The market takes a dive on coronavirus fears, but strong earnings weather the storm … three sectors are beginning to outperform — and more gains could be coming
As I write Monday morning, markets are in “fear” mode, with the Dow down more than 460 points due to concerns about the coronavirus.
More cases were confirmed over the weekend, leading to increased worries of economic fallout around the globe. There are 2,862 cases so far in China, pushing the death toll to 81.
First, and most importantly, our hearts go out to all those who are affected personally. But second, how do we, as investors, respond?
Is this something that should lead to a substantive change in our market strategy, or is market volatility just a buying opportunity?
Famed investor Louis Navellier addressed this question earlier today in a special podcast:
What are the fears out there?
Well, clearly there’s a big fear that the lockdown in China — because of the new virus — is going to really curtail economic growth.
After discussing how China didn’t handle SARS correctly some years ago, Louis notes how the fear today is that coronavirus will lead to commerce grinding to a halt. But is that fair?
Back to Louis:
… this is a common theme. Remember Ebola? We were all going to be dead from Ebola? … Everything’s being hyped … the news media loves to cover viruses …
Louis then expands his commentary, bringing the Davos conference into his discussion. He points toward the takeaway that “something is wrong in Europe.” He discusses their negative rates, the weak Euro compared to the Dollar, and other general concerns including this Friday’s official British departure from the EU.
Louis notes how, in light of all this European uncertainty, much of its capital continues to flow here to the U.S., which fuels our stocks, and in particular, a certain type of stock.
Back to Louis:
As interest rates go down, it just naturally fuels the dividend growth stocks we like so much, and they’re the oasis …
I don’t care if the market is down 2%, it just doesn’t bother me. Because my best defense is a good offense of these dividend growth stocks.
I want to encourage everybody to hang tight … let dividend stocks naturally attract capital …
Overall, Louis is looking beyond the coronavirus and is bullish as we head into the heart of earnings season — which, historically, is great for Louis’ recommendations. That’s because they’re all rooted in earnings strength (earnings power is at the core of his investment selection criteria). To learn more about Louis’ approach, click here.
***Louis isn’t the only InvestorPlace analyst noting the strength in dividend stocks
Regular Digest readers recognize John Jagerson and Wade Hansen as our resident quant/technical analysts. This simply means they use historical market data to identify patterns and trends that help guide their investment decisions.
In last week’s update to Strategic Trader subscribers, John and Wade began by discussing the overall strength of the S&P. But then they pivoted, pointing toward a few select sectors that have begun to outperform the broader market.
As you might have guessed by now, these sectors share one thing in common — big dividends.
From John and Wade:
… if you dig a little deeper and look at the performance of the individual sectors within the S&P 500 during the past few weeks, you’ll see an interesting trend is emerging. The sectors with high-dividend yielding stocks are driving the lion’s share of the January gains.
Starting in early January, the Real Estate Select Sector SPDR Fund (XLRE), the Utilities Select Sector SPDR Fund (XLU) and the Consumer Staples Select Sector SPDR Fund (XLP) — exchange-traded funds (ETFs) tracking sectors that contain stocks that pay great dividends — all started climbing higher.
You can see this move starting around Jan. 7 and Jan. 8 in the comparison chart in Fig. 1.
Fig. 1 — Daily Comparison Chart of SPY, XLRE, XLU and XLP — Chart Source: TradingView
So, the question is then “why?” What’s behind this outperformance?
John and Wade point toward a corresponding drop in longer-term yields — specifically, the 10-year Treasury.
Back to John and Wade:
You can see this downturn illustrated in the red box on the daily chart of the 10-year Treasury yield as represented by the CBOE 10-Year Treasury Yield Index (TNX) in Fig. 2.
Fig. 2 — Daily Chart of the CBOE 10-Year Treasury Yield Index (TNX) — Chart Source: TradingView
The TNX had been forming higher highs in late 2019 (see the green arrow) as bond traders started demanding higher yields on their longer-term Treasury investments.
Unfortunately, that trend didn’t have enough momentum to carry through the end of the year. The highs the TNX was forming on its chart started to flatten out by late December (see the blue arrow).
The TNX ultimately started to decline and form lower highs this month (see the red arrow).
As longer-term bond yields have started dropping again, traders have started looking for other sources of yield. They seem to have settled on stocks with strong dividends.
***Let’s step away from John and Wade for a moment to add some additional historical context
As you know, traditionally, bonds have been a great diversifier to a stock portfolio. On top of that, for decades they also played the role of “income asset.”
For example, below you’ll see a chart of the 10-year Treasury dating back to 1980. Check out those fat yields!
As recently as 2007, the 10-year was posting a 5%+ yield.
Meanwhile, where was the S&P dividend yield?
As you can see below, it has basically remained rangebound over the last 20 years — with the exception of 2009’s Global Financial Crisis. Its average range has been between 1.5% and 2.25%.
Now, this makes sense.
S&P dividend yields were, historically, much lower than 10-Year Treasury yields because investors typically bought stocks for growth and bonds for income.
But in the last few years, this historical relationship has become distorted. Regular Digest readers know one of the biggest contributors to this distortion, as we’ve discussed it many times here — international capital flight. It’s what Louis described briefly in his podcast, which we referenced earlier in this Digest.
In short, just like water eventually sinks to the lowest level, investment capital tends to find its way to the highest-yielding investments. And today, the U.S. is offering some of the highest yielding sovereign bonds in the world.
As recently as August, roughly $15 trillion of government bonds worldwide traded at negative yields. To put that into perspective, that’s about 25% of the entire sovereign bond market. This figure has almost tripled since October 2018.
So, when, say, a German investor faces a negative-yielding 10-year German bond … or … he could just as easily buy the U.S. 10-Year Treasury yielding 1.74%, it’s a no-brainer.
That German investment capital flows here, driving up bond prices, which pushes down bond yields.
As I write, the 10-Year Treasury yields 1.74%. Meanwhile, the S&P yields 1.80%. In other words, today, income investors are better off buying the average S&P stock than the 10-Year Treasury bond.
Of course, this has happened on several occasions over the last few years, but it’s illustrative of the investment bizarro-world we’re currently in.
So, if the average S&P stock pays more income than the 10-year Treasury, then no wonder high-yield dividend stocks are surging.
***On that note, let’s jump back to John and Wade for examples of just how much more income there is in dividend stocks today
From John and Wade:
The real estate sector, the utilities sector and the consumer staples sector all have stocks with dividends that yield more than the 1.78% the TNX currently offers.
Here are a few examples from the top 10 holdings of the three ETFs that correspond with the sectors we mentioned:
Real Estate (XLRE):
* Crown Castle International (CCI) — 3.24% dividend yield
* Welltower (WELL) — 3.96% dividend yield
* Public Storage (PSA) — 3.59% dividend yield
Utilities (XLU):
* The Southern Company (SO) — 3.64% dividend yield
* Dominion Energy (D) — 4.37% dividend yield
* Duke Energy (DUK) — 3.99% dividend yield
Consumer Staples (XLP):
* Philip Morris International (PM) — 5.27% dividend yield
* Kimberly-Clark (KMB) — 2.85% dividend yield
* The Procter & Gamble Company (PG) — 2.36% dividend yield
When buying high dividend-yielding companies like this right now, traders get not only get the added bonus of great dividend payments but also see the value of the stocks increase.
***So, what crystal ball can we look toward to know whether dividend stocks will continue climbing?
Simply enough, John and Wade suggest just paying attention to TNX.
Keep an eye on the TNX. If it continues to fall, high dividend-yielding stocks are likely going to see even more money flowing into them. This should continue driving them higher, helping them outperform the S&P 500.
We’ll continue to keep you up to speed here in the Digest.
Have a good evening,
Jeff Remsburg
