seven periods of more than a year when Value dominated and seven periods of more than a year when Growth outperformed. As seen in the chart, despite the overall underperformance that started after the 2008 crisis, value has had its period of outperformance overgrowth. The last period of outperformance has only started recently, indicating that we may be either in or near such a cyclical inflection point, and thus I expect VYM to outperform. Goldman Sachs Furthermore, I expect such outperformance to be further enhanced by the ongoing inflation (such as those revealed by the March CIP data as aforementioned). As shown in the chart below, Value stocks’ historical outperformance has correlated with the prevailing interest rates, which in turn correlate closely with the inflation rate. Moreover, historical data demonstrate specifically that the higher the treasury rates are, the larger the possibility that value can outperform growth. Due to persisting inflation, our current treasury rates are in the 4~5% range, towards the higher end of the historical spectrum since 1979.  So, if history is of any guidance, I see a good possibility for VYM to outperform the S&P 500 in the years to come. JPMorgan data Risks and final thoughts The main risk to my thesis (that is, in addition to all the generic macroeconomic uncertainties) is a soft landing. In this scenario, the Fed can gradually cool inflation and smoothly lower interest rates. In this case, growth stocks have more time to catch up with their current valuation to continue without any major price corrections, and will likely outperform value funds like VYM. There are people far more qualified to assess the odds of a soft landing, and I will refrain from offering my two cents here. I encourage you to read JPMorgan CEO Jamie Dimon’s recent comments on soft landing (the gist is quoted below and slightly edited by me): … markets are pricing the chance of a soft landing, i.e., modest growth along with declining inflation and interest rates, between 70% and 80%. I believe the odds are a lot lower than that.   All told, I prefer value to growth under current market conditions in general. In terms of specific funds, I think VYM is a suitable candidate among the value universe due to its low fee, diversification, and the quality of the holdings. Finally, the fund is even timelier now than the time I last wrote about it despite the large price rallies in my view, judging by the development of inflation since then and value’s historical resilience regarding inflation.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":1,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2426542610"}