The second quarter provided a reminder not to make hasty decisions in response to market swings. After logging an all-time high in February, the S&P 500 was on the brink of a bear market in early April after President Trump's trade war rattled investors.
American exceptionalism was declared dead. A spike in inflation seemed imminent. Recession chatter grew. And some investors undoubtedly made knee-jerk trades they now wish they could take back.
By June, the S&P 500 had made a stunning comeback and reached a new record high, marking the fastest recovery in history after a drop of 15% or more.
Source: Bloomberg
Trade deal optimism, fairly benign inflation readings, and steady economic data helped fuel the market's comeback. The government's unusually large deficit (rare outside of recessions or wartime) likely added support as well. Once again, tech and AI stocks led the way.
Since the tariff selloff bottomed on April 8, the S&P 500 gained 25% while chipmaker Nvidia surged more than 60%, the tech-focused Nasdaq index jumped 33%, and the Magnificent Seven rallied 37%. Bitcoin-linked firms, unprofitable businesses, and speculative meme stocks fared even better as traders bid up the riskiest corners of the market.
Most dividend strategies, known for their steady cash flow and lower volatility, didn't keep up in this risk-on environment. The dividend aristocrats and the popular dividend ETF SCHD returned around 10%, less than half the S&P 500's gain from its April low.
Source: Simply Safe Dividends
A 20% rally in the stock market over just two months has occurred only five other times since 1950. In every one of those cases, stocks were higher 1, 3, 6, and 12 months later. In momentum-driven markets like this, fighting the tape has historically been a losing battle.
That said, the S&P 500's relief rally now has the market trading at 22 times expected profits in the next 12 months, 35% above its 20-year average multiple.
Source: Bloomberg
The market has never been more concentrated either. Today, the top 10 stocks make up nearly 40% of the S&P 500 — far above the 25% to 30% seen during the late 1990s dot-com bubble and the Nifty Fifty era of the early 1970s. The giants of those periods eventually stumbled.
I don’t know if history will repeat. Neither does ChatGPT, since much of Big Tech's fate depends on whether AI-driven revenue can catch up with today's massive capital spending on data center infrastructure. But I do know this: over time, fundamentals always win. During periods of quick profits, it's easy to forget that a stock represents ownership in a business. And the long-term value of that ownership depends on how much money the business earns and how much it returns to shareholders.
That connection becomes clear with time. Our three model portfolios turned 10 years old this summer, with an average holding period of nearly eight years. I feel entitled to call myself a patient person based on that track record — and my wife doesn't read this newsletter often enough to argue otherwise.
Pick any long-term holding and you'll see that, just as Ben Graham wrote in The Intelligent Investor back in 1949, the market really is a weighing machine over time.
Take McDonald's (MCD), for example. We initiated a position in June 2015. The table below shows the fast food giant's annual change in earnings along with its dividend yield. Summing those figures (the "Value" column) provides a rough estimate of McDonald's intrinsic value growth each year.
While results were lumpy, especially in 2020 when indoor dining shut down, it's reasonable to estimate that McDonald's underlying value compounded at around 12.5% annually over this period. This was driven by 10% annualized growth in core earnings plus an average dividend yield of 2.5%.
Source: Simply Safe Dividends
And McDonald's stock? Annualized total returns came in at 13.1%, nearly mirroring business value growth.
Of course, market prices rarely track fundamentals year to year, as the table below shows. The "Market" column reflects McDonald's total return, which was at least 10% above or below the restaurant chain's estimated annual change in intrinsic value in seven of the nine years.
Source: Simply Safe Dividends
In the short run, the market is a voting machine, driven by fear, greed, and everything in between. But in the long run, fundamentals win.
McDonald's isn't an outlier. Diaper and tissue maker Kimberly Clark has compounded in value at roughly 5.7% annually since our November 2016 purchase, roughly matching its 5.1% total return. Regulated utility American Electric Power? An estimated 8.4% annual growth in value versus a market return of 8.8% since July 2015. And the list goes on.
Charlie and I let our marketable equities tell us by their operating results — not by their daily, or even yearly, price quotations — whether our investments are successful. The market may ignore business success for a while but eventually will confirm it.
Investors shouldn't focus on the market's mood of the day, but rather on the earnings power and long-term outlooks of the businesses they own.
Our corner of the market — high-quality dividend growth stocks — makes that job easier. Most of the firms we hold have paid safe and rising dividends for many years, track records made possible by time-tested moats, reliable cash flow, strong balance sheets, conservative capital allocation, and the ability to adapt.
We don't need to bet on major unknowns like AI adoption, autonomous driving, the value of crypto, and whether Big Tech's high valuations will hold. Nor do we need to guess when the next bear market might arrive or whether international stocks will outperform.
Instead, we focus on assessing the safety of each company's dividend and the attractiveness of its long-term outlook. Our goal is to help you find great businesses trading at reasonable prices, delivering steady income, and growing in intrinsic value over time.
Dividend investing hasn't been in fashion lately. When the S&P 500 compounds at 20% annually for three years, even solid companies can fall out of favor as the market starts to feel more like a casino than a place to invest in businesses. But that will not last forever. For now, it's worth remembering Buffett's advice: measure success by business performance and stay patient as the market moves through its unpredictable cycles. And in the meantime, take time to enjoy your rising stream of dividends.
We will continue doing our best to help you stay the course and keep your portfolio within the guardrails no matter what comes next.
Thank you for your continued support of Simply Safe Dividends. Please feel free to reach out with any questions or ideas for how we can keep improving the service for you.
