Growth is the New Value

The markets remained pretty quiet this past week. My sense remains that we’re merely consolidating the rally from the December 18th low the on the S&P500. A proof of that is that a few times during the week, the Volatility Index, (aka, VIX), dropped below 12. This brought this so-called “Fear Index” to some of its lowest levels in the past seven years.

Based on Friday’s closing levels, the Dow is down by 0.70 percent, the S&P lower by 0.50 percent, with the NASDAQ up by 0.50 percent about half way through January. (1) The January Barometer, devised by Yale Hirsch in 1972, states that as the S&P 500 goes in January, so goes the entire year. The indicator has registered only seven major errors since 1950 for an 88.5% accuracy ratio. Last year worked nicely…we’ll have to see how the rest of the month goes.

What does the title mean anyway?

We had our annual Opus group meeting last week; a time where we talk about the year ahead, as well as get to talk with a number of thought leaders about their views of the investment environment. Based on what a number of them said, we distilled their comments down to this title phrase. Here are some examples from them and others that helped us create it.

The short version is that, based on today’s price to earnings values, dividend paying stocks – especially in the utility and telecom sectors – are now trading well above historic valuations. After some good returns over the past couple years, many dividend paying stocks, often considered to be stable, took a hit in the second half of last year. After Ben Bernanke first spoke of the Fed taper in May, interest rates started to rise. Stocks that are primarily seen as income oriented trade somewhat like bonds in that the direction of interest rates can affect their price.

So, this announcement had a big impact on higher-yielding stock returns. If you believe that – at some point – what’s gone up will likely come down, the guidance from most of our speakers is that it may be a really good idea to transfer assets from those areas into companies or funds favoring dividend growth. Good candidates can include companies which have raised their dividends over each of the last 5 years and which have a positive cash flow after dividend payments.

While you may lose some near-term cash flow, it will probably still remain well above current CD and similar issues. And you can also improve your potential to stay ahead of inflation and maintain your purchasing power.

According to John Wightkin, director of equity research applications at the Schwab Center for Financial Research, “Specifically, our research found that dividend-paying stocks with low payout ratios (dividends per share/ earnings per share) or low price/earnings (PE) ratios (market value per share/ earnings per share) would have generally had better total returns than dividend-paying stocks that don’t meet at least one of these criteria.”

The “bubble” and value

There’s still a lot of talk of a market bubble with many people. None of our speakers felt this to be the case now. It seems to me that a necessary condition for any stock bubble is the overvaluation of the stocks most sensitive to the overall stock market’s movement. However, while seemingly backward, it appears today that many high beta stocks (aka, cyclical stocks) are now, in fact, the undervalued issues. (Beta is a term used to describe the volatility of a company relative to the overall market. Put another way, high beta stocks are those stocks with the highest sensitivity to overall market movements.) The low beta companies are less sensitive to the economy, i.e., the utilities and telecom, for instance. So, the cyclical/growth stocks have the value in today’s market.

We disagree completely with this bubble notion. Seems that the strong market rally that’s been missed by a bunch of investors is hardly grounds for a financial bubble. It seems very unrealistic that high beta stocks could be selling at historically conservative valuations if there really was a stock bubble underway. In his book, Devil Take the Hind Most, Edward Chancellor demonstrates that financial bubbles tend to follow similar patterns.

Most important, his work suggests that valuation, current enthusiasm or a market correction alone does not constitute a financial bubble.

Let me know if you’d like to talk about these coming changes and how they may affect your investing situation.

Cheers!

Mike

509-747-3323

(1) CNBC, 17 Jan 2014

Securities and Investment Advisory Services offered through KMS Financial Services, Inc.

To get an overview of economic conditions, use this link. It’s updated monthly.http://www.russell.com/Helping-Advisors/Markets/EconomicIndicatorsDashboard.aspx

Past performance is not indicative of future returns.

Investing in securities of any type involves certain risks, including potential loss of principal. Investment return and principal value in a bond and/or securities portfolio will fluctuate so that investments, when sold or redeemed, may be worth more, or less, than the original investment.

Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.