EQ: What is Operation Twist, and what kind of impact do you think it can or will have on the market?
Stovall: Operation Twist is the Federal Reserve taking the maturing short-term securities and reinvesting them into longer-term Treasury bonds, thus helping to keep longer-term rates lower to make cash available. Business and consumer loans are more closely tied to the 10-year note than to the Fed funds rate, so the purpose is to keep interest rates low and make capital available for those who want to borrow.
In terms of the impact of the market, I think we’re already seeing it. We had five days of equity growth in the week ending September 16. We’re seeing fairly nice return in place on Tuesday, September 20* in anticipation of the Fed meeting conclusion on Wednesday. I think the market is hoping that there could be something additional to Operation Twist that is revealed when the minutes come out.
EQ: As the Federal Reserve continues to focus on keeping interest rates low, Treasury yields have suffered. As you noted in your most recent Sector Watch, Treasury yields have now fallen below that of the S&P 500’s dividend yield. Historically, how often has this happened? How long do these periods typically last?
Stovall: It’s a fairly rare event; much rarer than a Blue Moon. The last time that this occurred was March and June of 2009. Prior to that, it occurred in the late 1950s, so it’s not a very current or recent event whatsoever. However, interestingly enough, of the 20 quarters since 1953 in which the S&P 500 did yield more than the 10-year note, the S&P 500 rose by an average of 20 percent, 12 months later. Also, when the yield on the S&P 500 has been within 1 percent on the yield of the 10-year note, the market has gained an average of 11 percent. This has occurred over 19 observations since 1953. Getting returns on average of anywhere from 11 percent to 20 percent isn’t bad when you compare it with the 8.4 percent average return of all rolling 12-month periods since 1953.
EQ: You also noted that typically when this phenomenon does occur, it creates a nice buying opportunity for investors. Can you tell us more about that?
Stovall: I’m a little bit concerned about whether this will end up leading to a substantial higher market 12 months from now because I still think we are precariously close to slipping into another recession. We realize that even though this is a favorable factoid–and as a result maybe we want to maintain a neutral exposure to equities because the risks do remain relatively high–that you want to be careful as to which equities you do gravitate toward. I believe that if you gravitate toward higher cap, higher quality stocks such as those that have more consistently raised their earnings and dividends in the past 10 years or so, that you will do better. Plus, if you look toward those companies that offer a dividend yield of 3 percent or more, then again, I believe that you will be amply rewarded in the coming 12 months because if the market does advance based on the favorable factoid, the old saying is that, “A rising tide lifts all boats.”
EQ: What are some examples of companies that fall into that category?
Stovall: You can use the S&P MarketScope Advisor service and screen for companies that have a S&P quality ranking of A- or better. This means that these companies have had an above average consistency of raising their earnings and dividends in each of the last 10 years, have a dividend yield of 3 percent or more, and currently have a Buy recommendation by S&P equity analysts. Some examples include:
- Consumer Staples — Coca Cola (KO) and Altria Group (MO).
- Energy — Chevron Corp. (CVX)
- Financials — Travelers Co. (TRV)
- Healthcare — Abbott Labs (ABT)
- Industrials — General Electric (GE)
- Utilities — UGI Corp. (UGI)
So I think the best way to go for the months ahead is to focus on larger cap stocks, which tend to do well when the market looks a little suspect, and combine that with ones that have a consistency of raising earnings and dividends, and that also pay you while you wait for this market volatility to subside.
EQ: You mentioned that investors should maintain neutral exposure to equities. Can you elaborate on that a little more?
What that means is that we have a lot of good things we can point to, and we have a lot of bad things we can point to. So you certainly don’t want to be overexposed to equities more than your time horizon and risk tolerance would dictate. But because there’s the potential of a nice return in the coming 12 months based on the potential of the these favorable factoids, we’re saying that if your normal equity exposure is 60 percent then stay at 60 percent. Don’t go to 65 percent or 70 percent, but at the same time don’t be underweight equities. Yet because there’s still a lot of risk out there, the equities that you do focus on should be larger cap, higher quality issuers that pay a nice dividend yield. History is a great guide, but it’s never gospel, and at the same time, none of these factoids have an unsoiled track record. All of them have misreads of about 20 percent if not more, so there are going to be times when these things don’t work and this could be one of them.
*Editor’s Note: This interview was conducted on Tuesday, September 20, 2011.
Disclosure: Henry Truc has long positions in MO and GE.