'Dividendsanity' And The Case For Sticking With Utilities ETFs

By Niklashausen :

In a recent series of articles at Marketwatch and on SA, Michael Gayed has criticized "Dividendsanity" - which he defines as "the complete love of dividend-paying stocks by portfolio managers and media pundits" - and the "negative narrative" and "end of the world trade" dominating investment decisions at the moment ( see here , here , and here ).

As evidence he points to the current overvaluation of the utility sector relative to the technology sector:

"Think about that for a moment. The fear trade made the technology sector, which has growth potential and is global, trade at a discount to utilities, which are more domestic, heavily indebted, and have little to no top-line growth. This has occurred because of the complete and utter fear about the future, and obsession with all things dividends. Take a look below at the price ratio of the Technology Select Sector relative to the Utilities Select Sector SPDR. As a reminder, a rising price ratio means the numerator/XLK is outperforming (up more/down less) the denominator/XLU. For a larger chart, visit here ."

(click to enlarge)

At the right margin of the chart he supplies to illustrate this relationship Gayed has added an upward-pointing arrow, implying that a reversal or "Summer Surprise" is about to take place, sending technology stocks higher relative to utilities. But I'm skeptical.

Since I hold Vanguard's Utilities ETF, VPU, I decided to test Gayed's ideas with Vanguard investment products. First I looked for a sector fund with a low correlation to VPU. As the table below shows, over the last 126 days Vanguard's Information Technology ETF, VGT, has shown the lowest correlation with VPU at .35 (source:

[[VAW]] [[VCR]] [[VDC]] [[VDE]] [[VFH]] [[VGT]] [[VHT]] [[VIS]] [[VNQ]] [[VOX]] [[VPU]]
VAW 1.00
VCR 0.85 1.00
VDC 0.64 0.76 1.00
VDE 0.84 0.75 0.64 1.00
VFH 0.84 0.82 0.66 0.78 1.00
VGT 0.86 0.87 0.65 0.77 0.80 1.00
VHT 0.82 0.82 0.78 0.75 0.80 0.80 1.00
VIS 0.90 0.89 0.74 0.81 0.89 0.83 0.85 1.00
VNQ 0.74 0.76 0.67 0.66 0.83 0.68 0.75 0.78 1.00
VOX 0.68 0.70 0.67 0.65 0.75 0.63 0.72 0.75 0.65 1.00
VPU 0.41 0.44 0.68 0.44 0.42 0.35 0.52 0.47 0.55 0.47 1.00

I then constructed a 3-year chart of VGT/VPU similar to Gayed's chart of XLK/XLU, but with a 10-week simple moving average.

(click to enlarge)

Since the graph shows the ratio of VGT's price to VPU's price, when the plot is rising the Information Technology ETF is doing better than the Utilities ETF. When it is falling, Utilities are doing better than Information Technology.

What we see are three peaks when VGT reached a high valuation relative to VPU: April 2010, February 2012, and late March / early April 2012. In all three cases, the VGT/VPU ratio was greater than .98. We also see five valleys when VGT was undervalued relative to VPU: July 2009, August 2010, and August, September, and December 2011. In all these latter cases, the VGT/VPU ratio was less than .82.

Note too that a false bottom occurred in June 2011, when the ratio dipped below .88, popped up a bit in July, and then crashed below .82 in August. This reversal happened at about the same ratio that VGT/VPU has today, .87. To me this suggests that it's not yet time to sell utilities and buy technology, but rather a time to be wary of another false bottom.

Michael Gayed may be right that investors are too fearful right now to give up their dividends and embrace the potential of high-growth technology stocks. But the optimistic arrow pointing to a "Summer Surprise" at the right margin of his graph seems premature and unjustified to me. The various crises and dangers facing the world economy still seem to warrant caution and prudence more than hope and exuberance. Investors should probably wait until the VGT/VPU ratio drops below .82 and then rebounds above the 10-week moving average before jumping out of utilities into information technology. Perhaps "dividendsanity" is just another word for prudence.

Disclosure: I am long [[VPU]].

Additional disclosure: I am not a registered investment advisor and do not provide specific investment advice. The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusions.

See also 10 High-Growth Stocks Under $5 Undervalued By Levered Free Cash Flows on

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

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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