The Fed Jawboned Dividend Stocks Lower, But It Won't Last

Includes: EES, EXT, EZM
by: Rising Dividend Investing

Our Investment Policy Committee believes there is little evidence to support a tapering of the Federal Reserve's Quantitative Easing program. We believe the chatter among the regional Fed presidents in recent weeks about tapering QE bond buying is, in reality, jawboning intended to take some of the steam out of the stock market.

As of mid-May stocks had risen over 30%, on a year-over-year basis. At about the same time, Wall Street titans, JPMorgan and Goldman Sachs lifted their price targets for the S&P 500 Index for both year-end 2013 and 2014. We believe the hot stock market combined with Goldman's and JPMorgan's bullish affirmations caused the Fed to conclude it needed to reduce the optimism in the stock market by a notch.

The easiest way for it to accomplish this was to broach the prospect that the economy is strong enough to produce modest growth without QE. We don't believe Chairman Bernanke or a majority of the voting members of the Fed have any intentions of actually beginning the tapering process, but they knew that their words alone could dampen the bond and stock markets.

When news of possible QE tapering hit the financial press, Treasury bond prices began to slump. This caused a sell-off in high-yield dividend stocks, such as utilities, telecommunications, REITs, pipelines, and the defensive stocks. Most of the cyclical stock sectors such as financials, consumer cyclicals and industrials continued to move higher. These latter sectors were judged to be the winners in an economy that was beginning to pick up momentum.

Over this past weekend, we studied hundreds of stock and bond charts, as well as all recent government economic data. Our first response to what we saw was -- It's knee jerk. The sell-off in certain sectors was too symmetrical. Stocks of widely varying fundamental prospects were treated very much the same in the sell-off. This is almost always a sign that what we are seeing is traders slinging stocks back and forth to each other, not long-term investors making strategic shifts.

In our judgment, the recent economic data does not convince us that the economy has reached a self sustaining level. Employment is still growing at a subdued rate. The Purchasing Manager's Manufacturing Index recently registered a very disappointing score. Consumers are still focusing their spending on the basics. The pattern we see going forward is very similar to the one we have traveled the last two years -- muddling along.

There is a piece of economic data that we believe almost assures that the economy is nowhere close to being self sustaining: core inflation data. The preferred inflation measure of the Fed, the Core Personal Consumption Deflator, is currently registering inflation at 1.2%. That is far lower than the Fed's target of 2%. Furthermore, inflation at that low a rate is saying that, even with the rebound in auto and home sales, there are no building inflationary pressures in either employment or plant capacity. In short the Fed may actually be more worried about the downward trend of core inflation than it is of the rising stock market. Its tapering talk is just to keep the markets honest and the speculators guessing.

Dividend-paying stocks have sold off sharply in recent days. Don't worry too much; they'll be back when it becomes clear that the economy is still strolling and nowhere near a gallop. The world is desperate for income. We cannot imagine a scenario that would lift interest rates to a high enough level over the next year to make bonds a better buy today than dividend-paying stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.