With Markets At All Time High, How Should Dividend Growth Investors Act?

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Includes: DIA, SPY
by: Khen Elazar

Summary

The Trump presidency was a surprise for almost all of us. It sent both the Dow Jones and the S&P 500 to all time highs.

In addition, we are probably going to see another interest rate raise in December 2016.

Should investors sell? Keep buying stocks? Or just accumulate cash and wait for the drop?

Introduction

Just as investors were surprised when the British people voted in favor of leaving the European Union, they were surprised when Donald Trump was elected president of the United States. The markets have been more than thrilled since election day, and both Dow Jones (NYSEARCA:DIA) and S&P 500 (NYSEARCA:SPY) are at their all time highs.

Moreover, we are looking forward for another interest rate raise in December, as Yellen kept implying. I believe that this rate hike is already priced into the market, as the bond market already suffered from the prospect. However, none of us knows what Yellen will say in the press conference. If she talks about 2 rate raises in 2017, I believe the market will react positively. However, 4 planned raises might cause the market to tumble a little bit.

The current situation is very confusing for most investors. It makes you think about you strategy, as the whole economic environment might change. The Fed might increase the transition speed of its monetary policy. At the same time, the fiscal policy executed by the Trump administration might include a huge stimulus package, and a whole different fiscal policy compared with what we saw with the current administration. Investors including dividend growth investors like me, don't like uncertainty.

In this article, I will look deeper into the uncertainties in the markets. I will try to understand them better in order to figure out whether the markets are expensive. The goal of this analysis is to decide how should the dividend growth investor should act in the current environment.

What does Trump presidency mean for the market?

Trump's economic policy is all over the place. In his campaign he stated about many measures he is willing to take. Some were very liberal, almost libertarian policies, while others were Keynesian policies, and even protectionist policy, which is more popular in failed countries nowadays.

Trump has been speaking about repealing the Dodd Frank Act. He said that it was a terrible, that it doesn't allow the banks to do their job. He said several times during his campaign, that he will repeal it in order to allow banks to do their job, and lend money to businesses. Any deregulation acts will support the financial sector, and you should expect the sector to boom if he does this.

Moreover, Trump said that he is willing to lower corporate tax in America. This would make the U.S. a much more compelling country for businesses. It might encourage companies that left for Ireland for example to come back. He is also willing to allow companies to return their cash to the U.S for reduced tax. These measures will support most companies based in the U.S.

On the other hand, Trump might take some very dangerous measures. He might try to oppose globalization. I believe that no one can oppose it. However, trying to do it can be harmful for the economy, for the people and the corporations. Everyone enjoys trade agreements like NAFTA which help Americans buy products for cheap while corporations can lower expenses.

Imposing tariffs on merchandise from Mexico will make products more expensive for the majority of Americans. In order to save jobs for several thousands people in plants, millions of Americans will pay protectionist fees. This is unthinkable, and makes no sense at all in my opinion.

Federal Reserve adds more uncertainty

The Fed will probably raise the interest rate in December. Yellen has already said several times that the economy is ready for another raise. While the current raise seems imminent and the market is ready for it, we still don't know what the medium and long term plan is.

Yellen continued the policy of Ben Bernanke, but Trump said that he is willing to replace her in 2018. We have no idea who will lead the Fed or what his policy will be. Moreover, the new chair will have to execute a monetary policy that will support the fiscal policy of the Trump administration.

The monetary policy will have to work with the fiscal policy. During his campaign President- Elect Trump said that he is going to spend a lot of federal money on infrastructure. Together with tax cuts, we are talking about somewhat irresponsible policy that should create faster growth, but will also create a lot of new debt. The Fed will have to raise the interest rate much quicker than some analysts anticipated if the fiscal plan will be executed.

The market also seems expensive, but it means nothing

So we enter an era of uncertainty while the market is at all time high, and many analysts believe the market is expensive. Is it really expensive? and what should we do? First of all, most parameters cannot predict whether the market is expensive. According to a research made by Vanguard only two metrics can partially predict if the market is expensive. They did it correctly 40% of the time, which is not very promising. However, I will look at both of them to try and get some insights.

The first metric is the P/E. According to the research it can somewhat predict if the market is expensive. The current P/E of the American stock market is 21.2 which is a little bit expensive. My rule of thumb when it comes to stocks is to look for P/E lower than 20. I only buy stocks with P/E higher than 20 if I see clear path for fast growth.

The second metric is the Shiller P/E- Cyclically adjusted price-to-earnings ratio. It is a more sophisticated metric that takes into consideration the moving average of 10 years of earnings. It is used to ignore one time fluctuations in earnings. When we look at the American market, the CPAE is 25.5 which is very expensive, and roughly where we were back in 2008.

You can use this website to see updates about the P/E, CAPE and other metrics. So if the market is expensive, should I as a dividend growth investor keep buying stocks? The truth is that I have no idea if and when the market will decline. Take a look at the table below. It shows many corrections. Some of them were brutal, some were when the market was considered cheap. It is impossible to predict, you can only guess.

Click to enlarge

What should I do?

The first possible option is accumulate cash, and wait for the drawdown. I won't sell my stocks, I will just have more cash in my portfolio ready for the right moment. The problem is that I might miss the gains in the stock market while I wait. This waiting can take years. Even if the market drops, who knows when I should actually start buying stocks. Maybe I am trying to catch a falling knife?

Another possibility is to look for assets that are less volatile like bonds. However, at the age of 26, I believe that I should allocate my capital to stocks as they offer higher returns for the long run. Besides, look what is going on in the bonds market, it is just as volatile as the stock market at the moment.

The third possibility is the one I chose. I will stick to my investment plan. I will keep transferring money from my checking account to my brokerage account on a monthly basis. I will keep buying individual stocks that in my opinion are valued fairly or even cheap. If the market keeps climbing, I will keep doing it. If we see a correction, I will keep doing the same as well.

I believe in my strategy of allocating funds to the brokerage account on a monthly basis, because it worked for me so far, and I believe it is the best way to cope with market corrections. Even if you invested in the Nikkei 225 in the 1980-1990, and kept investing after the bubble burst and reinvested dividends, you managed to achieve high positive returns.

Conclusion

We are entering a volatile era. In 2016 we saw some concerns about China. It continued with the Brexit in June, Trump in November and we might see instability next month in Italy if the current prime minister resigns, after the people reject his constitution changes.

If you think 2016 was volatile, 2017 might be full of more uncertainties. Elections will be held in both France and Germany, and in both countries we see the populist right wing parties emerging. Globalization is challenged across the world, and solidarity between nations is questioned as Euroscepticism is spreading. The globalization is a dialectic process, and we see some drawback lately.

The easiest thing to do is stop following the plan. However, I think that it would be terribly wrong to do so. We have a plan so we can follow it not only when it's easy, and everything going according to the plan. You might need to revise your plan, and see that it still fits you long term goals, but do not abandon it. Don't act impulsively.

In this month I kept following my plan. I bought some shares of Omega Healthcare (NYSE:OHI) as the current valuation seemed very compelling. If you think the market is too expensive, and it is hard for you to stick to the plan, try diversifying. Use the website to find cheaper markets, and look for opportunities there. Look at western markets like Australia and Norway. The opportunities are there, ignore the noise and stick to your plan.

Disclosure: I am/we are long OHI.

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.