Despite Corona Uncertainties - I Will Be Loading Up On Quality Stocks

Summary

• The stock market has entered a period of massive uncertainty resulting in near-record volatility and rapid losses.
• Yields are dropping to new lows, resulting in tremendous pressure on the dollar.
• I believe dividend investments remain key to a successful long-term investment and should be bought at a discount.

I have to be completely honest. I hoped I did not have to write this article. Since my last market update, a lot has happened that warrants a new update. In my last article, I was bullish as economic indicators were bottoming and supporting cyclical stocks. Everything went right until the coronavirus escalated. Right now, we are in a period where current economic news does not matter. While leading indicators and jobs further strengthened, investors looked the other way as everything will be worthless once the coronavirus shows its true colors and impact on the economy. Needless to say, my dividend stocks took a beating. Nonetheless, I am everything but depressed and look forward to buying more at lower prices. In this article, I will tell you why.

Source: PhocusWire

Volatility Is Back - And It Has Gotten Ugly

If there is one thing the market hates, it's uncertainty. Everything that causes uncertainty somewhat pressures stocks. In 2008, it was the uncertainty surrounding liquidity and loans, in 2016 the market was pressured by rapidly falling commodity prices and a manufacturing recession. In 2018, investors were facing trade uncertainties. Q1 of 2020 is shaping up to be the quarter crushed by the coronavirus. While stocks held up quite well in the first weeks of the year, everything came down crashing when global coronavirus cases started to accelerate. I am sure everyone knows what the S&P 500 chart looks like, but here is the bigger picture:

Source: TradingView

As stupid as this sounds, but we are once again in a correction that is clearly visible on the chart. We are actually in the quickest correction in history. Never before have stocks entered a correction at a faster pace than in 2020. On top of that, the market is moving by 3% almost every day (either up or down) for almost two weeks. That's no surprise as volatility is at its highest levels since the recession of 2008.

Source: TradingView

Oil has hit its lowest level since 2016, energy stocks (XLE) are down 32% since the end of 2019 and the long-term bond ETF (TLT) is up almost 20% since February 17, 2020. Madness is real and I would be lying if I said I wasn't affected. As most of my readers know, I have a significant part of my money in dividend stocks. While I hate being in this position, one needs to accept that there is no gain without pain as cliche as that might sound.

While I have not sold a single share, I will make some changes. For example, I will sell all actively managed funds I own. While I am writing this, my biggest position is a dividend fund at the Dutch Robeco firm (see my SeekingAlpha) biography. I am selling not because I dislike their services but because I expect the dollar to rapidly depreciate and because I want to actively manage my flow of dividends. As a Dutch investor, this means my dollar assets will relatively depreciate in a scenario where the dollar weakens further. While this does not apply to US-based investors, I am convinced you will benefit from my explanation and my solution to the problem.

The Dollar Is Dead - And So Is Yield

This sub-title might be a bit exaggerated, but I believe it surely applies to the mid-term and current central bank policies.

On March 3, 2020, the Fed executed an emergency rate cut. The Fed funds rate declined from 1.75% to $1.25. That's a decline of 50 basis points to fight the ongoing market decline. The market jumped more than 2% within a minute. Unfortunately, the market immediately declined as investors did not care enough. In my opinion, the Fed should not have lowered interest rates, or at least only by 25 basis points. The current environment is not suffering from liquidity problems but from fears that supply chains are breaking down due to sickness. One cannot fix that by lowering interest rates (only). Your decision to avoid crowded places is not based on too high-interest rates but on health concerns. Either way, the market was not satisfied as investors are still expecting 50 basis points cut to occur in March. Yes, that would be a 100 basis points cut within one month. The graph below shows the difference between the 2-year government bond yield and the Federal funds rate. Note that this graph does not yet show the emergency cut. In other words, expectations are not more than 100 basis points, but 50 basis points.

Source: TradingView

The reason I hate to see this is because it makes 'finding yield' even more difficult. By cutting rates and expecting even further cuts, the market in the US has put itself into a disadvantage. Even compared to Europe with its fragile governments and refugee crisis and negative interest rate policies.

Below is a graph that compares 2-year government bond yields from the US to those from Germany and Australia. The orange line is the Australian 2-year yield minus the US 2-year yield. The black one replaces Australia with Germany.

Source: TradingView

As you can see, investors were better off in the US since the recession as yields in other regions declined much more rapidly. The trend really heated up when the ECB started to move to negative interest rates. As you can see, this trend has changed and momentum is building rapidly in 2020. Within weeks, both charts made new multi-year highs. As a result, the dollar index as pictured below lost almost 5% within 2 weeks. While markets were tanking rapidly, investors did not care to buy the world's safest currency - that's how strong this trend is.

Source: TradingView

And that's not everything, the S&P 500 dividend yield is almost 80 basis points above the 30-year government bond yield. That's unfortunately not a typo. In other words, while dividend stocks have increasingly become dividend proxies, we are now in a situation where even lending your money to the government for 30 years won't cover the expected 2% annual inflation rate. And even stocks are not worth buying as long as the coronavirus is threatening supply chains.

I Am Buying

See, as I expect the dollar to further depreciate, I am looking for ways to change my portfolio. First of all, I am still a bull and believe in the market's long-term potential. As a result, I will continue to buy stocks. I will start buying currency-hedged ETFs listed on Euronext Amsterdam. For example, this MSCI World ETF from iShares allows me to track the stock market without being exposed to currency risks. In addition to that, I will put at least 25% of my money in high quality US dividend stocks.

Below is a list of stocks I consider buying and or adding to.

Source: Portfolio Visualizer

A simple equal-weight portfolio based on the stocks above has returned roughly 17% per year since the end of the 1990s and outperformed the market in both bull and bear markets.

Source: Portfolio Visualizer

The reason number one I am adding to my portfolio is the stock market decline of currently more than 15%. These declines happen every other year and are a good way to expand one's portfolio. The other reason is that I am 24. God willing, I have many years left to benefit from the stock market and dividend payments. This is also the reason I have almost no bond exposure. The third reason is based on everything discussed so far. With bond yields close to zero, I believe owning quality dividend stocks is valuable - except if you expect the economy to never ever recover...

Takeaway

I wish I could tell you when the economy is going to recover. While I have been able to predict almost every economic turn since 2013 based on my leading indicators I have no idea how this whole coronavirus thing is going to play out. It could be bad, it could be better than expected, and it could be devastating. What I do know is that the market is not going down forever. With the market being down 15%, a lot has been priced in already. On top of that, yield developments have created a scenario where avoiding dividend stocks could be a costly mistake.

I will increasingly add to my portfolio over the next few weeks. I am planning on buying the stocks you saw in the Portfolio Visualizer screenshot. I will also buy a hedged MSCI World ETF to be prepared in case the dollar starts to fall even further.

My advice to everyone is to play it safe. Regardless of whether you are a trader or investor, keep your cyclical exposure small and focus on stable companies that can provide either sustainable dividends and or companies that have a proven track record of following the market (for traders). Don't use the money you might need in the short-term and don't make sudden decisions based on emotions.

It sounds easy, but this market is tough. Best of luck to everyone and let me know what you think!

- Leo

Thank you very much for reading my article. Feel free to click on the "Like" button, and don't forget to share your opinion in the comment section down below! My long-term investments are stated in my Seeking Alpha biography.

Analyst’s Disclosure: I am/we are long O. 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.

This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.