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I recently discussed the state of the economy and stock market with Neil Hennessy, head of the Hennessy Funds. Hennessy doesn’t run any ETFs, but follows a dividend strategy in most of his mutual funds.

Hennessy agrees with Ed Keon, the portfolio manager at Quantitative Management Associates, that there continues to be a high level of caution and pessimism in the country. (Cautious Forecast for Next 6 Months)

“American investors have absolutely no faith that their government can correct the problems,” says Hennessy, adding that companies are not hiring because they don’t know what the health care and regulation costs will be. “If I don’t know the cost of an employee, why would I hire one?”

He says most people have moved pass the financial crisis to focus on three contentious issues that currently dominate the media: the new health care system, immigration and the poor job the government did about cleaning up the oil spill in the Gulf of Mexico.

“There’s no leadership coming out of Washington,” says Hennessy, and “no confidence in leaders, leads to no confidence in the stock market.”

However he predicts that companies will focus on dividends to make the stock market go higher. Currently companies are hoarding historical levels of cash. Hennessy says the 30 companies in the Dow Jones Industrial Average have $500 billion in cash and short-term investments on which they are currently earning barely anything. He believes “more and more companies will raised dividends” to attract investors by offering higher yields than bonds. Holding to the dividend philosophy, he says put your money into something that will earn something in a down market.

The Hennessy Total Return Fund seeks both capital appreciation and income by following the well-known dividend investing style of the Dogs of the Dow. This strategy holds the ten highest-yielding stocks in the Dow industrials. A stock with a high yield is typically one whose price has fallen, hence these are the “dogs.” The fund puts 75% of its money into the Dog stocks and the remaining 25% in short-term Treasury notes.

Year-to-date, the Total Return Fund is beating the S&P 500 return by 3.3% to 0.96%. For the past twelve months, the fund topped the index by 0.23%. However, for calendar year 2009, the index outdid the fund 26.5% to 16.9%. The fund currently yields 1.7%, but most of that is eaten up by the 1.27% expense ratio.

A good dividend ETF is the iShares S&P US Preferred Stock Index (NYSEARCA:PFF). When Hennessy talks about increasing dividends, he means the dividends paid by common stock, which can be increased whenever the companies chooses to do so. Preferred shares are more like bonds in that their payments rarely change, so this fund won’t get the upside from increasing dividends. Since preferred payouts won’t increase if the companies boost their dividends, preferred shares typically pay a higher yield. The iShares S&P US Preferred Stock Index is up 7.3% year-to-date, with a 6.9% yield and expense ratio of 0.48%.

Disclosure: No position

Source: Hennessy Affirms Negative Outlook