Co-produced with Treading Softly
Welcome to a new administration. Joe Biden has officially been sworn in as the 46th President of the United States, and whether he was your chosen pick or not, he's Mr. President now. With that, we now need to focus on the market.
The market is not taking a break but continues to move forward. What's great about the equity markets is that they are a forward-looking mechanism. For the markets, the COVID-19 pandemic is a thing of the past. Smart investors are seeing the economy re-opening, people traveling, on cruise ships, going to malls, restaurants, and theaters. Things will get back to normal.
With a slim majority in the House of Representatives and the Senate, Democrats and Biden's administration have the room to push an agenda forward concerning COVID-19 stimulus, immigration overhaul, and infrastructure spending. We see two of these focuses providing more fertile ground for the market to move higher.
This is why we are seeing strong momentum across the markets.
Only A Handful of Stocks Led the Markets Higher
It's well known that the Nasdaq is technology and growth heavy (including FAANG stocks), but you cannot let the S&P 500 be forgotten either.
With Tesla (TSLA) now having joined the S&P 500, its concentration is likely to have only gotten worse. TSLA saw a massive spike in price leading up to and after its entrance into the S&P 500.
The Real Reason Behind the Soaring Markets
There are many reasons why the markets keep going higher, including:
- Pres. Joe Biden has been inaugurated and all the news cycle about attempted coups is over.
- COVID-19 numbers are rising, but the world is focused on the rate people are being vaccinated.
- The U.S. economy has been very resilient in the face of the pandemic. This has been evidenced by the vast majority of economic indicators, and the solid earnings season that we have witnessed in the third quarter.
However, the big reason why the markets are seeing such strong momentum is the enormous amount of cash that was sitting on the sidelines prior to the election outcome and the vaccine news. I have been pounding on the table that investors take advantage of the market weakness for many months now. You can check my report dated Oct. 21 about High Dividends And The Bubble Of Cash On The Sidelines.
Take a look at the large cash inflows coming into equities.
Value stocks have lagged growth stocks overall in 2020, as it has in previous years.
However, in the later months of 2020 and into 2021, value stocks have staged a strong comeback:
Value took off as the year ended and a rotation from growth to value occurred. As we can see above, value stocks have a long way to go to fully catch up to growth. This sets the stage for stronger returns from value, but also means they are extremely cheap in comparison.
All this coming together has created a perfect time to buy high-dividend stocks before their relative cheapness is gone. What other factors also are in play? Let's have a look.
The Prime Rate Will Remain Near Zero
The Federal Reserve has not sparked any hope in the prime rate being raised for a couple of years. The committee, which decides on rate changes, expressed its belief that rates will remain near zero. I expect that will continue until 2023 at least.
Janet Yellen has been tapped by Biden to be the next Treasury Secretary. Long-time investors will remember Ms. Yellen as the Federal Reserve Chair being referred to as the "dove of all doves." She's credited for most of the policies that helped the economy recover from the Great Financial Crisis. In fact, she has been the "protector" of equity investors, and has our backs. We can expect a very accommodating environment from both the Federal Reserve and the Executive Branch.
For you and me, this means that returns on CDs, money markets, and Treasuries are effectively yielding negative returns if inflation is factored in. These negative rate options are not viable ones. Savers will continue to be pushed to seek other options for their hard-earned money, whether in preferred shares, baby bonds, or high-yielding stocks.
The Gap Is Ready to Close Between Growth and Value
Growth vs. value has been a long-time disagreement, but when it comes to total return investing, growth has been dominant again in 2020. I personally invest exclusively in high-dividend stocks. For me, building a portfolio for retirement means recurring income for the long term. This is not for price gains alone. I recognize that the valuations and concentration in a select few growth stocks have propelled them to unsustainable values. This trend will not continue.
The great news is that "value stocks" have been seeing their biggest rally in decades as evidenced by the recent strength in the Russell 2000 index. Large and institutional investors started to shift their portfolio from growth stocks to value stocks at the end of October, creating leadership in value stocks as seen in the performance of the Russell 2000 index (IWM) vs. the S&P 500 index (SPY):
The Russell 2000 index which is comprised mostly of value stocks has returned 30.75% compared to only 4.95% for the S&P 500 index since Sept. 1.
I get arguments every day that FANG stocks, or the Apples (AAPL) and Googles (GOOG) (GOOGL) of the markets, have strongly outperformed over the past two years. But past results are not indicative of the future. For sure, rising tides will lift all boats, so I don't expect those that are holding these red-hot tech stocks will lose money. But they are set to strongly underperform in this kind of environment as "value" outperforms growth.
As income investors, we rarely jump into stocks that do not pay dividends. Value investors have strong tailwinds going forward. Profit taking from growth names into value picks will continue until growth sees its values return to historical norms.
The good news is that "value stocks" in general, and most dividend stocks in particular, remain extremely cheap relative to the markets. This is despite the recent rally. Remember, we are starting from a very low point for these stocks which have underperformed growth stocks for many years now. There's still tremendous upside, in addition to "locking in" the high yields that are offered today.
With debt being cheap, banks being stingy to savers, and growth names not meeting the real-world cash needs of many retirees and investors – many value names today offer both high dividend yields and large upside potential.
Yield - A Function of Dividend Rate and Price
Often the mantra – high yield means high risk – is misunderstood. Like many other mantras, it looks good in writing and maybe on a t-shirt in your favorite color, but it often is misused.
The yield offered by any security is determined by the dividend rate paid by that company and its share price. As the rate goes up, or the price goes down, the yield will rise. Likewise, the inverse is true. Often companies will see high yields after rapid price declines and this could be a sign of something catastrophic, but not always. This is why understanding real risk is important.
Being afraid of anything with a high yield is like being afraid of anything painted red. It's silly. Fire is red, so that red barn must also be bad! You'd likely want to lock up the person thinking like that, but some of you do when it comes to yields.
Perceived risk is what "high yield equals high risk" plays into. It's an off the cuff, no research risk evaluation on how you feel about security. The real risk looks at the fundamentals of that security and determines if the risk is actually present. I hate when someone says "I feel this company is risky" without a minute of research. I don't pay my bills in feelings. I pay them in dollars. Likewise, a dividend isn't paid in feelings but in dollars that flow through a company. The ability to locate firms with irrationally high perceived risks vs. the real present risks will allow you to buy firms at higher than normal yields and not step on landmines.
Pick Your Place and Buy It Soon
With markets reaching all-time highs, the key right now is knowing what you want to buy and getting on it. The market will not leave opportunities like we see available today open for long. The rally in value stocks, notably in "high dividend stocks," is just getting started. We have not seen this kind of shift into small-cap value stocks since the year 2000.
Value stocks have underperformed growth for over two decades, creating an enormous valuation gap. This rally in value stocks is not just a short-term one. Due to the enormous valuation differential, it's here to stay for months, and probably years. I don't think the markets are going to look back on that change in leadership for the foreseeable future. This means that for those of you sitting with cash on the sidelines if you don't get in the game soon, you'll be missing out.
Near-zero interest rates and a bubble of cash pouring in from the sidelines has created a strong tailwind for equities. Ultimately, it's liquidity that drives the markets and the system is swimming with liquidity. There are trillions of dollars sitting in cash and bonds, which were further magnified by the government stimulus aid and liquidity injected into the system by the Fed. So, it took a very long time for investors to leave bonds and pour money into stocks, and it's happening right now.
For us income investors, we are living on the cusp of an opportunity to enjoy for the next three years at least. Those who act and act wisely will establish the foundation of wealth creation that future generations will enjoy. I'm planning to buy as much as I can, and you should too. We remain in a secular bull market that is likely to last another two years at least. Every pullback is a buying opportunity.
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