High Volatility? No Worries, Big Gains Ahead

Summary

• The month of September (the worst month of the year historically) is over.
• There is probably more volatility ahead, but this is healthy, and a great time to buy any dips.
• We remain in a very strong bull market. Investors need not worry. I explain why.
• There is a huge upside for cyclical and inflation-resistant stocks in the 4th quarter, and over the next 12 months at least.
• Long-term investors are set to be very well rewarded!
• Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Learn More »

AndreyKrav/iStock Editorial via Getty Images

Summary

The month of September was over on Thursday, and it was the worst month of the year. U.S. stocks tumbled as rising bond yields deepened a rout in growth and technology stocks. The S&P 500 index closed the month down by 4.8%. The tech-heavy Nasdaq Composite slid 5.4% while the small-cap Russell index fell the least at 3.9%. At the same time, the 10-year Treasury yields have jumped to 1.5%.

For much of the past year, many investors piled into shares of fast-growing technology companies, wagering they would deliver relatively robust profit growth and betting that treasury yields would keep falling. Last month, that trade hit a roadblock. Rising treasury yields have the largest impact on large-cap growth stocks that are very much richly valued. If you recall, in early 2021 an increase in interest rates created a rout in technology stocks. This is because:

1. Growth and technology stocks valuations are based on the "present value of future cash flows", and as interest rates go up, these projected valuations go down.
2. Second, growth stocks rely on highly competitive prices to sell in volumes. Rising costs make this more challenging.
3. Furthermore, the U.S. dollar is getting stronger which is another negative factor for growth stocks.

At HDO, we have been warning about rising long-term rates, and we have avoided the high-growth big tech hype. Now don't get me wrong, we are in the midst of a spectacular bull market, and all solid stocks are set to go higher, even growth stocks, but there will be a big rotation away from growth.

All eyes today are on small-cap cyclical stocks, which are set to gain the most from higher treasury yields. We have seen more resilience in small-cap "value stocks' these past two weeks, and I fully expect that they will surge in outperformance for the next 12 to 24 months. This is why we have strategically overweighted our "model portfolio" with high-yielding small-cap stocks, and most notably the cyclical ones.

By definition, "value" stocks have a lower price/earnings ratio. In other words, they are valued based on the money they are making today, not earnings that the market is projecting in the future. As long-term rates rise, money today becomes more valuable relative to money down the road. Companies that are producing excess cash flow and paying it in dividends today become more valuable compared to companies that are expected to make money later.

Some Good News

The month of September tends to be the worst month for stocks if you look at the average returns since the year 1928. The price action last month is in good company with history.

The great news is that the last quarter of the year has traditionally been the best quarter for stocks as you can see from the chart below – on average, no negative months in Q4 and continuing into January.

Source: HDO

Lower Interest Rate for longer

Although I have been warning that long-term interest rates would go up, I expect that they will remain on the very low side relative to their historical levels. This has been confirmed by Janet Yellen who said that she expects interest rates will remain low for a very long time, when she was asked about her worries about the soaring national debt level. In fact, she said that the government has been saving money despite the national debt continuing to rise.

The Federal Reserve still has some tools in its chest. When long-term rates get too high, it will have a negative impact on growth stocks, and threaten a stock market meltdown. The Fed would likely reimplement "Operation Twist" or even restart quantitative easing buying long-term treasuries to keep rates down.

What is important to note here is that "lower for longer" interest rates will make dividend stocks more attractive than ever. The "hunt for yield" is only set to accelerate, and the solid dividend stocks such as the ones we target at HDO will continue to see increased demand and even more upward price pressure in the coming years. The yields that income investors can lock in today are unlikely to last long. This is why it is great to be a high-income investor in today's yield-less world that is not expected to change, for at least a decade in my opinion.

After all, the Fed is ready to do anything to avoid a recession, and the stock market is a primary focus for them. My price target for the S&P 500 index over the next 3 to 6 months is at the 4600 level (or up by 5.5% from here), and by the end of 2022 at the 4900 level (or up by 12.6% from here). The Fed has got our backs as investors!

Source: Alamy

Conclusion

The factors that are driving this bull market are still here. Low interest rates, high cash levels, high liquidity in the system financed by central bankers across the globe. Government spending budgets are increasing, while Central Bankers worldwide have clearly stated that they will allow inflation to run hot and will not interfere. Cash is trash, and the best way to protect your money is by investing in assets including solid dividend stocks and real estate. Income-producing securities are one great way to do it.

As I have been re-iterating to members of my investment community, we are in a high-liquidity-driven bull market. I would strongly suggest that when everybody is bearish and convinced of a huge pullback, is not the time to worry. This bull market will almost always surprise to the upside, as we saw on Friday. The downside risk is low, and the upside potential is huge. I would emphasize for income investors not to trade this market, but hold on to their positions. Income-wise, we had one of the greatest September months where we collected about 30% of our yearly dividends. While there is a small chance of further market pullback, I still view every pullback as a buying opportunity for those who are not fully invested. There is a huge upside to our prices coming from now till year-end and even much more over the next 12 to 16 months. Please keep a long-term view on your solid income stocks!

If you still have cash to deploy, there are plenty of high-yield opportunities today that we are highlighting in our "model portfolio". It is a great time to be loading up on super dividends while they are still cheap!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Treading Softly, Beyond Saving, PendragonY, and Preferred Stock Trader all are supporting contributors for High Dividend Opportunities. Any recommendation posted in this article is not indefinite. We closely monitor all of our positions. We issue Buy and Sell alerts on our recommendations, which are exclusive to our members.

Comments

[Take&run]

Great day today !

[Rida Morwa]

@Take&run Very nice market day indeed

[Take&run]

@Rida Morwa I’ve gone big on LVS when it hit bottom and have already made a ton on United airlines . I was just in Vegas and although masked, I have full confidence Vegas will come back big !

[1575]

SPX or its future /ES will go 4150 area in two weeks , market needs a flushing down to hit bottom !

[Make good choices]

@1575 Flush twice to $4,090.... would be 10% off the recent high of $4,545.85

[MikeM856]

The biggest problem with this optimistic view on the market, is that it does nothing to address the effect of constricting supply chain capacity, and global supply shortages that are going to hit the market in the near term. Prices will be forced considerably higher. That in conjunction with increasing energy shortages, and energy led manufacturing shut downs in China, will force prices even higher.

[Take&run]

@MikeM856 fair point but I think to look at other segments is the key which wouldn’t be directly affected

[jerseyvalueinvestor]

"Income-wise, we had one of the greatest September months where we collected about 30% of our yearly dividends."

How is it possible to collect 1/3 of all your annual dividends in 1 month. Are many of your stocks annual payouts once a year in sept? I dont get it

[YesRight]

Liquidity will be lowered. Extreme price pressure in slimst all commodities. Slowing profits. Spreading default in China. CB more hawkish. But the fed will save us so keep bullish. What are you smoking man.

[Gladiator321]

Yeah, I might dig into some utilities and consumer staples amid this inflation scare.

[Rida Morwa]

@Gladiator321 Good thinking, unregulated utilities can often adjust faster than regulated ones.

[High Yield Cash Flow]

The secret to my high yield cash flow is to buy-low and collect the dividends to invest in future cash flow investments. Having patience is a virtue in this market. Joe HYCF ;-)

[PendragonY]

@High Yield Cash Flow

Sounds like a good plan.

[rgranlund]

Another buying op today - how fortunate!

[fm.dividend]

@rgranlund

Yup. I've been nibbling on down days too

[PendragonY]

@fm.dividend

Yesterday was a down day? Hmm, I was up (not a lot, but still up).

[GreenDream69]

@PendragonY same here.

[TheHarlequin]

I am not sold on the idea that there is going to be a great rotation out of growth stocks. A sharp price correction certainly, but not a rotation away. Growth stocks tend to be disrupters of old tech eg tech that simply won’t survive the new green area, as well innovators of new tech like smart phone apps, Saas, Iaas and so on. Once valuations get real investors will have no choice but to hold these stocks or face underperforming the market over the medium to long term.

The point you made about total market ETFs and FANG stocks (weighting) is also the reason why FANG stocks valuations deviate from fair value, often significantly and can stay that way for some time. When cash flows in or out of ETF or there is a market correction (up or down) the manager has to buy or sell large quantities of FANG/large market cap stocks to ensure the fund tracks the index. The higher the market cap the greater the volume of shares that have to be bought or sold. This can create a shortage or an overhang of shares available in the market. This is a relatively new phenomenon (since ETFs are a relatively new concept) and I don’t think investors and some old school analysts fully appreciate the ETF affect on market data.

[Hachilio]

Thanks for the article. Very good. I prefer rates not stay this low- I would like savings account to pay interest, and for companies to not over-leverage into bankruptcy.

So I’ve been steadily buying stocks on the aggressive side. And paying off debt on the defensive side. With what is left over - I invest in my home and my happiness!

[Rida Morwa]

@Hachilio You are very welcome, sounds like you have a good plan you are following

[heresthewire]

I've never personally paid any attention to what month it is in regards to my stock market investments and my buying/selling decisions. I've found January thru December to be an equally great time to make investment dollars over the course of my 30+ years in the market.

That said, and since my September brokerage statements were just posted in my account, I decided (after reading Rida's piece) to take a look at my monthly change in value numbers. Could the 9th month of the year been a bummer without me realizing it as the 4 week period passed? An increase of $331K for the month means I'm lovin' September just as much as the prior 8 months of 2021. :)

[PendragonY]

@heresthewire

In the aggregate September tends to be a bad month. But that doesn't mean that every stock and portfolio is down. I did okay (better than the market anyway) in September. You seem to have done very well. Congratulations.

[Ibberman]

@heresthewire I felt good about $45K until I read your comment. 👀

[heresthewire]

@PendragonY No question that "performance varies from portfolio to portfolio". My September was especially profitable thanks to my investment in what was a $2 stock (AEHR) that is now trading in the low teens finance.yahoo.com/...

So, while some of my investments had a "red" September my overall diversification led to a nice gain for the month. Thanks for the congrats. :)

[Mister Doom]

Too optimistic…..

[Take&run]

@Mister Doom why am I not surprised on your comment based on your name 🤣?

[omarakthar]

Buy the dip ! I just bought 69 Tesla

[Rida Morwa]

@omarakthar Buying the dip can often result in additional income - so long as what you're buying pays dividends

[Take&run]

@Rida Morwa there are a lot of quality stocks out there at their lows with nice Divys . I’m going to pick up more Hormel !

[GreenDream69]

@Rida Morwa True, And while I fully agree on the dividends bit, even sans dividends it can also pay off if you later sell on an upswing. Depends on the company and where it's going to go.

Dividends are the "safe" or "conservative" means of making money on the market but it's not the only way and more power to those who make it the other ways.

[Alternative Investing]

What are the ytd results for the HDO portfolio in terms of actual income dollars (vs LY income $) and in TR?

[Rida Morwa]

@learning to be patient with mr mkt we update our returns here for those looking for a historical record: www.1hdo.com/...

[Alternative Investing]

@Rida Morwa thanks are these ytd results thru September 2021? And could you address the income only (divs,distros,cap gains from any sells) component comparison vs LY in real dollars

[Brute80]

Hi Rida, thanks again for another informative article. I was just wondering, if you feel small cap cyclicals are what is set to outperform during the next 12-18 months, would this be what the Russell 2000 primarily consists of? Thanks again!

[Treading Softly]

@Brute80 As a whole we have leaned more towards diversified CEF vs any one specific holding or ETF

[Make good choices]

I know most people following here are dividend stock owners. I would like to point out that during dips and high volatility, option premiums are, at a premium (pun intended).
The high premiums allow you the opportunity to sell far out of the money covered calls on your dividend stocks, and still earn very good premiums to supplement your ROI.

IF the covered call is in the money at expiration day, you can "buy to close" the covered call, at a loss, and simultaneously "sell to open" a covered call with an out of the money strike, with a far enough away expiration to earn a net credit.
A word of caution, don't sell a covered call with the expiration day in the same week as the ex-div. date. This is when you are most likely to get exercised early.
You need not worry (too much) about losing your shares of stock, when you know how to roll and to avoid placing expiration day in the same week as the ex-div. date.

If you are considering adding to your shares on the dip, instead of placing a limit order, you may want to consider selling a cash secured put, at the strike price you would like to buy the stock. You get PAID a premium to buy the stock, at the price you want to pay.
You may ask: What if the stock doesn't come down to my strike price on expiration day? I will lose the opportunity to buy the stock at a lower price.
Answer: You also lost the opportunity to buy the stock at a lower price when you placed a limit order and the stock never dropped to your limit price.
The difference is, with a cash secured put, you earned a premium.
Knowledge IS power, only IF you apply that knowledge.

[Rida Morwa]

@Make good choices Many HDO members make extensive use of options to boost their incomes. I personally do not use options in our Model Portfolio to make it as friendly as possible to as many investors as possible.
We have an entire chat room dedicated to Non-HDO holdings and Options trading that is very lively.

[Make good choices]

@Rida Morwa Thanks for the info. How do I access this chat room?

[Rida Morwa]

@Make good choices Once you have joined and have access to chat - on the left side is a list of our various chat rooms for our members.

[John R. Clark]

Last year in the pandemic a friend of ours bought a new crew-cab pickup truck. He volunteered for extra teaching at school and earned enough to pay off the truck in 16 months with $12,000 left over.

Guess what our man just spent all of it on? Dividend stocks --- 12 @ $1,000 each! He plans to buy more every month with the ex- double truck payment that he's learned to do without. This while still adding to his 403(b) account with the district.

That truck was rather an extravagance but our friend, who comes from a family of wastrels, has uses for it with his craft skills. Now that it's paid for, he is applying his learned thrift and knowledge to build lasting income streams.

I learned years ago to commend people for doing big things right, even if their choices aren't the best in someone else's opinion, and especially in view of past errors and neglect. Ten years ago this friend often had to borrow from my wife and me just to keep up between paydays. (He's still a friend from repaying us promptly and fixing things at our house.)

Now when he comes to visit we're glad to hear of his plans and progress one month at a time. Thanks for reading!

[Rida Morwa]

@John R. Clark Thank you for your comment.

[PendragonY]

@John R. Clark

Thanks for sharing the experience of your friend with us.

[Tbone-of-ILL]

Thanks Rida,
You are one of my favorite Writers.
Your advise seems to be reasonable and spot on to this amateur investor.
Having recently retired, how and what % should I transition into High Dividend Stocks. Have about 500K in Mutual Funds mix in the following amounts. 19% International, 27% small Cap, 12% Mid Cap, 42% Large Cap. Not sure if it is better cash out all and dollar cost average back in?

[Rida Morwa]

@Tbone-of-ILL You are very welcome, thank you for your kind words. I am entirely invested in high dividend opportunities between stocks, bonds, and preferreds. I provide weekly insights like this to my HDO member community and a Model Portfolio that's designed to help them mimic my personal portfolio and our success. My public reports will continue to be released but to get a full view, joining our community may be the best jumping off point for you.

[Phil in OKC]

@Tbone-of-ILL A couple of years before I retired, I joined HDO. To start building my HDO portfolio I rolled over my current 401K into a Rollover IRA, which gave me access to the entire HDO Portfolio. I continued to max out my 401K and when I retired I rolled it over again into my IRA. The mutual funds in my 401K were OK for building up investing capital, but I had decided to build an income portfolio, where I would not have to cannibalize my capital.

[Tbone-of-ILL]

@Phil in OKC Thanks for comment

[Sane Man]

The market undercurrents have been in a rolling sea of red since June. The Russell , yes it was down less in September but it has been down 10% since June with about a third actually in bear market territory. Fixed income down and CEFs, whether equity -fixed income , have been hit pretty hard the last few weeks too! As well as utilities and REITS. In fact I believe almost half the S&P has been in correction territory for a while too. And let’s not even talk international with the dollars strength. Precious metals-horrible! A disciplined and diversified portfolio is not looking so rosy this year at all. But being in CEFs and stocks with between 4-9% distributions and dripping them and averaging down is gonna move the needle when the dust settles. Inflation and higher rates will help leveraged loan funds -BDCs and ultimately REITS and utilities-which don’t perform as bad as people perceive in a rising rate environment. Those that sell now don’t realize those sectors add ballast to a portfolio. The last 2 big crises-the housing meltdown and Covid , REITS have bore the brunt of. This I believe skewered the sectors long term performance.

[Rida Morwa]

@Sane Man Thank you for commenting and sharing your views. REITs were definitely impacted by the GFC and COVID. Many lower yield REITs are viewed as bond alternatives and as such higher Treasury yields puts strong pressures on their market price. This is why I invest higher up in the yield curve in excellent opportunities.

[BM Cashflow Detective]

High volatility?

A little too general.

Buy with confidence in the face of downward volatility.

... and get wealthy with upward volatility.

Volatility comes and goes, but big gains always ahead.

The normal work of a value investor in an environment of high volatility.

But the causal factors that actually drive this bull market are also there all along.

Entrepreneurial ingenuity and cash flow-oriented corporate management.

As long as these factors are visible, I don't worry. No matter what the Fed does.

Notice. Endogenous characteristics of companies always beat the exogenous factors of politics.

Real assets with "idea rich" backgrounds that satisfy people's needs are the key to prosperity.

The real reason we are in an ongoing bull market.

Even the Fed cannot prevent that. Because that is timeless as long as there are people with ideas. They will always find a solution for every problem that comes up.

[JackCr]

@BM Cashflow Detective So what are some of the equities you like these days?

[Rida Morwa]

@BM Cashflow Detective Thank you for sharing your opinion.

[BM Cashflow Detective]

@JackCr

For example, I currently like and own:

$APAM $PM $MO $BTI $BMY $BEN $LGGNF $AMGN $OMC $UNM $RGA $RE $VCTR $SMG $PATK $ABBV $MRK $AZN $BWA $RNR $CI $LMT

...to name some high yield and DGI stocks.

I recently combined these with $AMZN and $FB.

Growth and dividend stocks together works very well for me.