Valuentum Exclusive Analysis for the Discerning Investor

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Hi everyone:

It’s Brian. Can things really stay this good? It’s a question that I keep asking myself. For starters, the investment landscape has changed quite a bit over the past decade. Years ago, interest rates were near-zero, and an intense focus on dividends may have made a lot of sense. Interest rates are now much higher, and that means risk-free assets offer yields that are a multiple of that of the yield of the S&P 500. The markets in this regard are starting to make a lot of sense as Dividend Aristocrats have suffered a difficult year so far in 2023.

I think many of these names will likely remain depressed until risk-free rates fall below that of the average S&P 500 company again – which may be a long time and likely in a difficult market environment overall. In the meantime, other areas will likely have performed much better than this group. We’re just not living in a near-zero interest rate environment anymore, and it might be very likely that the expected returns on many dividend paying stocks in the next few years may be just their dividend yield, itself. Could we see a multi-year drought in capital appreciation for many dividend payers and growers? Perhaps.

Many investors in Dividend Aristocrats are focused on dividend growth, and I don’t think many companies -- save for a couple -- will disappoint on this front. So, in this regard, things should be okay for this cohort of investors as capital appreciation and total return may be a secondary condition for them. So far in 2023, the area of large cap growth has outperformed the Dividend Aristocrats by roughly 50 percentage points. We’ve been pounding the table on large cap growth for years now. One could have made a career out of betting on large cap growth stocks during 2023. The media has now popularized this group as the “Magnificent 7,” but we’ve been early, and we’ve been right.

Another thing that has changed over the past decade or so is just how heavily government agencies are involved in the markets. We learned through Greenspan to flood the markets with liquidity following the dot-com crash, and Bernanke did the same during the Great Financial Crisis. But Powell took things to another level during COVID-19. We nailed the COVID-19 crash in 2020 and the massive bull market run in 2021, but the course of these events has fundamentally changed our risk assessment for equities. We now believe that black swan scenarios, already low-probability events, will only be short-term in nature with little lasting impact. Another Great Depression is just no longer in the cards, in our view.

What that means is that the proposition for equity investors, which already is tilted in their favor in the long run, is now even more favorable in a post-COVID world. What gave us the conviction to stick with the massive bull run from the COVID-19 bottom in March 2020 through today is precisely for this reason. It has paid off nicely. We still believe 2022 was an aberration that was quickly corrected in 2023, but the past 18 months were a long time to be proven correct – an eternity when we’re publishing 60 newsletters a year. But the point remains – betting against the equity market for even a couple years is probably the wrong move. With that in mind, things are good right now. Great, even. From what I can tell, this economy is booming even with interest rates where they are. People are spending money and spending it like mad.

But is it sustainable? Well, four major concerns come to mind. First, there’s personal credit card debt, which is soaring. Then, there’s excess savings, which is falling. Third is the resumption of student loan payments. Fourth is the housing market, where prices remain resilient despite higher rates. Offsetting these dynamics, however, has been the strength of the job market and the massive wealth build during the past several years. Wage gains during the past few years have been huge as companies have struggled to keep on help, and the wealth effect has been massive -- the biggest increase in median net worth the past three decades over the prior three years. With risk-free yields where they are, wealth is generating a nice risk-free return, even if they are just parking their assets in certificates of deposit.

Today, I feel like we’re right back where we were at the end of 2021. Large cap growth is booming. Small cap value is trailing. Dividend payers are stagnating. The markets are making a lot of sense again. But I do have my worries. When things are going this well, some market choppiness is probably in the cards. The S&P 500 is now bumping up against the high end of its downtrend, so the remainder of this year will likely see some increased volatility. On the back of Nvidia’s momentum and the great promise of artificial intelligence, however, I wonder if the first half of 2024 will be awesome followed by a very difficult back half of 2024 as some of my concerns finally catch up to the markets. But that just might be at the time the Fed starts cutting rates.

Let’s keep an eye on things, but for now, the bias through mid-2024 remains higher, in my view. I hope you had a wonderful holiday!

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Brian Nelson, CFA

President, Investment Research

brian@valuentum.com

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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, RSP, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE, DIA, RSP, QQQ, and SCHG. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.   

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