Why We Are Bullish On Equities Despite The Big Run
Summary
- We share our views on equities and explain why we remain bullish despite the big run since May 2020.
- High dividend stocks are the best place to be.
- We also share our best dividend picks to buy today.
- Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Get started today »
Co-produced with Beyond Saving
Market Update
With the markets moving on a definite positive tone, we thought we would give our readers and followers a quick update sharing our views on equities in general and high dividend stocks in particular.
The fact is that this huge rally we have seen from March 2020 lows has taken most retail investors and investment professionals by surprise. Pessimism was at its highest point, and unfortunately many retail investors gave up and sold positions at a big loss. In the past two weeks alone, the S&P 500 has rallied 8.1% and the Dow has climbed 10.8% higher.
Here at High Dividend Opportunities, we took an opposite view that the markets are set to rally, and we encouraged our members to remain invested. It was our opinion that we will see a sharp recovery. Basically our optimism was from a belief that any lockdown would be only temporary, and that the economy will be able to recover fairly quickly. Based on the jobs report, it was confirmed that the economy is well ahead of all expectations. The recovery began quite soon and in full force, driving the equities higher.
Another Strong Reason Behind the Big Market Rally
There's another reason for stocks to have seen this very strong rally. I have explained it in many of my previous market updates. Investors across the board are hoarding large amounts of cash and there's no other place to invest and get yield. While many retail and professional investors missed out on the rally, it has been institutional investors that have been massively buying equities. The reason is that bond yields are so low that institutions were forced to sell bonds and buy equities to enhance their returns. Basically, for these institutions, there was just no other alternatives to buying equities.
Risks to the Equity Markets
There are three main risks that we should highlight:
- Another virus scare that would shut down the economy again. There are hopes that a vaccine will be available in early 2021, but the risk remains that if infections increase prior to that in late 2020, and government reinstates restrictions, then we may see another pullback.
- The Fed stops its bond repurchase program and liquidity initiatives. If that happens, then yields on Treasuries will go up, and it could result in a pullback in equities. The good news is that the Fed will most likely continue to add liquidity to the system, which would support the price of equities. So I view this risk to be a low one.
- Inflation risks: The high liquidity being pumped into the system should eventually increase the risk of inflation, and thus prevent the Fed from keeping interest rates at the current level. Inflation is a real risk, and this is why we have started a series of articles on how to protect our members against inflation. Having said that, it's unlikely that we will experience inflation before two to three years, and therefore I rate this risk as a low one too.
What Does History Tell Us
We just saw the strongest 50-day period whereby the S&P 500 has surged more than 39% during this small period. This is the S&P 500’s biggest 50-day move in more than 75 years. Bespoke did some historical analysis based on such a move. This 50-day surge could indicate that there's further strength in the coming months.
There have been two other instances since 1952 where the S&P 500 index rallied over 30% in a period of 50 days. Interestingly, these strong surges were followed by even higher moves for the S&P 500 index in the one-month, three-months and six-months periods. According to the study: "Those two short-term massive spikes turned out to be the first inning of multi-year bull markets."
Furthermore, Bespoke expanded their study to look at 50-day gains of 20% or more. There were seven such instances and in all of these instances, the S&P 500 gained an average 10.1% in the next six-month period. Based on this study, the medium- and long-term outlook is very bullish.
Equity Market Valuations
Based on a P/E Ratio, the markets look overvalued today. Currently, the forward P/E Ratio is at 24 times which is very high. However, based on the yield spread between the S&P 500 companies and Treasury Yields, they are not expensive.
Here it's worthwhile to note that while corporate earnings have declined and unemployment has soared, going forward this should all reverse fairly quickly. Companies are set to re-hire at an unprecedented rate and earnings are set to get a big boost as the economy resumes back to normal after the lockdowns.
Of course, the markets are forward looking. Taking into account that corporate earnings will most likely be much higher next year, the P/E ratios will compress, resulting in lower valuation of equities, meaning that the valuations that look expensive today will not be as expensive in the year 2022. According to analysts' estimates, the P/E ratio for the year 2021 should be at 17 times which puts it in line with prior year valuations.
Short-Term Outlook
While I'm bullish on the medium- and long-term outlook of equities, I am not bullish on the short-term outlook. The markets have gotten ahead of themselves. At this point, the very likely scenario is that we will see a market pullback. However, such a pullback is likely to be met by those who missed the rally and wish to buy and hold for the long term. There's a massive amount of liquidity out there which will continue to push the market higher, and it's likely that investors are now looking to go toward all-time highs.
The bottom line is that the stock markets will possibly see a 5% to 6% market decline short term. Following the pullback, I believe that we will see a period of consolidation and that by year-end the markets should be higher than they are today. The major risk is if the virus infection rates increase significantly to prompt another wave of shutdowns. With interest rates at their all-time lows, dividend stocks are set to continue to see high investor demand, which would set them for the best returns over the next two to three years. High dividend stocks with solid cash flows are the best place to be.
As part of our Marketplace service, we are continuously monitoring the equity markets on behalf of our members and provide guidance on the best high-yield investments to buy. We are currently recommending a +40% allocation to fixed income, mostly in preferred stocks and preferred stock CEFs such as John Hancock Preferred Income Fund (HPI) yielding 7.2% and Flaherty & Crumrine/Claymore Preferred Fund (FFC) yielding 6.7%, among other CEFs.
Best High-Dividend Stock To Buy For the Week
Every week, we provide a summary for our members on the best high dividend stocks to buy.
While we are bearish on the market in the short term, we would like to highlight some of the best picks to buy for those who have larger cash positions, are adding new cash or on a pullback of 3% or more for the S&P 500 index.
We would also like to caution our readers of falling into the "recency bias" trap. Recency bias is something we have discussed in previous articles, it's the habit of putting more weight on events that occurred recently than on things that happened further in the past. For investors, this bias frequently appears in relation to stock prices.
Consider EPR Properties (EPR):
Data by YChartsIf we think of the past few months, EPR is up over 100%. It's up 240% off its rock bottom in March. Since most recently, EPR was trading in the $20s, it's easy to look at it today and say "wow, that is expensive." If we asked people to comment on EPR's price, a lot of people today would describe it as "high," and you might see comments like "I will consider adding when there is a dip."
When we look at the long term, we gain some perspective.
Data by YChartsLooking at the long term, it's very easy to imagine that today is very likely going to look like EPR in say late 2009. Yes, the bottom passed, but it was still cheap relative to what it was in 2008, and more importantly, cheap relative to what it would be in 2010 and beyond.
Someone sitting at 1/1/2010 might have looked at EPR and decided it was "too expensive" because of recency bias. Here's what the chart would have looked like:
Data by YChartsIt was up 130% from April. However, in 20/20 hindsight, we know that Jan. 2, 2010, was an excellent day to back up the truck on EPR.
Data by YChartsEPR went on to more than double the performance of SPY over the next year.
Long term, EPR is still very cheap. Investors today are not going to be unhappy about it if they hold for the next few years. Even if we do see the immediate bullishness wear off, concerns over AMC possibly filing bankruptcy resurfacing, another round of COVID-19, or other possible unforeseen obstacles. We added EPR to our portfolio because we believe it's an extremely well-run REIT in a very profitable niche and that they have the balance sheet and ability to handle problems in a manner that will reward shareholders over the long-haul. In short, we bought it because we believe it's a very good company that's trading at a discount.
With that in mind, this week we are going to focus on those picks that we believe have very good long-term value. These are great companies that are trading at a discount, even if relative to last month they are expensive, and even if there is some risk of a broad market sell-off in the near term.
Other Great High Yield Picks
We also are sharing today three picks that we recently highlighted to our members and are worth buying/adding today. Note that yields are as of June 8.
1- Equity REITs
- W. P. Carey (WPC) - Yield 5.8%. In the early stages of the market decline, Beyond Saving wrote in an e-mail "if WPC drops below $70, I think we should snap it up." As it turns out, we were able to issue our alert when WPC was in the $50s buying at a price well below what Beyond Saving thought was a great price. WPC has reported revenue collections in the mid-90s, outperforming their peers by significant margins. This is a great triple-net REIT, and like we said last week in regard to Realty Income (O), "The opportunity to buy this blue-chip at a discount is closing." O is now a little bit outside of our buy range, while WPC is still there. Those who do not have a full allocation should pick some up while it is still below $70.
2- Healthcare
- Physicians Realty (DOC) - Yield 4.9%. DOC primarily owns medical office buildings (MOBs). This market was very strong pre COVID-19 and there's little reason for the drop. Doctor's offices have great rent coverage and are among the first businesses being allowed to open back up across the country. DOC's rental collection was 96.8% for April, with 3.3% of that being collected in May. May rental collections appear to be on track to match that. As the rest of their tenants open, we expect that DOC will be collecting materially all their rent next quarter. A great medical REIT to add to a defensive portfolio.
3- Mortgage REITs and Financials
We continue to add to our mREIT positions. Compared to some other sectors we invest in, agency mREITs had modest performance last week. The market has stabilized and there has been no real news to act as a catalyst. We can expect the sector to continue climbing slowly/trending sideways, and look for some upward catalysts to be in earnings. Last week, we saw the 10-year Treasury rate go up, rates at the short end stay low (their cost to borrow) and prepayment rates were lower in May than in April. All of which is very bullish for agency mREITs. None of which was really reflected in the price action last week. mREITs continue to trade at a large discount to their last reported book values, and book values are almost certainly much higher after last week.
One of our highest conviction picks today is:
- Annaly Capital (NLY) - Yield 13.7%. The oldest pure agency MBS mREIT will be internalizing, which will enhance shareholder value. Additionally, NLY is well positioned to benefit from declining borrowing rates. NLY is very likely to maintain their generous dividend.
Conclusion
Despite the big rally, we remain bullish on equities in the medium and long run, and we will possibly see new market highs relatively soon. You cannot fight the massive amount of liquidity that's in the market today. Furthermore, there's no better alternatives (or investment opportunities) than equities. With interest rates being so low, and expected to remain so for the foreseeable future, we believe that solid dividend stocks that offer a high level of income are set to strongly outperform.
When recommending high dividend stocks, we also look for the resiliency of the business model so that cash flows remain strong in both good and bad times. Each week, we provide our members a list of dividend stocks to buy, add, or take profits on. As highlighted in the report above, we have been long HPI, FFC, DOC, EPR, NLY and WPC, and we remain bullish despite their huge recent run-up and the profits we made. We plan to hold these high yielders for the very long term.
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This article was written by
Rida Morwa is a former investment and commercial Banker, with over 35 years of experience. He has been advising individual and institutional clients on high-yield investment strategies since 1991.
Rida Morwa leads the investing group High Dividend Opportunities where he teams up with some of Seeking Alpha's top income investing analysts. The service focuses on sustainable income through a variety of high yield investments with a targeted safe +9% yield. Features include: model portfolio with buy/sell alerts, preferred and baby bond portfolios for more conservative investors, vibrant and active chat with access to the service’s leaders, dividend and portfolio trackers, and regular market updates. The service philosophy focuses on community, education, and the belief that nobody should invest alone. Lean More.Analyst’s Disclosure: I am/we are long HPI, FFC, EPR, O, NLY, WPC. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (56)
We have the biggest disconnect from the real economy since the Dotcom Bubble and still people are thinking everything will be ok. When do they get it.
If Asset prices only go up we would all be jumping in the markets like crazy and that's what is happening. But lets see how the FED Put and Government bailouts play out.
Maybe we have found the holy grail and will never experience a recession again and just dump money on everything as soon as things get dire.
Stocks like AAPL, MSFT and others just felt back to their October 2019 levels in one of the biggest and fastet crashes ever in March. I don't know but that seems a bit ridiculous to me.
I had expected see them pull back to at least their 2015 or 2016 prices.
Lets be honest the stock market tanked a bit but that was not a crash more like a minor correction.
@Rida Morwa, you seem to be wildly optimistic and in a "buy, buy, buy" mode about 150% of the time! Is there any point in the history of the universe where you suggest selling out? :)
There's something wrong, too much euphoria, not enough substance in the numbers.
Stay on the sidelines for now, but keep the watchlist ready.
insurance business on the winning side. No less than the sage of Omaha has
always liked the insurance business.
