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Here in Vermont, we’ve had three straight weeks of near-perfect spring weather. It seems too good to be true. Which is why I’ve been bringing my raincoat to work each of the last few days, just in case.
And that’s essentially a microcosm of what’s happening on Wall Street right now.
Stocks rose to record heights yet again yesterday, with the S&P 500 closing at 1,909 for the first time ever. The index has now risen in almost a straight line for two and a half years. November 2011 was the last time the S&P pulled back as much as 10%. Nothing has been able to slow this rally of late.
With the good times rolling on Wall Street, why then are investors suddenly loading up on dividend stocks? For the same reason I’ve been packing my raincoat when it’s 75 degrees and sunny out: human nature.
When times are good, we always assume that things will eventually even out. And vice versa. The law of averages dictates it. That theory also holds true on Wall Street.
Though stocks rise over time, no bull rally has lasted forever without a substantial (at least 10%) correction. Eventually, some economic or geopolitical event will trigger a major pullback. When it happens, you’ll want to have a few reliable, low-beta dividend payers in your portfolio.
And that’s why investors have been snatching up dividend stocks of late.
Four dividend-heavy ETFs – the iShares Select Dividend (NYSE: DVY), iShares High Dividend (NYSE: HDV), SPDR S&P Dividend (NYSE: SDY) and the Vanguard High Dividend Yield (NYSE: VYM) funds – are up an average of 4.9% year to date. That’s more than double the 2% return in the S&P 500 in 2013.
The flood to dividend paying stocks is a sure sign that investors are batting down the hatches in preparation for a coming storm. It may not come next week, next month or even this year. But eventually, stocks will hit the skids – at least in the short term.
Dividend paying stocks offer a cushion for when share prices go south. Not only does the nice 3% or 4% yield help offset a 3% or 4% decline in another stock, but the higher-yielding dividend payers are often well-established blue-chip companies that are more even-keel than, say, an upstart growth stock.
To borrow from my original analogy, low-beta dividend paying stocks are a nice raincoat to have when the trading skies suddenly turn grey. The stocks in the four ETFs listed above have an average beta of 0.8, and an average yield of 2.9%. Having stocks in your portfolio that yield roughly 3% and are less prone to wild price swings provides security when things go bad.
“Sell In May” hasn’t reared its ugly head yet. Stocks are actually up more than 1% this month. It’s still early in the market’s traditional sell-off period, though.
The fact of the matter is that stocks typically decline from May through October. Since 1950, the Dow Jones Industrial Average has been essentially flat during the market’s “worst six months,” versus an average return of 7.5% from November through April.
And with the S&P 500 already at all-time highs and trading at 15.3 times forward earnings estimates – higher than the 10-year average forward P/E of 13.8? Well, you can see why so many investors are taking defensive positions by loading up on dividend paying stocks.
You’d be wise to do the same. It may feel silly doing it. But don’t be afraid to bring your raincoat to work on a sunny day.
You’ll be glad you have it when it inevitably starts to pour.
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