After losing 18% in 2022, the S&P 500 began the new year on a strong note with a 6.3% gain in January. The most hated stocks of 2022 led the charge as speculative fervor returned to the market.
An index of non-profitable tech stocks tracked by Goldman Sachs is up 28% after losing over 50% in 2022. And the bank’s basket of the most-shorted stocks in the Russell 3000 has surged 23% following its worst year ever, according to the Wall Street Journal. Any discussion of speculative investing wouldn’t be complete without mentioning bitcoin, which gained around 40% last month.
The defensive, blue-chip dividend stocks we like were not in style during January as the market’s movements felt more akin to the stimulus-fueled frenzy seen throughout most of 2020 and 2021.
The surge in risky assets surprised me given the backdrop of a slowing economy, continued interest rate hikes, and inflation that remains well above the Fed’s long-term target.
But the market’s narrative has started to shift. The pace of inflation has moderated in recent months. Corporate earnings have yet to fall off a cliff. The labor market remains strong. And the Fed’s pace of interest rate increases has slowed to a crawl.
Fed Chair Jerome Powell on February 1 even declared that “we can now say for the first time that the disinflationary process has started” as supply chain fixes and a shift in demand from goods to services alleviate some of the price pressures triggered by the pandemic.
Powell still emphasized that ongoing interest rate increases remain appropriate to return inflation to 2% over time (versus 4.4% in December, per the Fed’s preferred measure). He also insisted that the Fed will stay the course with high rates until the job is done, refusing to loosen prematurely.
The market isn’t buying it, though. At least not in recent weeks. Stock investors seem to believe that inflation will be subdued in short order without causing more than a mild economic slowdown. And as inflation comes down, so will interest rates.
Responding to these shifting expectations, bond yields edged lower during January, with the 10-year Treasury yield falling from about 3.9% to 3.5%. This helped fuel the surge in volatile and risky stocks that benefit the most from looser financial conditions.
Investors can drive themselves mad trying to anticipate these abrupt rotations in the market. Such shifts cannot be predicted with any consistency, despite the urges you might feel to chase price momentum, which continues until it doesn’t (or until I buy, in my experience).
Never forget Warren Buffett’s wisdom shared in his 1987 shareholder letter: the stock market is a manic depressive (emphasis added below).
“Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.
… an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace.”
– Warren Buffett, 1987 Berkshire Hathaway Letter
Rather than chase performance trends or time the market, I much prefer to stay invested in a timeless, long-term dividend growth strategy.
This approach is easy to follow – assemble a diversified portfolio of a few dozen high-quality dividend stocks you hope to hold forever. And it produces a rising stream of passive income that is detached from the stock market’s gyrations.
Generating income without needing to sell shares also makes price volatility easier to ignore, reducing the chances of succumbing to behavioral mistakes like panic selling.
Should the tide go out, a conservative dividend portfolio may provide better downside protection as well since it holds mostly blue-chip companies that are profitable and maintain solid financial positions. We saw that play out in 2022.
Today’s relatively high bond yields can pair well with a dividend portfolio, too. Especially for conservative investors prioritizing safety. You can read our thoughts on that here.
Looking ahead, earnings season is in full swing. Companies in the S&P 500 are on track to see their fourth-quarter profits decline by about 5%. While this marks the first drop in profits since the pandemic, dividend increases continue to far outpace cuts.
Only five companies out of the approximately 900 in our Dividend Safety Score coverage universe have reduced or eliminated their dividends so far in 2023. (All had Unsafe or Very Unsafe scores; you can view our real-time track record here.)
Each of these businesses, which included an office REIT, apparel company, and Canadian utility, faced earnings pressure and wanted to direct more cash towards debt reduction due to today’s higher borrowing rates.
This may be a common theme throughout 2023 as more highly leveraged companies seek to improve their financial positions. Balance sheets are an important consideration when we evaluate a company’s dividend safety.
Fortunately, many businesses remain in good shape despite the slowing economy. Here were some of the notable dividend raises announced over the past month:
Valero: +4.1%, first hike for the oil refiner since before the pandemic