Wall Street wags sometimes refer to a correction as a “yield rally.” But for many people, particularly those who are relatively new to the stock market, August’s sharp drop in prices was nothing to crack wise about.
Right now, many advisors are having conversations with investors to assure them that the world has not ended, despite increased volatility and screaming headlines about major drops in the Dow. The mischievous term “yield rally” does not reassure. Yet, it does contain a kernel of truth.
Corrections do provide an opportunity to rebalance into equities at lower prices. Since dividend payments are not automatically cut in market declines, long-term investors who buy into corrections get higher yields.
Overall, the 6.3% decline in the S&P 500 during August produced a small bump in the index’s yield from 2.09% at the end of July to 2.22% a month later. Nobody will get rich from that yield rally.
If you dig deeper, however, you may find some attractive long-term dividend choices. Looking at the S&P Capital IQ database of U.S. equities, 2,670 issues had yields higher than the 2.17% offered by the 10-year Treasury note at the end of August. That group includes stocks whose yields are unsustainably high and are likely to see a dividend cut. If we add a 5% yield ceiling to our criteria, the list shrinks to 1,066.
Within the large-cap S&P 500, 210 stocks had yields between 2.17% and 5% as of the end of August. But capitalization size alone does not indicate that a stock is worth buying. (Remember Enron and MCI?) Applying S&P Capital IQ’s proprietary Quality Rankings, a computerized scoring that measures the growth and stability of earnings and dividend over the past 10 years, the list grows even smaller. When we apply a B+ (average) or higher Quality Ranking, we have 71 stocks in our universe. Limiting our selection to the two highest categories, A and A+, gives us a list of 44.
Among those stocks are Coca-Cola (KO, 3.4% yield, 53 consecutive years of dividend increases), Procter & Gamble (PG, 3.8%, 59 years), Genuine Parts (GPC, 2.9%, 59 years) and ExxonMobil (XOM, 3.9%, 33 years). Some of these companies have specific challenges that go beyond the stock market correction. For example, XOM faces low oil prices and KO is seeing weaker domestic soda sales. But the old Wall Street adage “buy straw hats in the winter” may be worth remembering.
If you prefer to own a pre-assembled collection of straw boaters rather than buying them one at a time, consider some of the ETFs that specialize in dividend growth. As would be expected, the three largest such funds experienced declines in August. Even with the decline, the largest of these dividend growth funds, the Vanguard Dividend Appreciation ETF (VIG) has a yield of just 2.19%, the virtual equivalent of the S&P 500’s yield.
Slightly higher yields are available in next two largest funds in the category, the iShares Select Dividend ETF (DVY) and the SPDR S&P Dividend ETF (SDY).
Is the yield rally over? Or will lower prices (and higher yields) be available to those who wait? Trying to predict the short-term movements of the stock market has always been a fool’s errand.
But we can say for certain that good quality dividend-paying stocks, including those with decades of annual dividend increases in their histories, are selling for lower prices now than they did a month ago. That should not be the sole reason for buying them, but it is a very good reason to take a closer look.
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