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Don’t Write Off High-Dividend Stocks Yet

It was a rough quarter for high-dividend ETFs; don't expect a sequel

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Assessing the Odds of Mean Reversion

The next question is whether DVY is set to close its first-quarter performance shortfall in the month ahead. First, a look at some historical factors:

  • In the 33 quarters of DVY’s existence, the S&P 500 has produced a negative return in 11. DVY outpaced SPY in seven of these 11 down quarters, or 64% of the time. The four in which it lagged occurred in the run-up to the 2008 financial crisis, when DVY’s above-average weighting in financials took a toll. In the 22 quarters in which the stock market rose, the two ETFs were evenly split, with DVY coming out on top in 10 and SPY in 12. These numbers support the conventional wisdom that higher-yielding stocks would be more likely to outperform in times of heightened investor risk aversion.
  • Is underperformance for DVY vs. SPY more likely to be followed up with a rebound or additional underperformance? The results here are inconclusive. In the 15 quarters in which DVY had lagged prior to this year, the next quarter brought outperformance on seven occasions — indicating that the chances of a mean reversion following a quarter of underperformance are essentially a toss-up for DVY.
  • Similarly, there only have been two occasions when DVY underperformed to the extent that it did in the first quarter (Q2 ’08 and Q1 ’09). In the first, DVY outperformed by an 18+ percentage point gap in the following quarter, while on the second occasion DVY underperformed again, by two percentage points. Again, the results from this small sample don’t provide much information.

Given the inconclusive nature of the historical data, investors might be better served by looking at the sector breakdown of DVY versus SPY to see if a second-quarter mean reversion is in order.

Sector SPY DVY Difference
Technology 18.61% 4% -14.61
Financial Services 13.07% 10.36% -2.71
Energy 11.94% 3.59% -8.35
Industrials 11.69% 15.17% +3.48
Consumer Defensive 11.37% 16.14% +4.77
Health Care 11.13% 3.72% -7.41
Consumer Cyclical 9.46% 7.11% -2.35
Communication Services 4.13% 3.19% -0.94
Utilities 3.34% 30.31% +26.97
Basic Materials 3.24% 6.3% +3.06
Real Estate 1.78% 0% -1.78

From this table, it’s apparent that the two largest sector divergences are technology and utilities. Not coincidentally, technology was the second-best sector behind financials during the first quarter, while utility stocks lagged the market by a wide margin. This, more than anything, helps explain the underperformance of DVY in the first three months of the year. For DVY to play catch-up in the second quarter, we will likely need to see a pause in the tech rally and/or a rebound in utilities.

Factors that would facilitate a reversion trade in utilities would be a rebound in natural gas prices and stable to lower interest rates, while the key factor fueling a pullback in tech would — of course — be a slowdown in Apple (NASDAQ:AAPL).

The Prediction

With all of the hype surrounding dividend stocks in the second half of last year, a period of underperformance had become almost inevitable. Now, a further shortfall in DVY will require the continuation of several trends that are already very extended: the rally in Apple, the drop in natural gas and the continued positive news flow needed to keep the VIX in the mid-teens. If one or more of these reverses in the quarter ahead, DVY likely will close its performance gap relative to the rest of the market.

In short, don’t write off high-dividend stocks just yet.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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