Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: Hurricane Irma is threatening to hit Florida and the Southeast U.S. by the weekend. It’s potentially the strongest storm ever recorded and is expected to cause significant destruction. From an economic and market standpoint, how should investors brace for the potential impact of this storm?
Stovall: Well, I think if history is a guide – and obviously, it’s never gospel – hurricanes have been traditionally more of a regional event, even when they’re as large as Katrina, Sandy or Andrew. So, while over the first month after the hurricane has hit, the market might end up posting a slight decline, the market has been up three and six months after by as much as 4.5% on average. This is mainly because hurricanes require rebuilding. and what has happened is you have old, depreciated structures that get damaged to the point that they have to be replaced, and they end up getting replaced in today’s dollars.
As a result, the local economy is actually given a boost after all is said and done. That is traditionally why the market responds favorably, because on average it does not end up throwing the US economy into recession. Really, the only time we’ve had a major decline one, three and six months after a hurricane hit was back in 2008 when Ike hit, and that was because we were already in the midst of the financial crisis. I think that instance ended up riding the wave of a downward trend in equity prices to begin with, and that hurricane did not initiate a selloff. Really, none of them have.
EQ: On Wednesday, Federal Reserve vice chair Stanley Fischer announced that he is resigning, effective in mid-October. Does this introduce any new uncertainties as to how the market willwatch the Fed going forward?
Stovall: I think it reminds investors that the makeup of the Fed is in transition, or possibly likely to be in flux. There are questions as to whether Fed Chair Janet Yellen will remain after her term expires at the beginning of 2018.
One thing that is certain, however, is that Stanley Fischer is regarded more as a hawk than Janet Yellen is, and as a result, there’s the potential that the tone of the Federal Reserve could become more dovish, which may end up delaying the timing as well the magnitude of future rate increases.
EQ: In this week’s Sector Watch report, you gave a reminder of sorts, particularly to income investors, as to why they own stocks in the first place, and that is for the dividend. Do you feel that dividend investors have lost sight of this in the current market environment?
Stovall: Yes, I used the analogy that if you are an income investor, you should actually be thinking like a landlord. A landlord’s sole purpose is to develop positive cashflow based on the consistent payment of rent. So those landlords will be getting references as well as credit checks for potential tenants, and once they pass those tests, then the income streams take over. Landlords don’t price their properties on an hourly, daily, weekly or even monthly basis. Their focus is on the consistent cash generation.
So, the same goes for income-oriented investors. They should do their due diligence when purchasing stocks and look for those companies that have had a long track record of paying, if not raising, dividends as well as those with relatively low payout ratios so that if they do fall on hard times, they can continue to pay that dividend. At the same time, investors should remind themselves of why they bought these stocks — it’s because of the income, not necessarily because they need to fret over fluctuations in price, which are an eventuality.
EQ: That’s key because it’s easily to forget that sometimes in the near term with dividend stocks, especially when price fluctuations can wipe out an entire year’s worth of yield in a fell swoop. Longer term, however, consistent dividend payers have performed very nicely for investors. You discussed one group in particular in the Dividend Aristocrats. How well has this group treated investors over the years?
Stovall: Well, to answer the first part of the question, yes, price fluctuations can wipe out an entire year’s worth of yield in a single swoop. However, that’s only if you sell when the market price has declined as much as it has. If you are owning the stock for income, their dividend is not necessarily going to change, especially if they happen to be a company that has traditionally raised their dividends over time.
So, a company that is a Dividend Aristocrat is one that has traditionally raised their cash payouts in each of the last 25 years. You have some companies that have been offering higher dividends anywhere from 25 to 30, and even up to 54 years with companies like Coca Cola (KO), Procter & Gamble (PG) or Emerson Electric (EMR). These companies have continued to raise their dividends, even over difficult periods such as the tech meltdown and financial crisis.
So, I would start by looking at the list of 51 stocks in the Dividend Aristocrats, and then maybe do some cherry-picking based on the payout ratio. There are some companies where the payout ratio is above 100%, so maybe you want to avoid those. You might also want to look at companies that have a beta that is below 1 so that there is not a great deal of price volatility. Or, maybe you want to look at those companies that are offering relatively attractive dividend yields of 3% or more. Lastly, you may want to look for those that have favorable investment recommendations by CFRA Research. Or, maybe you might want to combine many of these factors together, but I think starting with a list of high-quality companies with superior track records of raising dividends in each of the last 25 years is a very good place to start.