There is no harder decision for an investor than making the decision to sell a good investment. It is always tempting to think the past will repeat itself, and good investments are not easy to find.
While the S&P 500 and most major U.S. indexes have rallied hard since the summer lows of last year, few sectors of the market have performed as well as dividend stocks over the last several years. Specifically, leading consumer staple and dividend stocks such as Coca-Cola (NYSE:KO), Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG), Altria (NYSE:MO), and Kimberly Clark (NYSE:KMB), have consistently outperformed most of the broader indexes by a fairly wide margin over the last couple years.
Still, while consumer staple companies have consistently been the strongest performing stocks in the market, cyclical stocks have consistently outperformed the broader indexes by a fairly wide margins over the last several month. Many leading cyclical stocks, such as GE (NYSE:GE) and Exxon-Mobil (NYSE:XOM), have significantly outperformed most leading consumer staple stocks by a fairly wide margin of recent as well.
History seldom repeats itself in exact form. Many consumer staple companies are now trading at the highest valuations these stocks have been at in years, and it is not reasonable to think these companies will continue to offer the same historically high income and total returns investors have recently seen. Leading dividend stocks also appear to be valued more based on yield more than fundamentals, and many consumer staple companies are increasingly relying on debt to increase these companies' dividends at unsustainable rates.
Still, the question raised by many dividend and income investors is why sell a successful investment if the story is still intact?
This is a particularly tough question for many investors because of the low cost basis that these individuals have in these companies. It is also a tough question because these stocks have consistently been amongst the best performing stocks in the market for nearly a decade.
Dividend investing is not fundamentally different than other investment strategies. The most important and immutable characteristic that most dividend investors look for is value. The only major difference between income investors and individuals more focused on total returns, is that while growth investors focus exclusively on total returns, dividend investors look for both strong income and total returns. This is exactly why many of the past arguments that traditional dividend and income investors have made against reallocating capital to more cyclical sectors are incorrect today.
The average age of individuals in the U.S. will increase significantly as baby boomers age, and with a growing deficit and fewer workers, the government is likely to increasingly look at taxing consumption and investment. The President has already taken a strong position on not extending the Bush tax cuts for individuals making over $250,000, and taxes on income and investment returns are historically low. While keeping the capital gains tax rate low encourages risk and investment, it is not clear that a low dividend tax provides any tangible benefit to the economy. If interest rates move and the dividend tax is raised even slightly, many high net worth investors will also shift capital to fixed-income investments that offer less risk and comparable income.
To conclude, many long-term investors are dangerously assuming that these individuals can simply hold dividend stocks and trade more cyclical companies, since business cycles over the last three years have been very short. A more balanced view is that while the slow and uneven recovery will not likely accelerate overnight, a near-term recession is also unlikely. While cyclical stocks may remain volatile for some time, volatile stock prices create great opportunities for long-term investors, and presuming that the economic recovery will not likely at least moderately accelerate over the coming years is an argument with little history behind it.
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.