Equities have been swimming in dangerous waters for several months now. The S&P 500 is narrowly outside of a bear market at the moment, down about 19% from its highs, but the Russell 2000 and Nasdaq 100 are both off by 28%. The pain for shareholders has already been pretty severe, but we may be entering the phase that could take stock prices another leg lower - earnings.
While a lot of forward-looking numbers, particularly those around economic growth, have been revised lower, corporate earnings forecasts largely haven’t been. The street is still expecting somewhere between 5-10% earnings growth year-over-year and few companies have warned that actual results could come in below estimates. What typically happens is that companies miss numbers for the prior quarter while lowering future quarter forecasts at the same time. It’s unusual for a company to warn at one point and then disappoint again shortly thereafter. They usually like to get all the bad news out of the way at once.
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That’s why I think that stocks are particularly vulnerable over the next month or so. I have a feeling we’re going to be getting a lot of bad news that isn’t already priced in. JPMorgan Chase and Morgan Stanley already disappointed last week. Several companies, including Facebook, Alphabet and Tesla, have warned that hiring is slowing. A month ago, Target said that it’s slashing prices and severely cutting margin forecasts in an effort to simply get inventory off the shelves. The early warning signs are already there and I think more are coming.
Therefore, I think it’s wise for investors to consider defensive positions here instead of trying to hit home runs. Just as much, if not more, outperformance can be achieved in down markets as up markets and dividend ETFs make a solid choice for trying to achieve that.
Dividend ETFs have performed quite well on a relative basis this year, especially dividend growth funds, with a handful even posting positive returns during the 1st half of the year. It’s not guarantee, of course, that they’ll continue outperforming in the 2nd half, but I like how many of them are currently positioned given the economic backdrop continues to deteriorate.
I want to discuss three dividend ETFs that I think are particularly attractive right now. All utilize a multi-tiered approach to stock selection to help identify those stocks that have a better than average chance of leading the market. On top of that, they all offer 3-4% yields and providing an important steady income component that many corners of the market still fail to offer (without taking excessive risk).
Consider adding these ETFs for a bit of safety and yield.
Schwab U.S. Dividend Equity ETF (SCHD)
If you’ve followed my work in the past, you know I’m a big fan of this fund. Instead of targeting any specific strategy, it targets stocks that have positive characteristics on multiple fronts. It starts by only considering stocks with a minimum 10-year history of paying dividends and then selecting those with attractive fundamental factors, such as high cash flow to total debt, high return on equity, dividend yield and 5-year dividend growth rate. It finishes by pulling the highest-yielding stocks out of this group and weighting them by market cap.
Investors get all this for a rock bottom expense ratio of just 0.06%. This ETF has performed in the top 40% of Morningstar’s Large Value category in each of the past 9 calendar years and is on pace to do so again in 2022. Its yield of 3.5% is twice that of the S&P 500 and has delivered these results with modestly less risk than the broader market.
If I could own only one dividend ETF, SCHD would probably be it.
Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)
SPHD hits a couple of themes that have performed particularly well in the past year - high yielders and low volatility. The fund’s index starts with the S&P 500 and identifies the 75 stocks with the highest dividend yields over the past 12 months. Within that group, the fund pulls out the 50 stocks with the lowest realized volatility. Qualifying components are then weighted by dividend yield, which helps SPHD offer investors a juicy 4% yield.
If there’s a drawback to this fund, it’s that results are usually feast or famine. In 7 of the past 9 years, SPHD’s performance has landed in either the top 5% or the bottom 11% of its Morningstar peer group. When it’s style is in favor, it’s a top-tier performer. When it’s not, underperformance can be severe.
The good news is that 2022 has been one of the year’s it’s been in favor. It’s currently in the top 3% of its group, outperforming the average by roughly 9% year-to-date. With the economy continuing to slow and global conditions getting worse, it’s reasonable to assume that this fund’s style will remain in favor for a while longer.
Invesco High Yield Equity Dividend Achievers ETF (PEY)
Dividend growth stocks aren’t necessarily known for their yields. Some companies have been raising their dividend for decades, but their yields still hover in the 1-2% range. PEY attempts to rectify that problem by pulling out the highest yielders within the long-term dividend grower universe.
PEY’s index initially includes stocks with a minimum 10-year history of consecutive dividend growth. From that group, it targets the 50 highest yielders and weights them by dividend yield. It doesn’t use the more strict 25-year history requirement to become a dividend aristocrat, but it’s looser requirement allows some of the more recent dividend growers to also make the cut. Overall, it’s a nice balance between dividend growth and high yield.
It also yields 4% right now.
With that being said, let’s look at the markets and some ETFs.
Energy and materials stocks have now turned into the two worst performing market sectors, reflecting the demand destruction that’s already occurring and the steep correction in many commodities. The market appears to have shifted its focus away from the inflation narrative and how high it will go towards the recession narrative and how quickly it’ll get here.
There are no particularly strong areas of the market right now, although defensive sectors have been doing a little better as they have all throughout 2022. While growth has struggled throughout the past several months, tech looks like it might be trying to make a bit of a comeback. As long as cyclicals take a back seat in this slowing environment, there might be space for select tech and growth names to lead again.
Semiconductors are another narrative-driven sector as Congress attempts to push the CHIPS bill through. This legislation would help fund the additional production of semiconductors in the U.S. and lessen the reliance of China. That’s good news for investment in the space, but chip companies have mixed feelings because it’s likely to lower the price of chips and impact profitability. Volatility has been higher in this sector recently, but price results have been fairly good.
Everything else among the growth sectors is still in pretty neutral territory. Cloud and blockchain stocks remain very volatile with mixed results. I’m still very leery of what the consumer space is going to do over this Q2 earnings season. There have been enough warnings to make me believe that there’s some fire with this smoke and I imagine the consumer discretionary space, in particular, could get hit hard.
The biggest losses right now are coming from energy and materials, but really the entire cyclical space is getting weaker. The initial bank earnings reports from last week were mixed to poor and I don’t think anything we’re going to hear from the financials from here on out will be terribly encouraging. Industrials have held up better than their peers, but they’ve begun underperforming as well. There’s really no safe space in this group and I don’t imagine the landscape is going to improve very much for a while. Unless we get an inflation report at some point that indicates pressures are coming down faster than expected, conditions don’t look very favorable.
Healthcare is still perhaps the strongest sector in the market right now. Biotech and genomics stocks have done very well over the past month, but the more traditionally defensive areas of this group are also doing relatively well. We’ve heard some rumblings on drug pricing lately and that’s typically been a negative for this sector, but I don’t see anything meaningful happening here at least until after the midterm elections.
The dollar remains the king of all currencies, but I’m worried it’s moving a little far, a little fast here. A strong greenback can have negative implications on the earnings front and I don’t think corporations need any more headwinds at the moment. Oil prices have balanced out a bit, but President Biden’s trip to the Middle East didn’t produce any real results that could have helped lower oil prices.