Dividends for Stability, Safety in a Mixed Market

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A few weeks ago, we talked to you about the 2023 stock market outlooks from a number of Wall Street strategists. By and large, those experts were more optimistic about this year than last, but many believe we'll still have to ensure more turbulence before reaching clearer skies.

This week, we'll discuss one way to navigate this kind of market scenario—including a few defensive stocks to consider.

The Tea

One of the biggest risks to your investment portfolio is…well, yourself. When the market is extremely volatile and losses start to pile up, like they did in 2022 and 2020, some investors begin "panic selling." In other words, they don't look at each investment to determine whether they think they'll fall farther—they simply see all the stock losses they've already piled up, and sell to avoid more.

YATI Tip: Before every buy and sell, do your research. These sites can help.

Now, most of those people sell out with the idea that they'll jump back in when things are less volatile. But no one exactly knows when the market will do what it's going to do. And many people that panic-sell miss out on some of the best-performing months as the market recovers.

Bank of America's Merrill unit studied the cost of trying to "time the market." Here are three scenarios for how much money an investor would've made over a 20-year period—from the beginning of 1992 to the end of 2021—if they had put just $1,000 into the stock market.

  1. Leave it untouched: $20,830
  2. Miss out on the 10 top-performing months: $8,244
  3. Miss out on the 20 top-performing months: $3,959

In other words, you'll typically get the best results from simply buying and holding.

That's easier said than done when, again, those losses start piling up. So one way to steady your hand is to invest in stocks with one or two (or both) traits:

  • Dividends: Dividend stocks pay cash to shareholders, usually on a regular basis, that act as another source of returns.
  • Low volatility: Some stocks tend to move roughly in line with the market on average. Some tend to move in a more exaggerated manner; gains can be faster, but losses can be pretty quick, too. And some stocks—low-volatility stocks—tend to act more steadily than the market.

A combination of knowing that you're still getting some returns from your stocks, even if their prices are going lower, as well as seeing some of your stocks move less drastically than the rest of the market, can help keep you calm and prevent you from making rash portfolio decisions.

YATI Tip: Another way to cut down on volatility? Spread your risk across several index funds.

The Take

To help you out with that, we've talked to Austin Graff, CFA, Co-CIO and Portfolio Manager of the TrueShares Low Volatility Equity Income ETF (DIVZ)about how to position your portfolio to better withstand the occasional market whiplash.

Market Outlook

"We don't really come up with market forecasts too frequently because it's a great way of being wrong," Graff says. "So what we do is try to figure out what the market's telling us."

Right now, the market is sending several mixed signs. For one, Graff says, the bond market is signaling rough waters ahead, but the Federal Reserve is effectively saying things are OK and we can keep rates higher for longer. "Our expectation is somewhere in the middle," he says.

Same thing goes with the equity market. Prices are recovering somewhat, indicating things are fine. "But management teams are saying differently," Graff says. "Across the board in Q4 conference calls, management is saying 2023 will be tough."

What do you do about that from a portfolio management perspective? 

"It makes place to play the middle, then weight yourself a little toward the side you think is more likely," he says. "We've shifted ourselves toward the slowing-down side because we think management has a better view of what's coming up."

What to Focus On, What to Avoid

Right now, America's "real economy" (basically, goods and services) is slowing down, but we're also experiencing higher interest rates than we've seen in a long time.

"From a slowing economic perspective, you want to avoid the more cyclical names," Graff says. "Stay away from transportation stocks, and other companies that are heavily dependent on economic growth to generate earnings and cash flow," he says. 

Instead, favor traits like high barriers to entry, products that can be sold in various economic environments, and business models that can perform in rough waters.

What does Graff like right now?

  • Defensive financials: Some market index providers—for instance, DIVZ holding CME Group (CME)—"provide defensive positioning."
  • Healthcare: "People are going to require healthcare services in good or bad."
  • Energy: "A lot of people are looking back at the past 10 years when energy had a tough time in rough economies, but when you look at supply/demand for underlying commodities, there's limited supply and demand is strong, especially with China strengthening. So we think oil could have a counter-cyclical effect."

"Then you look at the other side of things: valuations," Graff says. "Interest rates have a significant impact on valuations. Now that we have interest rates returning to a normalized level, people have to think about valuations again. You can't just go buy an expensive consumer staples company and expect it to keep getting more expensive. You need a balance between defensive names and attractive prices."

3 Low-Volatility Dividend Stocks

Graff says that the top 10 holdings of his DIVZ ETF are all names that he anticipates the fund will hold for at least the next three to five years. 

"We have a long time frame in the fund," he says. "We have high-quality companies that have attractive returns on capital and very shareholder-friendly capital return policies. Those dynamics create companies that are good for holding over the long term."

But we asked Graff to describe the opportunity in a few holdings. Among them:

  • Johnson & Johnson (JNJ, 2.7% yield): "J&J is a unique story because they're spinning off [consumer-health unit] Kenvue to focus on the higher-growth medical-device business. So it's transitioning to become a higher-growth company but trading at historical valuations. Also, management has sworn by the dividend, and they expect to continue along that path even after the spinoff. That's a pretty big statement because the dividend is not a small part of the business." [Note: Johnson & Johnson is an S&P 500 Dividend Aristocrat—a group of companies that have improved their annual payouts every year for at least 25 years. J&J has raised its dividend for 60 years in a row.]
  • AbbVie (ABBV, 4.0% yield): "AbbVie is unique because they have the largest/most successful drug ever produced in Humira, which is losing exclusivity in the U.S. over the next few years. It was already lost in Europe a few years ago. But the market has a binary view. Some say with Humira going away, AbbVie is worthless. But AbbVie has new drugs [Rinvoq and Skyrizi] that are taking over the Humira burden. They also bought the Botox platform a few years ago. So they have options that will offset the revenue from Humira, and the market is just forgetting this. Also, some new products can become complements to a treatment regime that uses Humira. And if they can get themselves into treatment plans for Medicare and Medicaid, they can hold onto market share for longer than you'd expect."
  • Verizon (VZ, 6.5% yield): Verizon has always been the best-in-class telco [telecom company].  Now they're coming on strong thanks to investment within the space, and massive install bases. We believe they're going to grow at a reasonable rate. You look at the premium plan share: Verizon is #1 because people believe in the reliability and consistency of the network. There's a lot more pricing power in that part of the network. [The stock] has struggled over the past year. When a company as high-quality as Verizon is hurting, that's a great time to buy unless there's a long-term issue. Right now, it's an opportunity to get in on a company that provides data infrastructure at a very cheap price: a sub-10 price-to-earnings ratio and a 6%-7% dividend yield."

Beware Yield Traps

While dividend stocks do help protect against price downside, there is such a thing as too high of a dividend yield. So investors seeking out safety in dividends should keep their eyes out for "yield traps."

YATI Tip: Looking for safe sources of high yield? Here are a few ideas.

"'Yield trap'" is a pretty common term for us in the dividend space," Graff says. "It means getting lured in by a high yield that a company's paying just for them to go and cut the dividend. You thought you had valuation protection, and it disappears because they cut the dividend."

One of the ways to protect yourself is to find companies that generate significantly more cash flow than what they pay out in dividends. 

"If you see a company paying a double-digit dividend yield, be skeptical," Graff says. "The market is very efficient. If a double-digit yield exists, a cut is likely happening. You usually won't find double-digit yields in companies with very high cash flow."

Riley & Kyle

Young & The Invested

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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