Each week, we tap the insight of Sam Stovall, Chief Investment Strategist, CFRA, for his perspective on the current market.
EQ: The latest Fed minutes were released Wednesday, and while it didn’t necessarily change much for its anticipated December rate hike, there seems to be some questions surrounding its plans for 2018. What did you make of the statement?
Stovall: Well, it seems as if inflation remains the only fly in the ointment for the Fed being set on its three rate increases for 2018. We’re still of the mindset that the Fed will raise rates when it meets in December, and three more times next year, mainly because we believe that the year-over-year percent change in the core CPI will rise from the current 1.8% to 2.1% by the fourth quarter of next year.
So, should the Fed raise rates by a full percentage point over four separate rate increases between now and the end of next year, we will still be in a stimulative monetary situation, and will just have gone from a net negative real rate environment to a net neutral environment.
EQ: Earlier this week, Fed Chair Janet Yellen announced that she will resign from the Federal Reserve Board in February when her successor Jerome Powell will be sworn in. Does this raise any concern for the transition and continuity of the Fed’s approach?
Stovall: Not really. I think, in many ways, Fed Chair Yellen is stepping aside and not remaining on the Board so that she allows the new Fed Chair to feel that they can take over and change things to the way they’d prefer to operate. But I don’t think there is going to be much change anyway. The new Fed Chair is likely to be fairly dovish in nature and probably will continue to move forward with the rate increases next year, but I don’t see him doing anything to upset the applecart, like accelerating the rate increases.
EQ: In this week’s Sector Watch, you discussed GE’s decision to slash its dividend in half. As one of the most recognized and established names in the stock market, this most likely had a profound effect on the confidence of many long-term investors. What kind of lessons can investors, particularly the buy-and-hold income crowd, learn from this?
Stovall: I think the best lesson here is that, just as paint jobs on brand new autos can fade over time, so can the luster of blue chip stocks. Just because a company has been in the Dow since its inception back in the late 1890s, does not mean it cannot fall on hard times. So, while buy-and-hold investors don’t have to be trading in order to get good portfolio returns year-in and year-out, they do have to monitor their holdings to make sure they don’t end up holding onto blue chips that end up simply chipping at the edges.
EQ: You also advised investors to focus on payout and quality by minding their “P’s and Q’s”. What are good thresholds to consider when looking at these metrics?
Stovall: As I’ve said before, being this late in the bull market cycle, I think investors do need to be focusing on quality. It’s like the old adage, “When seas get rough, sailors prefer a better-made boat.” Well, I define a better-made boat as a company that has consistently raised its earnings and dividends over an extended period of time.
The S&P Quality rankings are letter grades assigned to companies based on their 10-year track record of raising earnings and dividends, with those ranked A-, A and A+ as above average. One reason that these are better-made boats is because they tend to be less volatile. The high-quality companies have the beta of 0.92 on average, whereas the low-quality companies have beta of 1.08. Also, the average payout ratio for high-quality companies is 0.87 versus 1.06 (more than 100%) for the lower quality companies. So, I think investors can do themselves a favor by occasionally screening for these companies to see which ones look attractive based on their quality rankings and payout ratios. They should also know, however, that those two items are backwards looking.
So, what about forward-looking? There you can include investment recommendation by CFRA or whomever your favorite analyst happens to be. So, I did just that. Using CFRA’s MarketScope Advisor Platform, I chose only those companies with above-average quality rankings (A-, A or A+), had a dividend payout ratio that was less than 70%, and with the highest investment recommendation of 5 STARS. I came up with nine stocks that fit the bill.
So, I think investors can use this kind of screening tool to monitor their own stocks to see where they would fall in this kind of listing, and also use it to come up with new candidates should you want to replace existing ones.