Financial markets are, at their heart, expressions of conventional wisdom. What moves prices is the desire of a majority to buy or sell. It follows then, that whether trading for the short term or investing with a much longer outlook, marker participants are essentially attempting to predict the actions of others. As we move into 2019 with a market collapse in full swing, it therefore makes sense to look back at the last time fear was this dominant for clues as to what people may do next year.
The events of 2008/9 are in many ways completely different from the current situation. That selloff was based on a real crisis in finance that led to a real recession but, so far at least, this move has been about what might happen, not what is actually taking place.
If we assume that the worst-case scenario will not materialize, next year will be about some kind of recovery, but, as in 2010 and 2011, it will come with a backdrop of fear that will influence where people choose to invest.
With the benefit of 20/20 hindsight over a decade, the best strategy in those years would have been to buy high risk, aggressive growth stocks, but early in the recovery and with the memory of the collapse still fresh, most investors didn’t have the stomach for the volatility that went along with that. They generally preferred a safer strategy. Thinking back, the most prevalent advice at that time was to focus on a strong balance sheet and cushion any future volatility by buying stocks that paid a decent dividend.
Logically, of course, protecting against something that has already happened makes no sense whatosever, but the flawed logic isn’t the point. What matters is that locking the stable door after the horse has bolted is what people tend to do. That is why the chart for the Vanguard High Dividend Yield ETF (VYM) from the beginning of 2010 to the end of 2012 looks like this:
As you can see, the ETF price nearly doubled in that time frame, and that is without accounting for the dividends.
With that in mind, it is no surprise that on Squawk Box on CNBC this morning I heard, for the first time in this cycle, an investment manager suggest that their preferred strategy for 2019 was to seek out high dividend yielding stocks. Assuming that at some point early next year we begin a hesitant, somewhat fearful recovery, I would expect many more to take that tack.
If they do, then buying high quality dividend stocks becomes a self-fulfilling prophecy.
This is often referred to as the “Dogs of the Dow” strategy, and as you might expect these days, there are ETFs that can be used to employ it, the best known of which is the ALPS Sector Dividend Dogs Fund (SDOG).
The one-year comparative chart for that fund shows that it has woefully underperformed the S&P 500 this year, but that is not necessarily a bad thing. Once again, that falls into the category of something that has already happened, and it is one of the oldest rules of investing that eventually, everything returns to the mean.
So, as we move into the new year with fear the dominant emotion among traders and investors, it is worth looking back at the cautious, uneven recovery from another time when that was true. As the recovery from the recession progressed, aided by massive injections of liquidity from the Fed, risk came back into vogue.
Early in the recovery however, that wasn’t the case. Traders and investors, spooked by what had come before but aware that they should be getting back in the market, showed a marked preference for the relative safety of dividend stocks. The circumstances then and now are completely different, but human nature is constant, so a repeat of that next year looks likely.