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Early in the third quarter of 2016, stocks shook off the Brexit bombshell as global markets rallied, driven by better-than-expected earnings, improving economic data and an interest rate environment that remained supportive of equities relative to bonds in the near term. Market returns went nowhere in August amid the seasonal volatility that has been characteristic of late summer and early fall. Following July’s gains, investors took pause mid-quarter amid growing uncertainties surrounding the Federal Reserve (Fed) and the outcome of the presidential and congressional elections.
Equity performance remained mixed in September as an agreement to cut OPEC production buoyed energy shares, and news that the Fed would remain in a holding pattern, helped fuel a rally off mid-September lows. Economic data also provided a source of encouragement late in the quarter as forces that had been aiding U.S. growth—housing, auto sales and service-sector activity—lost some momentum but remained relatively robust. Back-to-school sales disappointed, but consumer spending overall remained healthy, as did job and wage growth. Manufacturing continued to struggle, although there were signs of a potential pickup late in the month. Meanwhile, European financial stocks ended the quarter under a dark cloud, with the U.S. Department of Justice proposing a $14 billion settlement with Deutsche Bank, related to the sale of mortgage securities from the mid-2000s.
In sum, with 2016’s all-important final quarter at the doorstep and third quarter data continuing to trickle in, hopes for a sharp second-half rebound have begun to fade. The Atlanta Fed’s closely watched GDP Now forecast for growth in the July-September quarter ended September at 2.4%, well below the 3.5% estimate at the end of August. At the same time, no one is seriously talking recession, just more of the same—muddling along while awaiting the key event of the year: Nov. 8’s presidential and congressional elections.
Fund Performance & Strategy
In spite of the recent turmoil in the market, Federated Strategic Value Dividend Fund remains focused, as always, on providing a high and rising income stream. It ended the month with a 30-day SEC yield of 2.8% (A Shares at maximum offering price) and gross weighted average yield of 3.9%. The fund’s yield exceeded that of the broad market represented by the S&P 500 (2.1%), the 10-year U.S. Treasury note (1.60%) and even the Dow Jones Select Dividend Index (3.6%), which aims to represent the domestic high-dividend-paying universe. The fund also realized nine dividend increases in the third quarter with the most notable increases from Reynolds American (9.5%), Altria (8.0%) and McDonalds (5.6%). This is Reynolds’ second increase in the calendar year, as it also raised its distribution in February for a cumulative increase of 27.8%. Reynolds recently announced that it would move its target dividend payout ratio to 80% of earnings, up from the current 75%, which led to the 9.5% increase at the end of July. For the trailing twelve months, 30 companies within the fund have increased their dividends accounting for 34 increases overall.
During the third quarter, the fund produced a total return of –3.0% (A Shares at net asset value). Over the same time frame, the S&P 500 Index and Dow Jones Select Dividend Index returned 3.9% and 1.4%, respectively. The flight to safety that was apparent in the first half of the year came to an end as an abrupt reversal in investor preferences took hold in the third quarter. A “risk on” environment dominated as investors favored low-yielding, high-beta, low-quality small-cap equities. Stocks in the lowest-yielding quintile of the U.S. market outperformed stocks in the high-yielding quintile by 6.3%. Similarly, stocks in the highest-beta quintile led stocks in the lowest-beta quintile by 14.5%. Similarly, stocks with a “C-D” quality rating outpaced stocks with an “A+” quality rating by 12.6%. Such stocks are not conducive to a dividend-oriented investment strategy and consequently the worst-performing sectors in the broad market were the defensive, dividend-rich Telecomm, Utilities and Staples sectors, which returned -5.9%, -5.6% and -2.6%, respectively. The top performer in the broad market was the cyclical Information Technology space, which posted a 12.9% return.
Regardless of current investor preferences, Federated Strategic Value Dividend Fund remains focused on dividend-friendly, non-cyclical sectors such as Consumer Staples, Utilities and Telecom Services. The largest detractors to performance were these very sectors with total returns of -2.8%, -4.8%, and -4.4%, respectively. Within Consumer Staples, Reynolds American and Altria, posted returns of -11.8% and -7.4% each, giving back modestly on strong gains realized over the last several years. There were no fundamental changes to the fund’s investments in Utilities and Telecom Services; however, they came under near-term price pressure associated with strong performance in the first half of the year and ongoing speculation on when the Fed will raise rates again.
Performance quoted represents past performance, which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than what is stated. Other share classes may have experienced different returns than the share class presented. To view performance current to the most recent month-end and for after-tax returns, click on the Performance tab. Performance does not reflect the maximum 5.5% sales charge for A Shares. If included, it would reduce the performance quoted.
Click the Performance tab for standard fund performance.
Positive performance in the fund was noted in the Health Care sector, which posted a return of 1.3%. Highest performance came from Merck, which delivered a 9.1% total return due to positive second quarter earnings results from strong sales of its diabetes drug, Januvia, and its new PD-1 oncology therapy. AstraZeneca returned 7.0% after reporting in-line second quarter earnings and on the expectation of positive future pipeline development. At the security level, other investments that advanced in the period included Procter & Gamble, Diageo and PepsiCo, all within Consumer Staples, providing total returns of 6.8%, 4.7% and 3.4%, respectively.
Click on the Portfolio Characteristics tab for the fund’s top 10 holdings.
Notwithstanding current market conditions, Federated Strategic Value Dividend Fund will remain committed to its objectives of providing a high and rising income stream from high-quality business assets and will not alter its investment style based on near-term market preferences. The fund’s investment strategy looks beyond short-term market noise and focuses instead on the long-term drivers of total return: dividend yield and dividend growth. The fund’s holdings not only provide a substantial level of rising income, but they also tend to offer lower downside risk since the fund’s investments naturally tend to be mature, large-cap global companies that are committed to a generous dividend policy.