Don't Bet On Fed Policy Changes, Look For Stable Dividends Instead

This week’s monetary policy meeting at the Federal Reserve has most of the attention of the market, and there is little doubt that the outcome and concluding policy statement will generate short-term volatility.  This will be the case no matter what the Fed ultimately signals -- concern for the economic (and a reluctance to continue cutting stimulus), or confidence (indicating stronger chances for additional tapering).  There is a relatively strong set of economic data that sets the stage for additional tapering.  But when we look at most of the public statements made by voting members of the central bank, it is unlikely that we will see any sweeping changes near-term.  

Because of this, investors should be expecting a low interest rate environment for the foreseeable future.  We would need to see major gains in labor markets, or quickly rising levels of consumer inflation in order to change this view.  So, what is the best way to position for this scenario?  Does it make sense to move into commodities, stock benchmarks, or individual sectors?

Dividends, Dividends, Dividends

“Ultimately, the current environment favors investors moving into stocks with elevated -- yet stable -- dividend payouts,” said Rick Bartlett, markets analyst at CornerTrader.  The key word here is “stable,” as there are many stock choices that offer elevated dividends that might not be sustainable over the long-term.  One of the sectors that continues to look attractive from both perspectives can be found in business development companies (BDCs), and perhaps the best selection in this space is Prospect Capital (PSEC).  

Investors that are focused on dividend stocks tend to establish positions with a multi-year perspective.  So the best way to find winners in this space is to isolated stocks with solid fundamentals, strong project pipelines, and a reasonable payout ratio.  PSEC is one of the sector examples that best meets these criteria, and offers an impressive 11.9% annual dividend at the same time.  From a growth perspective, Prospect has posted some surprising numbers over the last three years -- growing from $1.7 billion in assets in late 2011, to roughly $5.1 billion last quarter.  From a comparative standpoint, performances like these will continue to push Prospect into the spotlight relative to some of its sector peers -- for example, Main Street Capital (MAIN).  

Use a Macro Framework, While Focusing on Sectors

At this stage in the game, it can be easy for investors to become distracted by the short-term fluctuations that are driven by daily news releases.  The Fed will almost certainly have this type of impact again in this week’s trading.  But it is important to remember that very little has changed when we look at the underlying activities supporting the economy.  There are very few arguments to be made for higher interest rates -- no matter what the Fed suggests at its next meeting.  Buying opportunities in dividend stocks should be seen if the Fed does ultimately signal confidence, increasing the prospects for further cuts in stimulus.  

For companies with like Prospect Capital that payout attractive dividends, there are industry-specific developments that will guide growth prospects in coming quarters.  In this case, Prospect’s real estate investments will be a key driver over these types of timeframes.  But the broader environment remains supportive for these types of investment strategies, as there is little reason to bet on major policy changes any time soon.