That One Important Chart Dividend Investors Need To Watch

seekingalpha04-22

In this article, I start by highlighting the importance of being aware of the impact of inflation on long-term returns in portfolios.The chart comparing the performance of growth and value stocks ...

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The main chart of that article can be seen below: Multpl.com While stocks tend to \"always go up\" on a longer-term basis, I wanted to highlight the importance of being aware of what periods of economic trouble and elevated inflation can do to long-term returns. In this article, I will discuss another chart I cannot stop thinking about. A chart that is having a massive impact on dividend (growth) portfolios. I'll explain why the chart matters so much, why it's turning to our (dividend investors') advantage, and how I'm trying to capitalize on it on a longer-term basis. So, let's get to it! That One Major Chart & Why It Matters Usually, in my articles, I discuss \"big picture\" issues, as I believe we need to be aware of major trends and developments impacting our portfolios. While all factors are interconnected, I watch macroeconomic developments (inflation, unemployment, growth expectations, etc.), supply chains (economic re-shoring, trade flows, etc.), and politics. Leo Nelissen (Research Framework) This year, we have spent a lot of time discussing key developments, including these two:  I have been in the \"higher-for-longer\" camp, as I did not expect inflation and interest rates to come down as quickly as the market expected. I have been a buyer of value stocks, ignoring growth stocks.  This brings some to the other chart I cannot stop thinking about. The chart below compares the S&P 500 Value ETF (IVE) to the S&P 500 Growth ETF (IVW). I use this chart as a proxy to monitor the relative performance of growth and value stocks. As we can see below, the ratio (including dividends) has been in a steady downtrend since 2007. TradingView (IVE/IVW Ratio - Including Dividends) This downtrend was fueled by a number of tailwinds for growth stocks:  Inflation has been rather subdued in the period between the Great Financial Crisis and 2021. Low inflation was supported by the shale oil and gas revolution in the United States, favorable labor dynamics, fewer geopolitical issues, and strong globalization. On top of that, major Western central banks were usually very dovish during this period.  I highlighted this favorable period in the chart below. Federal Reserve Bank of St. Louis With that said, the chart above also shows a return to above-average inflation. Since 2020, I've been in the \"higher-for-longer\" camp, as I expect many inflation tailwinds of the past to turn into lasting headwinds.  Globalization is suffering, pressured by ongoing supply chain re-shoring and new geopolitical tensions. The shale revolution has ended. Natural gas, oil, and coal supply growth is much slower compared to pre-pandemic years. Labor market dynamics have become less favorable. High inflation in 2021 and 2022 has worked its way through the economy, causing sticky wage inflation (supported by the aforementioned labor market changes).  Generally speaking, all of this is bad news for growth stocks - at least on a relative basis. After all, growth investing means buying companies that are expected to generate significant cash flows in the future. Value stocks are generally stocks that already generate substantial cash flows, which is why most of them are dividend payers. I'm painting with a very broad brush, as my main point is that elevated interest rates/inflation reduce the present value of an asset when discounting future cash flows. For example, it is much more attractive to bet on a stock that is expected to make a lot of money a few years from now when interest rates are very low. If rates are high, it makes more sense to invest in companies that are already very profitable. The chart below shows the same S&P 500 Value/S&P 500 Growth ratio. This time, however, I added the yield on the 10-year U.S. government bond. TradingView (IVE/IVW Ratio - Including Dividends, U.S. 10-Year Yield) As we can see, the outperformance of growth stocks since early 2023 was somewhat unexpected, as interest rates did not support it. This is also one of the reasons why I missed that trend, which was one of my biggest mistakes in recent years. I believe this is due to a number of reasons:  Inflation started a downtrend, which led people to believe that we could return to \"normal.\" The rapidly accelerating adoption of artificial intelligence (\"AI\") boosted major tech companies.  The bad news is that these reasons are running out of steam. Inflation, for example, hasn't declined since mid-2023. In fact, it has been higher-than-expected for four consecutive months and recently shown some upside momentum, fueled by energy and very persistent inflation in services. Data by YCharts This makes it very unlikely that we get sudden rate cuts - unless the Fed is forced to pick between protecting economic growth and fighting inflation, which wouldn't be bullish. Bloomberg According to Bloomberg: The risk of persistent inflationary pressures leading to a more restrictive than expected monetary policy stance remained the most frequently cited risk,\" the Fed said in its semiannual Financial Stability Report published Friday. Here is an overview of other Fed-related comments: Bloomberg With regard to the AI trade, it needs to be noted that this did not trigger a widespread rally in tech as we saw in 2020/2021. For example, over the past 12 months, the tech-heavy QQQ ETF (QQQ) is up 31%. This beats the S&P 500 by roughly ten points. The ARK Innovation ETF (ARKK) is up \"just\" 8%. Data by YCharts To me, this shows that this has not been a \"normal\" tech rally, but a very specific rally fueled by AI and a looser expected monetary policy. Now, it seems the market is realizing that this is not sustainable. For example, going into this month, the market traded at 21x earnings, which is well above the long-term average of 16.6x. JPMorgan Generally speaking, lofty valuations indicate the elevated probability of subdued returns in the years ahead. The overview below visualizes this. JPMorgan Now, I believe we are at a point where the market is figuring out what this could mean for longer-term returns.  Stocks are lofty valued, which increases the odds of subdued long-term returns. Elevated earnings growth may be a solution. However, can earnings grow at above-average rates when inflation is slowly but steadily pressuring the economy? Personally, I doubt it. How sustainable is the AI trend? While I have zero doubt that AI is here to stay and a major disruption force for many years to come, I believe a lot of tech stocks have gotten ahead of themselves.  NVIDIA (NVDA), for example, trades at just 30x forward earnings because it is expected to grow so fast. However, it trades at 31x sales, as margins are very high due to its superior product (pricing power). Data by YCharts While this article is not at all aimed at addressing NVDA, I just wanted to note two things:  Due to the rapid need to innovate in AI, companies have accelerated orders for AI equipment (including chips). This has pushed forward a lot of demand. This is similar to the pandemic, when other tech areas saw accelerating demand - followed by normalization. I expect a lot more competition for AI players in the years ahead as it becomes more \"mainstream.\"  Going back to the most important chart of this article, the market is shifting from growth to value. Zooming in on the IVE/IVW chart, we see that last week showed significant upside momentum in the relative performance of value stocks. Data by YCharts As we can see below, with yields on the rise, the Nasdaq 100 had its worst weekly drop since November 2022. Bloomberg In this case, Bloomberg summarized perfectly what we have been talking about in this article (and so many others). I added emphasis to the quote below: Fueling the reversal is an uptick in tensions that bulls may be less inclined to brush off after ringing up trillions of dollars in trading profits since late October. First among them is evidence that inflation has supplanted recession as the chief nemesis of central bankers. With commodities surging and economic data stubbornly hot, speakers led by Chair Jerome Powell have poured water on hopes for a long-awaited pivot in monetary policy. It also does not help that the 10-year yield is now above the S&P 500 earnings yield, which makes low-risk bonds a more viable alternative for riskier stocks - especially in a world of increasing uncertainty. Bloomberg In other words, I believe the value/growth relationship may be bottoming and close to gaining prolonged upside momentum. What Does This Mean For Me (And You)? On Friday, April 19, when growth stocks suffered, the S&P 500 fell 0.9%. My portfolio was up 0.6%, led by defense giants, consumer staples, other industrial stocks, and energy. This makes sense, as the three best-performing sectors were all \"value\" sectors. FINVIZ Although a one-day performance is usually meaningless, I'm bringing this up because it shows that \"simple\" value stocks were able to keep investors out of trouble when big tech was selling off. On a long-term basis, I expect the outperformance to continue, which is why I focus on a number of characteristics.  I buy companies trading below their fair value only. While it's hard to estimate what the \"fair\" value may be, I generally stay away from \"hot\" stocks. I buy companies with inflation protection. This includes energy (my favorite sector to hide against elevated inflation) and every company with a wide-moat business or business model that allows it to increase prices without immediately losing customers. While I'm going all-in on high-yield investments, I believe a bigger part of the future total return (capital gains + dividends) of the market will come from dividends. Over the past 20-ish years, the total contribution from dividends has been somewhat subdued.  Hartford Funds I also put a bigger emphasis on balance sheet health. If inflation remains sticky and the Fed is \"forced\" to keep rates elevated, it could put tremendous pressure on companies with poor balance sheets. When rates were low, a lot of companies got away with that. Now, the situation is different. I mainly care for companies with a rating of no less than BBB- (investment grade) or healthy leverage ratios, in case no official rating has been provided. So far this year, I have been an aggressive buyer of Texas Pacific Land (TPL), Canadian Natural Resources (CNQ), and Antero Midstream (AM). I'm also looking at a wide range of other value stocks, including exchange operator CME Group (CME), which I own, undervalued real estate like Prologis (PLD), which I don't yet own, and high-margin gold and energy streamers like Franco-Nevada Corporation (FNV), which I'm also looking to add to my portfolio this year. Needless to say, as I'm increasingly focusing on articles covering multiple stocks, I'll continue to discuss opportunities that I believe will guide us very well in what could be a prolonged favorable period for value stocks. Takeaway As we navigate through shifting market trends, particularly the recent surge in inflation and its impact on investment strategies, it's crucial to adapt our portfolios accordingly. The transition from growth to value stocks is gaining momentum, which emphasizes the importance of identifying undervalued companies with strong fundamentals and inflation-resistant business models.  By prioritizing dividends, focusing on balance sheet health, and strategically selecting investments in sectors like energy and real estate, we can position ourselves for potential long-term outperformance.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"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/2429941199"}