Summary
- We will show in this report that we may already be near a market bottom.
- A recovery could start as soon as this week.
- What if the market overshoots to the downside and we see a further pullback?
- The markets will recover and good stocks always bounce back.
- For "Income Investors," following the pullback, the markets are offering enticing yields. Start building a high-dividend portfolio today before it is too late.
The S&P 500 Index is officially in a "bear market". The index closed on Monday down 2.7%, reaching the 2,351 level, its lowest level since April 2017. The index is down more than 20% from its September intraday high of 2941 points. The widely accepted definition of a "bear market" is a drop of at least 20% from a recent peak.
Not all hope is lost: What is very interesting in this case is that the S&P 500 index is at a major support trend line that goes back to the year 2010. This is a level that bulls will defend with all their might. The chart below depicts the S&P 500 index ETF (NYSE:SPY):
Source: High Dividend Opportunities
The purple line is the 50% retracement from the 2016 lows. The black thin line is the 200 Moving Average. The red line shows a very established trend line that is a major support level. The green line shows a pattern of decreasing volume on every violent pullback since 2011. This technical chart is as good as it ever gets. It appears that an incredible buying opportunity is coming very soon.
Need a bigger picture than SPY? The NYSE Composite index is composed of 2800 Stocks. See anything interesting here?
Source: High Dividend Opportunities
We could very well be at the bottom of this correction.
What are the chances of a further pullback?
Before we go any further, I would like to highlight again that this pullback is more the result of negative sentiment rather than negative fundamentals. We have also shown in the charts above that we might be already near a bottom. But what about in the unlikely event this line does not hold?
Here it is important to note that today we do not have the "triggers" for a typical “bear market” to happen. Historically, "bear markets" have happened in the past for the following reasons:
- An economic recession in the United States, or in another major global economy such as Europe or China
- An asset bubble, such as a stock price bubble or real estate price bubble
- Technology stock speculations and technology stock bubbles
- Aggressive interest rate hikes, whereby bond yields become so high that it is more profitable for investors to buy bonds instead of stocks
- Spike in commodity prices, which impacts economic growth. Examples include spikes in oil prices, wheat, corn, steel and other metals' prices. Rising commodity prices usually result in increased inflation pressures and slows down the economy.
- Below is a table that depicts bear markets since the year 1940 and the reasons behind them:
Source: High Dividend Opportunities
The table below provides statistical percentages for the reasons or "ingredients" that triggered past bear markets:
Source: High Dividend Opportunities
Clearly today none of the above ingredients or triggers are available. The most frequent trigger for a bear market is an economic recession. Economic recessions are scary because, during recessions, companies start to struggle and post fewer profits. This results in a deterioration of the underlying fundamentals, and corporate profits start to decline. This is not the situation today. The state of the U.S. economy is solid and enjoying a period of low unemployment and low inflation. According to the Fed Chairman himself, GDP for the year 2019 will be healthy, and that growth will be above average and his assessment of the economy is 100% correct. We can come to the same conclusion by looking at the "probability of a U.S. recession chart" produced by the Federal Reserve Bank of New York.
Source
It is highly unlikely that a recession will happen in 2019. The most frequent trigger for a bear market is just not here.
Other reasons that have triggered a bear market in the past include extreme valuations, high commodity prices and aggressive rate hikes. We also do not have any of these other triggers today. Valuations are very reasonable if not low, commodity prices are very low based on historical standards and interest rates remain around their all-time lows. However, we do have fears that the Fed may be overly aggressive in its rate hikes, although these fears are overblown.
What if a deeper “bear market” happens?
Because we do not have the "triggers" for a typical bear market, the chances are that it will be a relatively mild one and unlikely to last long, simply because macroeconomic factors do not support it. Remember, the current pullback has little to do with fundamentals and more to do with negative investors' sentiment. Even if this scenario plays out, the worst of the downturn is likely to be behind us.
Dividend Stocks Set to Outperform
Heading into the New Year, there are two main factors that we need to be aware of:
- Earnings will be decelerating in every quarter of 2019. This isn’t too surprising considering the phenomenal earnings in 2018. For the 4th quarter of 2019, the S&P 500 companies' earnings are expected to slow to an annual pace of 17.4%, down from 28.2% in the third quarter. That is still fast, but considerably slower than 2018.
- Interest rate hikes will also decelerate or even stop altogether. If we look at the 10-Year Treasury yields, they pulled back from 3.2% to 2.8% meaning that investors are already factoring in lower inflation and lower interest rate expectations.
What this means is that there is a massive leadership change underway. Lower earnings growth coupled with lower interest rate expectations provides a very favorable backdrop for high dividend stocks and sectors. It will be imperative for income investors to identify those high-yielding dividend stocks that will be able to grow earnings and cover their dividends, even in a situation where economic growth slows.
With the 10-year Treasury yields below 3% and the dividend yield on the S&P 500 at only 2%, high-yielding stocks of 6% and above will be in high demand. Yield-hungry investors will continue to pour into dividend stocks. Furthermore, over the next few years, thousands of people in the United States will reach retirement age, and will be looking to re-allocate to high dividend stocks. The aging population phenomenon is not only affecting the United States; this is a global trend. Retirees across the globe are looking for yield, and there is no better place to invest than the United States.
Overall, because of decelerating earnings and sales environment for the stock market, investor speculation in risky technology companies is expected to slow down. Companies with stable and recurrent cash flows offering big dividend payouts to shareholders will lead this market.
Overview
The prices of equities today are factoring a deep recession and a disaster scenario which is unlikely to happen. The stock market will rebound. Good stocks always bounce back. It is only a matter of "when". We have made the case in the above charts that we could be near a bottom, which represents a great buying opportunity. A recovery could start as soon as this week.
Even in a worst-case scenario where a deeper "bear market" materializes, it will be the result of an overshoot to the downside and we do not expect it to last long.
We remain optimistic about the state of equities, and lots of money will be made from these levels. Bargain hunting is already happening behind the scenes by institutional investors. "Smart money" has been buying under the surface which tells me that the bottom is near. The markets are currently offering tremendous opportunities in the high yield space. For income investors and retirees, it is one of the best time to start picking up high-quality dividend stocks on the cheap. This sale is unlikely to last long.