Why Dividend Growth Stocks Are a Solid Strategy for Falling Skies and Rising Rates

It looks like stocks are headed into a bear market, and in such an environment investors would be wise to consider dividend growth stocks, an often underappreciated investment category.

Back in October 2015, the OECD Business Confidence Index started to roll over and head south. At the same time, the Federal Reserve was getting ready to raise rates in anticipation of an improving economy. Many voices spoke out against the premature rate increase for several technical and fundamental reasons. As if on cue, the ringing in of the new year revealed the real financial-economic-geopolitical ugliness others had seen. Now, high-profile investment gurus such as Carl Icahn and George Soros are telling investors we're headed for a repeat of 2008.

Given tumbling stock markets, a shift in China's strategy, plunging oil prices (is that really a bad thing?), Vladimir Putin, increasing dollar strength (bad for U.S.-based multinational corporations and exports but a definite benefit for U.S. consumers), the continuing hairball in the Middle East and the constant fear sown by different factions, anxiety and fear do seem to be the general backdrop for the near term. Only the lonely U.S. Fed appears to be bucking the consensus of bad news. So, what should investors do if they believe the U.S. economy and financial markets are sliding back toward a potential bottomless recession?

Most investors and money managers use a combination of fundamental and technical analysis to discover a "high probability" of future market direction. Many directional indicators have been developed, but once a direction has been predicted, it becomes a matter of tactics on how to position the portfolio to optimize returns and hedge risk. The Reality Shares Guard market sentiment indicator is currently showing an overall bear market with four of the 10 broad market sectors in the red and two more not far behind. On a back-tested basis, the Guard indicator successfully predicted the last two bear market cycles, in 2002 and 2008.

The dismal performance of markets ringing in the new year supports the indicator forecast. However, once a direction is accepted, it's no longer the time to worry about market direction and time to think about appropriate strategies and tactics. It becomes time to consider your portfolio asset mix, allocation, balancing and hedging strategies.

Portfolio design is a complex discussion, but the purpose of this article is to present an important asset class that makes a lot of sense. Investors need to be defensive by focusing on sectors and companies with strong balance sheets, earnings growth, and most importantly, a high probability of increasing dividends in the next 12 months. Investors should favor dividend growth over yield as interest rates begin to rise. The payment and growth of dividends are true signs of corporate fundamental health and are an important component of total returns for investors.

Dividend Growth Stock Recommendations: Based on the Reality Shares Advisors DIVCON Ratings, dividend growth stocks in the following sectors offer the best potential for dividend growth: Industrials, Info Tech, Consumer Staples, and Consumer Discretionary.

The next step in filtering the best candidates would be to use the DIVCON Ratings tool search function to check for Level 5 dividend stocks in those sectors. These selections represent the highest-probability stocks for dividend growth in the next 12 months. Of course, there are no guarantees, only probabilities; however, over the past 14 years the DIVCON model has correctly predicted dividend increases among DIVCON 5-rated stocks 96.8% of the time (from 2001 through 2015).

In conclusion, we believe -- and the historical evidence supports -- a dividend growth strategy is powerful in both up and down markets.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned. This article represents the opinion of Eric Ervin and may not represent the view of Reality Shares.

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