Economics Monthly Recap

Monthly Market Recap – June 2022

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!

Thank you for your support and please ask any questions below.


Dividend Dollars

Market Recap Monthly Recap

Monthly Market Recap – March 2022

The first quarter of 2022 has been quite volatile for markets. Concerns about the Russian invasion of Ukraine and the need for faster interest rate hikes to combat inflation weighed heavily on both equities and bonds. The first half of March looked rough as the S&P lost over 4% before ripping up to an overall gain of 3.8% for the month. As of the end of March, the stock markets have now recovered their losses since the Russia-Ukraine conflict began in February.

The end of March rally brought the S&P’s YTD loss to about 5% despite continuing concerns about inflation and hawkish monetary policy.

The narrative that inflation was transitory has definitely changed since the beginning of the year. The start of the war in Ukraine and the resulting commodity supply shock makes the decision of choosing growth or taming inflation for central banks an even more difficult one to make. Despite the uncertainties related to this conflict and its effect on economies, central banks have so far shown that inflation is the more pressing topic. With rising cost of energy, housing, goods, and food (fastest inflation rate in 40 years) the Fed raised interest rates by 0.25% this month for the first time since 2018, indicating a shift in policy’s stance from economic growth to controlling inflation. Fed members expect regular increases at most of the Fed meetings through the rest of this year. Other members have even stated that they support stronger rate increases.

In response, interest rates across the bond yield curve have shot up, with the 10-year Treasury notes jumping from 1.8% to 2.5% this month. The latest inflation reading came in at 7.9% suggesting yields could keep pushing higher if prices don’t show some downward pressure.

As yields rise, bonds and T-bill prices fall, thus this month’s sharp jump in rates has caused Treasuries to post their worst quarter since 1972. If inflation continues exceeding the Fed’s target of 2%, then bonds could remain under pressure longer as investors demand higher yields. With most longer-term bond yields sitting around 2.5%, well below the rate of inflation, real returns remain negative.

Regardless of the inflation situation, the US job market showed significant numbers this month with the release of the February jobs report coming in better than expected with nonfarm payrolls easily beating the consensus of forecasts. Unemployment dropped to 3.8% and the labor force participation rate moved up to 62.3% Wage growth was at 5.1% year-on-year.

This month, congress passed a spending bill to fund the federal government through September. This combined with last Decembers $2.5 trillion increase in the debt ceiling significantly lessens the risk of a looming financial crisis.

Overall, the outcome of the war in Ukraine remains uncertain. If tension escalate, we could see further pricing pressure on commodities and energy which would only serve to worsen the state of inflation and supply chain constraints that were already poorly managed through the pandemic.

However, geopolitical issues, as we have seen with the market’s bounce this month, have a harsh but quick impact on the markets. As we discussed in last month’s update, geopolitical events, on average, take 22 days for the market to bottom out and then 47 days to recover. This event took about a month. This is way its important to not panic-sell and not worry about the volatile ups and downs of the market in times like these.

It is important to have a constructive approach. One that emphasizes keeping a diversified portfolio of financially sound and strong companies that have long term potential. As a dividend investor, the best dividend paying stocks usually contain those traits. Holding dividend stocks of strong, established, tested, and successful companies makes it easy to buy when the price is down, earn more dividend income while the yields are high, and reap rewards of safe a steady income stream to support yourself with or use to grow your positions.

While it is impossible to predict what will happen in the coming months, I can confidently predict that the collection of businesses I hold in my portfolio will continue to deliver dependable dividends and make capital gains over the long term. Stay true to the strategy and I will check back with another update next month!

Economics Monthly Recap Stock Market

Monthly Market Recap – February 2022

The S&P 500 lost another 3% in February 2022, as headlines quickly pivoted from inflation and interest rate concerns to the dangerous situation unfolding in Ukraine as Russia’s military began its invasion on February 24th.

Some investors are understandably anxious about how these geopolitical tensions will end. Europe is experiencing its largest ground war since WWII and Russia holds more nuclear warheads than any nation in the world, so times are, without a doubt, grim.

From purely an economic standpoint, the numbers aren’t that scary. Russia and Ukrain make up less than 2% of worldwide GDP, and global banks have less than $100B of exposure to Russia. To help make put that number into perspective, as of September 2021, the largest 15 US banks hold a combined total of $13.19 trillion in assets. Per the FDIC, qualifying community banks are required to have a leverage ratio of greater than 9%, which means the top 15 US banks have roughly $1.18 trillion in equity capital that can be used to eat credit losses.

It is increasingly likely that this conflict escalates into a larger-scale European clash or a recession-inducing energy crisis as Russia pumps about 12% of the worlds oil and supplies over 40% of the EU’s natural gas imports.

Forecasting how this event plays out is impossible, but if history is any guide, U.S. stocks take most geopolitical events in stride. LPL research featured in a blog post a review of major geopolitical events starting with Pearl Harbor. On average, the S&P 500 experienced a total decline of 5% and bottomed after 22 days followed by an average recovery time of 47 days. Thank you to @GenExDividend on twitter for sharing this information.

Vanguard did a separate analysis of geopolitical events but arrived at the same conclusion: sell-offs related to these risks are typically short term.

There’s always the chance that history does not repeat itself. But fortunately, only about 1% of S&P 500 companies’ sales come from Russia and Ukraine. Few American-based businesses should experience a substantial financial hit as a result of these conflicts. Some business are benefiting, as evident in the oil and defense sectors ($CVX and $LMT are my most notable holdings in this aspect).

Recently, numerous countries have announced plans to invest more in armed defenses, Russia is a loose-cannon when it comes to cyber-attacks, and oil and gas prices are surging which could encourage more energy independence via more oil/gas production or renewable resources within the US. If you’re looking to benefit off of the conflict, I recommend looking to stocks involved in oil, energy, defense, and cybersecurity for those reasons.

That said, war still introduces various risks to the world’s economy, including the potential for a long term energy crisis. With global inflation running high, a restriction of the world’s energy supply from Russia would only serve to worsen inflation. High oil prices affect everything from transportation and manufacturing and utilities. It is very likely that we will see a period of sustained inflation. This hurts consumer purchasing power and slows growth. This also increases the pressure on the Federal Reserve to stabilized prices by lifting interest rates and shrinking balance sheets, both of which are actions that the Fed have committed to throughout this year. The Fed needs to walk a fine line of using these actions to cool the economy while also being weary that doing too much can cause a recession.

From high inflation, to Fed actions, to the Russia-Ukraine conflict, investors will always have to be ready for these risks. However, a calm approach to a well diversified portfolio is more than enough for simple investors, like myself, to ride out any crisis with positive returns given a long enough holding period.

This is why I like dividends. Companies that pay dividends consistently (through the good and bad times) are companies that are built to last. They tend to have strong cash flows, healthy balance sheets, wide economic moats, safe debt levels, etc. While not all dividend paying stocks have these traits, I believe through research and screening we have built a portfolio of companies that embody most, if not all, of those characteristics.

As Warren Buffett says, “Risk comes from not knowing what you’re doing”. Every time I see a dividend hit my account, I am reminded about the durability of my positions. Stick to the plan and you will succeed!