A disturbing pattern is defining the third quarter: Companies are seeing earnings rise, but on almost no revenue growth. Cost-cutting is accounting for the positive results, and that can last for only so long. Without renewed top-line growth, profit margins will contract — hence the selling pressure on Friday and again today.
Those are the headlines that catch people’s attention, but what goes unnoticed on days like these is just how well high-yielding dividend portfolios held their ground, thanks to the market’s appetite for yield.
Unfortunately, the level of uncertainty regarding the future of taxes, GDP growth, government regulation, the cost of healthcare and rising household inflation is keeping trillions of dollars on the sidelines. The stock market has been characterized by light volume, net outflows from equity funds and net inflows to bond funds for most of 2012. And yet the S&P 500 hit 1,474 in mid-September before undergoing the current consolidation phase that has the benchmark index off only 4% from its high and still up 10% YTD.
Clearly, this rally, fueled by fiscal intervention from the Fed, the ECB and the Chinese government, has cushioned what would otherwise very likely be a full 10% correction based on the string of companies lowering guidance during the past three weeks. It’s understandable why so many investors have missed out on stock market gains: Many argue that it’s being artificially sustained by monetary easing and not by organic growth.
The Fed’s pumping up of the housing market is the primary bright spot for the U.S. economy, but it’s like a bike tire that needs more and more air because it has a leak (runaway deficit spending).
Until the next Congress and White House administration fix the leak, the market will lack the kind of trust and confidence that characterizes bull markets of yore — which in turn lends even more credence to owning income-bearing stocks.
One high-yielder that rebounded from Friday’s reactionary selling is KCAP Financial (NASDAQ:KCAP). It previously operated as one of many business development companies in middle-market business origination. It also finances and manages a portfolio of term loans and provides mezzanine bridge financing. But KCAP has since expanded its business to include venture capital and management of alternative assets.
It has taken on a diversified three-pronged approach to deliver strong earnings and dividend performance, and adopted a dividend reinvestment program (DRIP) that provides for reinvestment of dividends for stockholders. At the current annual payout of 96 cents, the shares are sporting a yield of 10%.
Taking a “steady as she goes” approach against an investment landscape that looks more and more like a minefield is how investors can avoid a round trip of their 2012 gains in a matter of days. As long as the yield on the 10-year Treasury is below 2%, and the 30-year bond trades below 3%, the money flow into high yield will remain very positive.
Bryan Perry is editor of Cash Machine, a newsletter focused on dividends and income investing.
