Market Volatility May Pay Dividends, Eventually

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About: Flaherty&Crumrine/Claymore Preferred Securities Income Fund (FFC), HJV, HMLP.PA, JBN, JBR, JCP, KTP, PFH, STK, HMLP, Includes: AAPL, BA, BUD, CAT, DIS, GE, GS, HOBEX, IBM, IOFIX, KO, MHGVY, MIC, MRK, PEGI, SEMPX, SHLDQ, V, VTR, VZ, WBA, XOM
by: SA Marketplace
Summary

The Federal Reserve's rate hike consistency has had a predictable effect on dividend-yielding companies as much of the market. So what's next?

Marketplace authors see opportunities cropping up and the opportunity to mix offense in defense in the current climate.

Favorite names for 2019 venture off the beaten path, even when it winds back towards a beaten-down blue chip.

2018 seems to be ending on a bad note in the markets. December is setting the wrong kind of records, and Q4 has been a bumpy one in general. This is what happens in the stock market sometimes, but it's been easy to forget over the decade-long bull market.

We're using the end of the year as a chance to lift our heads, survey the market, and see what might be coming ahead. To do so, we're inviting our Marketplace authors to do a series of roundtables. 2018 was another steady growth year for the platform, and we have a lot of great voices on the Marketplace, so we wanted to share their perspective with you.

Our Year End Marketplace Roundtable series will run through the first full market week in January. We'll feature ten different roundtable discussions, with expert panels chiming in on Tech, Energy, Dividends, Other Income strategies, Gold, Value Investing, Small-Caps, Alternative Investing Strategies, Biotech, and the Macro Outlook.

This roundtable looks at dividend investing. Has the rising rate environment changed the game? How much does the market volatility matter? We ask our panel:

Seeking Alpha: What was the big story or lesson learned for you in 2018?

Richard Lejeune: We had a small rise in interest rates, and this resulted in a huge selloff in many high-yield issues.

Fredrik Arnold: Volatility can disrupt my buy-and-hold strategy. At best, volatility reveals bargains. At worst, volatility postpones profit-taking.

Joseph L. Shaefer: There was no lesson "learned" in 2018, only the repeat of lessons learned long ago - no market goes up or down in a straight line forever. As JP Morgan said when asked what the market would do going forward, he answered, "It will fluctuate." I have an article that shows the rise and fall and rise and fall and rise of the market over the past 20 years. There was no epiphany this year, just the inevitability of fluctuation!

Double Dividend Stocks: The Fed's ongoing deleveraging has lessened market liquidity, which has pressured equity prices over the past few months. Additionally, its rate hikes, although still at a modest level, have sparked concerns about future corporate earnings, due to higher interest costs. The Tax Act is now looking like a sugar high, and many companies will face tough comps in Q1-2 '19, due to the windfall they received in 2018 from the new tax laws.

Rida Morwa: The big story in 2018 is that high-flying technology and growth stocks that have led this market rally since November 2016 cannot go up forever. Going forward, market leadership will shift from growth to value. Many "value stocks and sectors", including high-yielding sectors such as Property REITs, Utilities, Business Development Companies and Midstream MLPs among others that have been out of favor, with many trading at their lowest valuations in years. It is time for investors to shift their investment strategy and allocate more funds to those sectors. Yesterday's winners are likely to be tomorrow's losers, and those stocks that under-performed in the past two years are set to shine. Investors are best served by allocating to higher-quality stocks, the highest for each sector.

SA: How much did the macro environment - increased volatility, rising interest rates - affect your investing strategy, if at all? If it didn't, what environment would affect your strategy (or your positioning, in any case)?

Richard Lejeune: The macro environment and market volatility have created some tremendous values in high yield. The best valuations we have had in years.

Fredrik Arnold: The upsurge in volatility across all sectors confirmed that a dividend yield strategy is an excellent indicator of two polarities: (1) challenges or (2) opportunities.

Joseph L. Shaefer: The macro environment affected and continues to affect my investment strategy. I've never believed the mantra from certain stockbrokers that you must simply buy and hold because "in the long run" the market always comes back. As John Maynard Keynes responded to that pabulum, "Yes, but in the long run we are all dead." I believe different times call for different tactical approaches to the market, all within the overarching strategy.

Double Dividend Stocks: Heightened market volatility in the fourth quarter increased option-selling yields to levels we haven't seen in the past few years.

Rida Morwa: The Federal Reserve has clearly disappointed investors with its interest rate outlook this week. With the new perceived uncertainties, there is a possibility that this market correction may last longer. However, I still believe that we will not see a full-blown bear market or any pullback even close to what we have seen in the last financial crisis of 2008 and 2009. Putting things into perspective: So far the S&P 500 index has fallen 13% from its record high logged on September 21. There is a risk that the index can further fall another 1% and up to 7% so the worst of this correction should be behind us. Also let us be clear: the one fact that Mr. Powell highlighted correctly is that the economic growth in the year 2019 will be slower but will remain robust. The risks of an economic recession in 2019 are close to nil. I still expect stocks to regain their buoyancy and to perform well into next year, with lots of room for the market to run. We should also take into account that the Fed has reduced its rate-hike projections for 2019 from three increases to just two. Furthermore, the Fed left the door open for review of these rate hikes: this means that the actual number of rate increases next year might be zero. I recommend that investors be patient and I am optimistic about the outlook for 2019.

SA: Mega cap dividend payers like Anheuser-Busch (BUD) and, alas, General Electric (GE) cut their dividends meaningfully this year. Sign of the times or something specific to those companies?

Richard Lejeune: I don't follow the mega cap dividend players. There is already so much excellent Wall St. coverage already for these issues. It's hard to add value by covering them.

Fredrik Arnold: There are companies that become too big to succeed by losing their focus and ability to innovate. More expensive cash due to higher interest rates will hurt dividends.

Joseph L. Shaefer: Specific to those companies. I don't think we really have the time or ink to discuss all the ways GE was mismanaged. Many a fine American company has been sidelined because of changing technologies or fickle consumer tastes - others manage to shoot themselves in the foot all from within.

Double Dividend Stocks: GE needs to conserve cash. However, as we pointed out in our recent article, "GE & AAPL: High Yield Alternative Strategies For Falling Knives", GE shareholders can make much more $ via selling GE options. GE has put options with breakevens well below its lowest price target that yield up to 30%-plus annualized.

Rida Morwa: When investing in any dividend stocks, three main points have to be taken into account: the sector outlook, company valuations and the safety of the dividends. In the case of GE and Anheuser-Busch, these two companies were clearly facing headwinds with demand for their products slowing down. Therefore this situation was company specific and does not change the outlook for the vast majority of the dividend stocks.

SA: Any dividend stocks you fear may be headed down a similar road? Or how are you avoiding these potholes?

Fredrik Arnold: At least half of the Dow industrial index needs to shed weight. I look for their prices to fall but dividends to hold or increase for Walgreens (WBA), IBM (IBM), Exxon (XOM), Merck (MRK), Goldman Sachs (GS), Coca-Cola (KO), Verizon (VZ), and Disney (DIS).

Joseph L. Shaefer: If it sounds too good to be true, it is likely a lie. We all have the ability to assess a company's revenues, earnings, cash flow and prospects for the future. In common stocks, I prefer companies that plow earnings back in their business while paying a respectable dividend that grows each year. In troubled times like we may be approaching now, I look more to preferred shares and alternative income offerings. In these cases, I don't expect capital gains, so I want maximum income consistent with the company's ability to continue offering the dividend or distribution I signed up for.

Double Dividend Stocks: Some MLPs have been challenged to cover their distributions in 2018, due to lower distributable cash flow. However, there are many others which are now offering very attractive and secure high yields, due to the market pullback.

Rida Morwa: In this economic environment, it is best to be defensive and avoid cyclical stocks. For example, we are avoiding the automobile sector which is a highly cyclical sector that can see dividend cuts in case of a slowing economy. Non-cyclical sectors include those sectors that will see continued demand even in case of an economic downturn, and those include for example Property REIT companies that enjoy long-term contracts with solid tenants, or high-yielding renewable energy companies whereby demand for electricity and power is relatively inelastic. Two good examples of defensive stocks that we like are Ventas (VTR), a healthcare Property REIT yielding 5.1% and Pattern Energy (PEGI), a renewable energy stock yielding 9.0%.

SA: What was a positive surprise for you in 2018, or a counterweight to the GEs of the world?

Richard Lejeune: I think we will see a lot of positive surprises in 2019 as a result of the brutal 2018 selloff in high yield.

Fredrik Arnold: Boeing (BA), Caterpillar (CAT), Apple (AAPL), and Visa (V).

Joseph L. Shaefer: The decision by the United States to stop kowtowing to every nation that wants something without offering equal value in return. The current trade and tariff dispute between the US and China engenders hair-pulling from Wall Street analysts because they only see (or care about) the possible economic consequences. National security and moral integrity count for more. There are many nations willing to sell goods to American consumers at a fair price.

Double Dividend Stocks: Marine Harvest (OTCPK:MHGVY), the world's leading salmon producer, has returned over 35% for our Hidden Dividend Stocks Plus subscribers in 2018. We're all eating more fish, and Marine Harvest continues to capitalize on that trend. It yields over 6%.

Rida Morwa: There are many examples that counterweight the GEs of this world. One has to look at the Property REIT sector, another high-yielding sector, to see what is happening. Despite all the fears over rising interest rates, REITs once again came ahead in the last quarter with very strong results. 46% of REITs beat on earnings expectations, 39% of REITs met their expectations, leaving only 15% missed on expectations.

While this outperformance may be surprising to many, we have long been vocal about how REITs are poised to profit in today's market environment. Yes, interest rates have been rising, and all else held equal, earnings of Property REITs have not been negatively impacted. If anything, many Property REITs keep reporting record earnings and hiking dividends. The reason is that interest rates are on the rise because the economy is growing at a healthy pace, and Property REITs tend to thrive when the economy is performing well. A growing economy leads to higher occupancy rates, higher rents, and more demand for real estate space in general. All very positive for REITs. It is directly reflected in the most recent results, with most REITs achieving higher FFO and dividends per share so far in 2018. We expect Property REITs to keep outperforming in their earnings in 2019 and beyond, and this is one of the best sectors for high dividend investors to consider today.

SA: Describe what's unique about your approach to dividend investing, and how it's suited for the current market (or, how you're adjusting it for the current market).

Richard Lejeune: The Panick High Yield Report focuses on many smaller issues including preferred stocks, and baby bonds with limited Wall St. coverage. There are more mispriced issues in areas that are too small for traditional Wall St. analysts to cover.

Fredrik Arnold: The high-yield chase has become super-risky. My next five-year plan is to perfect my techniques for targeting outstanding, proven dividend winners.

Joseph L. Shaefer: What is unique about my approach? Nothing. Anyone can do it. Just be willing to cover the waterfront of every dividend opportunity out there. I don't stovepipe myself into being a REIT specialist, though I use REITs. I look for dividend growers, preferred shares, REITs, business development companies, and alternative income sources with little or no correlation to the US stock markets. (In this latter area, I am finding great success with funds like IOFIX, HOBEX, PAITX, SEMPX and others.)

Double Dividend Stocks: We enhance dividend yields by selling options. This strategy can also add some defense to your portfolio, giving you lower breakevens. We also utilize some low-beta dividend stocks, which fly under the radar of the market, and can help stabilize your portfolio.

Rida Morwa: At High Dividend Opportunities, our aim is to find high-dividend stocks that have gone out of favor despite solid fundamentals, and that are trading at very cheap valuations. This strategy also often results in finding stocks with exceptionally higher yields. Some of our recent picks included Macquarie Infrastructure Corporation (MIC), a highly diversified company operating in the infrastructure segment. The stock had clearly over-reacted and lost 44% of its value due to the dividend cut, but investors seem to have overlooked the fact that their free cash flow only declined by 8% and does not warrant a drop of 44% in the stock price. Following the dividend cut, MIC has a better outlook, a huge dividend coverage, decreasing leverage, and a much stronger balance sheet. This stock, with a 10.7% yield, represents a perfect situation of a mispriced, high-yield quality dividend stock, the type we like to target.

SA: What is one of your best ideas for 2019, and what is the story?

Richard Lejeune: KTP and the other J.C. Penney (JCP) 2097 bond trusts including HJV, PFH, JBN and JBR are tremendously oversold. Some are now trading for less than 25 cents on the dollar. They are trading at a very large discount to the JCP 2097 bonds held by the trusts. JCP and the retail sector are currently despised by investors. Despite all its well publicized problems, JCP remains cash flow positive. It has excellent liquidity and has no major debt maturities for a few years. The new CEO has a chance to turn things around. A strong economy with low gasoline prices and the recent demise of some of its competitors such as Sears (OTCPK:SHLDQ) should help.

Fredrik Arnold: Double my holdings in GE at $5 and ride its resurgence for the next 40 years.

Joseph L. Shaefer: Only one, huh? But there are so many! OK, here's one I just started buying. The Höegh LNG Partners L.P. 8.75% Cumulative Redeemable preferreds (HMLP.PA) were issued at a $25 per unit par value on Sept. 28, 2017. I believe the switch from oil to natural gas is a force that is only beginning to sweep the world. Natural gas is a cleaner-burning fuel, we are finding it in ever-greater commercial quantities via horizontal fracturing and ever-better 4D exploration technology, and we now have the technology to liquify this gas in order to make shipping it across the oceans and around the world technologically and environmentally feasible and economically quite profitable. Höegh LNG (NYSE:HMLP) owns 2 LNG carriers and 8 (soon to be 9) Floating Storage Regasification Units (FSRUs.) Since the volume of natural gas in its liquid state is about 600 times smaller than its volume in its gaseous state, it makes sense to transport it in this manner. (After all, it takes energy to move the ship, as well). I think Höegh's expertise in FSRUs will appeal to many nations or utility giants who would find it more cost-effective to lease a regasification unit from a firm like Höegh LNG than to incur the expense and long learning curve of building their own regasification unit. This preferred has sold off to where its yield is now 9% per annum. Could the price decline further? Of course! In which case I will likely buy more, so long as I analyze that the issuing company looks like it will continue to increase its revenue and earnings enough to continue meeting all its debt obligations.

Double Dividend Stocks: The Columbia Seligman Premium Technology Fund (STK) holds big cap Tech names, such as Apple, Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Broadcom (NASDAQ:AVGO), and many others. Tech stocks are stingy with their dividends, but STK uses a covered call strategy to enhance the yields. After this past week's pullback, it's selling at 52-week lows, and it yields over 11%.

Rida Morwa: As stated above, for income investors, the year 2019 is the year to start getting defensive with higher-quality stocks. Some of our best ideas come in the Preferred Stock space. While preferred stocks seldom go on sale, market volatility has created some unique buying opportunities. Preferred stocks have not recovered despite the fact that the Fed stated that there will be less interest rate hikes going forward and despite the pullback in Treasury yields from 3.2% to 2.76%. For income investors, the preferred stock space is one of the most defensive and conservative way to get exposure to high-yield stocks. Because all the dividends on preferred shares have to be paid before any dividends can be paid to common shareholders, the dividend payment is also safer on preferred shares. Furthermore, preferred stocks carry substantially less price volatility than common shares, and thus can be more suitable for conservative investors and retirees.

Our best picks include a preferred share closed-end fund, Flaherty&Crumrine/Claymore Preferred Securities Income (FFC), yielding 8.2%. FFC is a solid closed-end fund that invests in high-quality preferred shares. It has a proven track record, a history of outperformance, and a very juicy yield relative to the safety and the quality of the fund. We recently wrote about FFC here. With a large discount to NAV and a projected yield of 8%, investors are getting a notably higher dividend yield compared to historic averages. It is opportunities like this one that we seek and are currently recommending to our investors.

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Thanks to our panel for sharing their insights on dividend investing. If you want to follow up on any of their public work or their Marketplace services, here are the links:

Our year-end Marketplace Roundtable series wraps up over the next two days. Tomorrow we cover alternative income approaches - REITs, CEFs, etc. - and then we compile the top ideas for a last article on Sunday.

Disclosure: I/we 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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Richard Lejeune is long KTP, JBN and JBR.
Fredrik Arnold is long GE.
Joseph L. Shaefer is long HMLP-A, IOFIX, HOBEX, PIATX, and SEMPX.
Double Dividend Stocks is long MHGVY and STK.
Rida Morwa is long VTR, MIC, FFC, and PEGI.