Stock Market Scores A+ On First Half of 2017 Report Card
The S&P 500 closed out the second quarter of 2017 on a mixed note, with some fierce sector rotation bringing about volatility that rattled investor’s nerves.
As of June 30, the S&P 500 is up 8.34% year to date. Growth stocks were swept up in last week’s correction in technology stocks.
Interestingly, of the high-profile tech stocks that have reported second-quarter earnings, the results have come in above forecasts, coupled with strong forward guidance. In the past few weeks, Adobe Systems (ADBE), Autodesk (ADSK), Red Hat (RHT), Oracle (ORCL) and Micron Technology (MU) all exceeded analyst estimates.
While there is clearly some short-term rotation into financials, it is my view that as more technology stocks announce better-than-expected sales and earnings starting in mid-July, the tech sector should firm up. Sparking the tech sell-off was the European Union’s announcement that it imposed a $2.7 billion fine on Google. That triggered algorithmic trading and high-frequency-trading-related sell programs around the globe that account for about 70% of total trading volume in today’s U.S. equity markets.
It must be noted that when technology stocks undergo correction, that money is not leaving the stock market. It is just being reshuffled to other industry groups, such as the biotech, financial and industrial sectors. These rotational corrections are actually quite constructive.
The underpinnings of the bullish trend for dividend-paying stocks remain strong and have improved during the second quarter. The S&P 500 dividend payout ratio in the second quarter remained at about 50%, or $400 billion, while stock buybacks were $508.1 billion. The S&P 500’s operating earnings were $958.1 billion in the first quarter, so 94.8% of these operating earnings were diverted to dividends and stock buybacks. Corporate America remains highly committed to maintaining high dividend payouts and strong stock buyback activity.
Furthermore, one of the reasons that the stock market seems to rebound quickly after technology sell-offs is that dividend bargain hunters appear and Corporate America likes to buy back more stock in the wake of the mechanical algorithmic-related sell-offs. In other words, the foundation under the S&P 500 remains strong thanks to (1) the best operating earnings in over five years, (2) a 50% dividend payout ratio and (3) continued strong stock buyback activity.
The sweet spot for the majority of investors is dividend growth stocks, which have performed well due to the S&P 500 dividend yield remaining very close to the 10-year Treasury yield. Historically, anytime the yield on the S&P 500 gets near the 10-year Treasury yield, it represents a strong buy signal, just like in mid-November and, before that, January 2016. Since the S&P 500 is merely following its operating earnings higher, price-to-earnings ratios are holding steady. Yet the 10-year Treasury yield declined in the second quarter, so relative to bond yields, the stock market is very attractive. Earnings are growing faster than the stock market’s gains.
Several Fed officials have publicly spoken out recently, questioning if the Fed should raise key interest rates further when Treasury bond yields are falling and the yield curve is flattening. These Fed officials are also talking about the lack of inflation, implying that the Federal Open Market Committee (FOMC) should be in no hurry to raise key interest rates further and the Fed has already “normalized” key interest rates. Few catalysts could be more bullish for dividend-paying stocks than the notion of the Fed tapping the brakes on further rate hikes for 2017.
Recently, Fed Chair Janet Yellen was at an event in London and said that banks are “very much stronger” and another financial crisis is not likely “in our lifetime,” since the Fed has brought stability to the U.S. banking system. Ms. Yellen stressed that the Fed has learned some lessons from the financial crisis, stating, “I think the public can see the capital positions of the major banks are very much stronger this year” and concluded by saying that “all of the firms (major banks) passed the quantitative parts of the stress tests.”
In fact, the Fed cleared 34 major banks, which account for 75% of the financial assets in the United States, to let them begin to return capital back to their shareholders, since they all passed the stress tests to ensure adequate capitalization. This news naturally is good and many major banks may choose to boost their dividends and/or redeem their preferred stock to return capital back to their shareholders.
To cap off the second quarter, the Commerce Department revised first-quarter gross domestic product (GDP) growth up to a 1.4% annual pace, compared to its previous estimate of 1.2% annual growth. The primary reason for the upward GDP revision was that exports rose at a 7% annual pace (up from 5.8% previously estimated) and consumer spending jumped at a 1.1% annual pace (up from 0.6% previously estimated). Optimism for second-quarter GDP growth remains high and most economists expect that GDP growth will at least double to a 2.8% annual pace.
When inflation is running at an annual rate of less than 2.0%, the 10-year Treasury is trading in the low 2% range, S&P earnings are forecast to average 9.45% for the first six months of 2017 and the financial sector that carries the second highest sector weighting of 14.81% is coming to life in a big way, there is good reason for investors to cheer for higher stock prices ahead.
This backdrop is golden for investing in high-yield assets and investors need look no further than Cash Machine, a high-yield income advisory letter that zeroes in on the best high-yield and growth assets the market has to offer. Just click here to learn how to put into place an action plan for the second half of 2017 with the guidance of a seasoned pro who has 33 years of income investing experience to help you obtain income that will be four to five times the 10-year Treasury yields.
In case you missed it, I encourage you to read my e-letter from last week about how investors can take advantage of the strong tech earnings with covered-call trades.
