Flight From Safety As the Market Steams Ahead

by Richard Band | September 20, 2012 8:09 am

Stocks took a breather Tuesday from last week’s torrid Fed-induced rally (even though the Dow closed a marginal 11 points the broader S&P 500 index posted a small loss, its second in a row) before some modest gains surfaced on Wednesday.

Pure momentum — the “dog chasing a truck” phenomenon — favors additional modest gains from here in the near term.  But the time for aggressive buying was in late May and early June, not now.

Back then, you’ll recall, we were snapping up oils, golds and industrials generally—stocks that tend to outperform the pack when the market is trending strongly upward.  In my June 4 blog, I advised you to buy tech-freighted iShares Russell 1000 Growth Index Fund (NYSE:IWF[1]).  It has since jumped 12.5%.

Market Vectors Gold Miners ETF (NYSE:GDX[2]), recommended in the same Journal, has climbed an even more brisk 14.3%.

Now, though, numerous barometers are urging us to caution.  For example, the equal-weighted Value Line Geometric Index[3], which I’ve cited in previous blogs as a good measure of how the “average” stock is faring, still hasn’t matched its March 27 high, let alone its (higher) April 2011 peak.  Historically, divergences like this between the blue chip leaders and the great mass of stocks have signaled trouble ahead.

Another bothersome sign is the growing evidence of speculative froth on Wall Street.  You can see it in this chart[4], which plots the ratio between two exchange-traded funds, PowerShares S&P 500 Low Volatility Index (NYSE:SPLV[5]) and the S&P 500 Spyders (NYSE:SPY[6]).

SPLV’s portfolio consists of the 100 safest (lowest-volatility) stocks in the S&P 500 index.  As the chart indicates, SPLV surged, relative to the S&P 500, from mid-March to early July, when investors were seeking safety.

Since July, however, we’ve witnessed a flight from safety.  Emboldened by the monetary shenanigans of, first, the European Central Bank and now our own Federal Reserve, investors have abandoned low-volatility stocks in favor of the fast buck.

Take a closer look at the chart.  You’ll notice I’ve marked off, in red, three previous instances in which the SPLV/SPY ratio came down into the zone where we now find it—and then reversed upward.  A fourth reversal may be approaching.  In other words, some event (the fiscal cliff?) that would draw investment capital back into safer stocks may be looming on the horizon.

If you’ve got cash burning a hole in your pocket, SPLV would certainly make a better buy at today’s levels than SPY.  However, I prefer to be even more selective.  Thanks to their high dividend yields, some low-volatility stocks offer greater protection than others.

In our October issue, I called your attention to PG&E (NYSE:PCG[7]), a California electric/gas utility with a generous 4.3% dividend.  (That’s more than double the yield on a 10-year Treasury note.)  PCG rates a buy up to $44.

A second utility to keep your eye on is Atlanta-based Southern (NYSE:SO[8]). This rock-solid outfit, serving one of America’s faster-growing territories, has boosted its dividend 11 years in a row.  What’s more, SO pays out only about a third of its cash flow in the form of dividends, giving you a wide margin of safety. Current yield: 4.3%.

If the stock dips to $44.50, we’ll add it to our Incredible Dividend Machine, replacing Exelon (NYSE:EXC[9]).  I see no immediate risk to EXC’s dividend, but the company’s earnings are likely to be under pressure for the next year or two.  SO represents a timelier value for new money.

Once we get our preferred price for SO, EXC will join the Dividend Machine’s Standby holdings:  Hang on to the stock, but don’t add to your position.  Both companies issue dividends during the last month of each calendar quarter (next payout December).

P.S.  The Treasury market seems to have regained its composure after Friday’s steep sell-off.  We can expect occasional bear raids, but — sooner or later — Wall Street will realize that the Fed’s “quantitative easing” can’t perform economic miracles.  Treasury yields will drop again, and bond prices will rise.

Endnotes:
  1. IWF: http://studio-5.financialcontent.com/investplace/quote?Symbol=IWF
  2. GDX: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDX
  3. Value Line Geometric Index: http://finance.yahoo.com/q/bc?s=%5EVLIC&t=2y&l=on&z=l&q=l&c=
  4. chart: http://profitableinvesting.investorplace.com/wcmedia/splv_rs_9-18-12.png
  5. SPLV: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPLV
  6. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY
  7. PCG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PCG
  8. SO: http://studio-5.financialcontent.com/investplace/quote?Symbol=SO
  9. EXC: http://studio-5.financialcontent.com/investplace/quote?Symbol=EXC

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