Many in the financial media are wringing their hands that the current bull market in stocks isn’t acting right. "It’s too defensive," they say. Put another way, they believe the wrong kinds of stocks are leading this bull; therefore, it is not to be trusted. Nothing could be further from the truth. One day these growling bears will admit they are wrong and come charging into this bull market. That will be the sign for us believers to know it’s time to leave. But, our guess is that time is a long way off.
The right stocks for a normal bull market are the so-called cyclical stocks – Basic Materials, Financials, Consumer Cyclicals, Industrials and Techs. These kinds of companies sell products that last for three years and longer. An uptick in these sectors of the stock market would mean that new incremental buying is occurring in these “long-term” sectors and would mean that big employment gains should be very near.
The leaders of the current uptrend in stocks are the defensive stocks – Consumer Staples, Healthcare and Utilities. Companies in these sectors sell products we buy and use every day -- think of Procter and Gamble (NYSE:PG) as the epitome of a defensive stock and Caterpillar (NYSE:CAT) as its counterpart. One can’t put off the purchase of Crest toothpaste nearly as long as they can put off buying a new D9 earth mover.
Today’s bull market is not a classic bull market from the perspective of what kinds of companies are leading the pack, but it is a bull market nevertheless. The easiest way to think of it is as an asset-allocation shift bull market. As the Fed has continued to keep interest rates near zero, more and more investors have decided to flee their poor treatment in Bondsville to head for better returns in the suburbs. They have traveled through the nearby communities of Junk Bondsville, Preferred Stockville, and - in recent months - have been moving into Dividendsville.
They have said, “I would rather take the risk of owning the common stock of Procter and Gamble or McDonalds than accept a 1.6% taxable return from a 10-year U.S. Treasury Bond.”
Certain types of large, multinational stocks are now being seen as having less risk than U.S. Treasury bonds. The math is simple: On an after-tax, inflation-adjusted basis the 10-year Treasury is a sure loser over its lifetime. That’s not even considering the sad shape U.S. Government finances are in today. On the other hand, Procter and Gamble and McDonalds (NYSE:MCD) are companies that have taken on all comers and are not only still standing, but prospering. Both have dividend yields near 3%.
PG has paid a dividend since 1891 and raised it for 59 consecutive years. PG’s dividend has risen at an annual rate of over 8% during the last three years and over 9% in the last five years. At an 8% growth in its annual dividend, PG’s dividend will double in nine years. Even if PG’s stock price does not move a penny over the next nine years, its dividend yield will rise to 6% - based on today’s price. Its internal rate of return would be about 4.5% from dividends alone.
Proctor & Gamble Dividend since 1970
MCD’s dividend growth of near 12% per annum over the last three years and 3-5 year projected growth rate are both higher than PG’s.
Procter and Gamble and McDonalds are not the only members of Dividendsville. There are nearly 100 (and growing) companies worldwide that are becoming viewed as being safer than governments.
You won’t find these kinds of companies standing in line for government hand outs. Indeed, it is the taxes these companies pay year after year that the U.S. government is so anxious to give away.
These companies cannot create income through taxation, but they can do something even better – compete. They balance their books every year. They navigate the byzantine regulations in every country in which they do business. They hire and train employees for jobs that have a future. They innovate. They take risks. They give back to every country and community in which they do business. And - most importantly - they build flexibility into their decision-making that allows them to be profitable nearly every single year.
Compared to bond yields, the current dividend yields of PG, MCD, and a host of other similar companies are actually higher than they should be. If the current slow growth economy continues through the end of this year, we believe dividend yields for these kinds of companies will fall to nearly 2.5%. For dividend yields to fall despite rising dividends for these companies, it would mean their stock prices would have to rise 15% or more between now and then.
This might seem like an overly aggressive view of the performance potential for these stocks, but there is a line forming in the heart of Bondsville that stretches as far as the eye can see. They are leaving town. Whether or not they know it now, they will find their way to Dividendsville. When they do, they will never leave.
Disclosure: Our clients and staff own MCD and PG. This discussion is provided for information purposes only. Please consult your investment advisor concerning any ideas expressed here.