For the month of June, the S&P 500 fell 8.4% and officially entered a bear market, or a 20% drop from a previous high. This is the 13th bear market for the S&P 500 since 1948. Bear markets often signal economic downturns. This is evident in the fact that 8 of the last 12 bear markets were followed by recessions.
When the economy contracts, the riskiest stocks are often hit the hardest. This includes companies with inflated balance sheets, cyclical earnings, lofty valuations, and poor profit margins. As we discussed last week in our article “What Dividend Strategy Does Best in a Bear Market?”, dividend strategies are inherently more conservative and therefore have performed relatively well in this falling market. The article shows that the S&P has fallen over 20% year-to-date, whereas many of the prominent dividend strategy ETFs had outperformed with nearly half as much in losses. Quality dividend-paying and defensive companies are a haven in times of uncertainty.
Many of the business in my portfolio (and in the holdings of those ETFs), have paid uninterrupted dividends for decades. 3M ($MMM), Lowe’s ($LOW), Coca-Cola ($KO), and Altria ($MO) have paid consecutive dividends for over 50 years! These companies have stood the test of time and are entrenched in their industries by providing essential goods and services. These kinds of companies generate consistent cash flows and keep healthy balance sheets, both of which are traits that allow them to weather the storm of economic uncertainty and recessionary fears continue to rise. Another benefit of investing in these companies is that we don’t have to worry about every little market movement, because these companies will keep the dividends rolling in and even growing! While the market is quickly giving up its pandemic gains, we continue build up our income through sticky dividends from quality companies.
Recessions are the greatest potential risk to a dividend portfolio. In the last 60 years, recessions are the only period in which the S&P 500 has decreased its dividend, according to Investopedia. When companies lose money, cutting the dividends are one of the easier solutions to preserve liquidity needed to pay debts, fund operations, and protect the balance sheet till profits bounce back.
A thin balance sheet, high payout ratios, and cyclical cashflows may allow for a relatively safe dividend when times are good, but these dormant risk factors can make cutting the dividend as the quickest and easiest measure for companies to curb their pain when times get tough. When looking ahead, continue to invest in companies with healthy balance sheets, strong moats/competitive advantages, and a history of paying dividends to avoid getting caught in this situation. Closely monitor your companies that appear to be more vulnerable to inflation and high interest rates. This includes companies that do not have strong pricing power, face higher input costs, and see falling demand for inessential purchases. Many consumer discretionary companies fall into this category.
A few companies that I invest in are at more risk here than others (Best Buy, Lowe’s, and Starbucks to name a few). These companies have conservative payout ratios, healthy balance sheets, and manageable debt levels that reaffirms my belief that the dividend is safe for the time being. While the market is down, it gives us long-term investors more opportunities to buy quality stocks at lower prices and higher yields while we wait this out. The upcoming quarterly earnings will give us a better outlook on how our companies our navigating this volatile environment. Stay tuned in to your holdings and take advantage of down stocks where appropriate. Lots of wealth can be made during bear markets if you stay grounded and logical in your investments!
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