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Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Over half the S&P 500 companies have reported earnings thus far this season. How are things looking right now?
Stovall: Well, things are looking pretty good. At the beginning of the quarter, it was expected that the S&P 500 would post a 4.2% increase in fourth quarter earnings. Now it looks as if we’re going to see a 6.7% gain. In addition, we’ve really not seen much of an erosion to 2017 results, which is positive because as we had progressed in 2015 and 2016, full-year estimates had begun to plummet like a stone. So it’s encouraging that this full-year estimate is holding up in low double digits.
What we’re finding also is that only three sectors are expected to post earnings declines for the fourth quarter—Energy (down 15%), Industrials (down 2%) and Telecom (down 2.5%)—but in general what we’re seeing is better-than-expected results for the majority of the sectors for the S&P 500.
EQ: Corporate guidance, particularly as it relates to the new political and economic environment, is key for investors right now. What have you seen from management teams thus far in terms of their views on 2017?
Stovall: I think they have high expectations but nothing tangible that they can actually point to in current earnings or even in current estimates. From an intangible perspective, expectations are that we will see some sort of a reduction in tax obligations. There is likely to be some possibility of lower-cost earnings repatriation, combined with the potential for infrastructure spending. So, we see those items being mentioned, combined with the easing of regulatory constraints. But because nothing has happened just yet—in terms of action or even details as to what’s likely to occur—I think, at best, management has just been able to mention that they’re aware of the potential changing landscape but can’t really point to anything substantive as to how it will benefit their bottom line.
EQ: In this week’s Sector Watch, you noted that the post-election run has translated to lower dividend yields. From a fundamental standpoint, should investors be concerned here?
Stovall: Not really. Like in the 1990s when we also ended up having very low dividend yields for the S&P 500, I wanted to see if it was an indication that investors were getting too confident or complacent, and if it had become too euphoric in terms of price appreciation. I then remembered that a lot of it has to do with relative yields between stocks and bonds. So, going back over the past 60-plus years, I found that whenever the dividend yield on the S&P 500 is within one percentage point of the yield on the 10-year note, stocks still do very well. In fact, they have been up by an average of 11% in price, rising about 80% of the time when this occurs. Typically, a solid 12-month price appreciation potential is what’s in store for investors when you have the dividend yield on stocks be fairly close to what’s currently being offered in bonds.
EQ: You’ve always said investors should avoid yielding to temptation. As yields have come lower, how should dividend investors approach this current market?
Stovall: I think they should first off realize why dividend yields and interest rates are so low right now. It’s because inflation is so low. Right now, the year-over-year change in the Consumer Price Index (CPI) is about 2.1%, whereas the historical average—whether going back to 1958 for the core CPI or 1948 for the headline CPI—is above 3%. So 50% higher is what we have been used to over time. A lot of investors forget that if they are getting paid a much higher yield on bonds, it’s because they’re giving up more of the money they make in the form of inflation when they go out and buy goods and services. So that’s why I tell investors, don’t yield to temptation and don’t chase the yield.
I would also say that you want to focus on those companies that have been consistent in raising their earnings and dividends over an extended period of time, like the Dividend Aristocrats, not because they are a yield play—since their dividend yield right now is equal to that of the S&P 500—but because these companies have raised their cash payouts to investors in each of the last 25 years. It’s as if you are a landlord, and you are looking for a tenant who will pay their rent regularly. So for your due diligence, if you will, in terms of getting a reference, well, here’s the reference that says this company has raised its cash payouts consistently for over a quarter century. So I say to investors, focus on quality companies this late in the bull market cycle, and chances are you will not be disappointed.