- 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 »
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:
- 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.
- Second, growth stocks rely on highly competitive prices to sell in volumes. Rising costs make this more challenging.
- 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.
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!
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!
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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.
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