Linda Duessel: Hello, and welcome again to the Hear & Now podcast. I'm Linda Duessel, Senior Equity Strategist at Federated Investors. And today, I'm joined by Daniel Peris, Senior Portfolio Manager and Head of the Strategic Value Dividend Team. Let's start by discussing the rate environment we're in. In the past several years, rates have been all over the place. The 10 year yield has been as low as 1.5%, and as high as 3.2%. What does that mean for the businesses that pay dividends?
Daniel Peris: Hello, Linda and thank you for having me on the show. The rate environment has been really fascinating. On one level, particularly when people are discussing investments and expectations of returns, they're discussing almost nothing but the rate environment. The expectation that the rate environment is going to drive returns. What's going to happen rates moving up? What's going to happen rates moving down? And that's fine. That's the stock market, and how it operates.
Daniel Peris: Curiously however, the level of company ownership and the generation of dividends from set ownership, the movement in rates, whether up or down, at these levels has had almost no impact and is not likely to have any particular impact on the generation of dividends. Interest rates moving up five basis points at a day or down 30 basis points in two months, doesn't change the consumption of food, beverage, tobacco, household products, pharmaceuticals, doesn't change consumption of electricity or oil production or these other things.
Daniel Peris: Those things continue along. They're more driven by GDP, which tends to be more stable. So you have two levels of effect. The stock market effect and then the business effect. Now, interest rates have very, very low levels or very, very high levels, will certainly have an impact on businesses. Their ability to generate cash flows, distributable cash flows and dividends, but we're actually not really there, but at the same time of course every single day, the change in interest rates even whether it's just a few basis points, this is for the 10 year, which is most important for us on the equity side.
Daniel Peris: Change in the 10 years, always given a power to change share prices. So why did the market go up today? Oh, because interest rates went down. Oh, why did the market go down today? Because, interest rates went up. Hard to tell whether that's true or not, but it's really important I think for investors to keep in mind the difference between interest rates and the businesses that they own.
Linda Duessel: Yeah, that's really is true. And something you said to me or, which you said earlier about sometimes people want to talk about nothing but the interest rate environment. I think it's great that you look at businesses and can they deliver and grow their dividends, which is really a great thing particularly these days. It's so funny. In my job as a market strategist and how many people over these last number of years have said, 'As I said, high dividend yielding, investing is probably a great idea in here. How could you say that when rates are going up?' And in fact they did not. So now what about these interest rates, which had been on the lower end of the range now and its impact on the market, the stock market? What do you think?
Daniel Peris: Yeah, I think there are really two, actually three observations I'll make. First of all, just to reiterate your point, but make it even clearer, I've been in this business for a couple of decades at this point in time, and really for the last 10 12 years, heard nothing but 'Oh, interest rates are going to go up.' This type of approach, the stock market's isn't going to work out during that period. Let's just be clear, everyone has been 100% convinced that interest rates are going up, and during this period-
Daniel Peris: ... interest rates have gone nowhere but down. So just take that as the wisdom of crowds and for whatever it's worth. So that that is the folly, a human folly as reflected in the stock market and expectations. That being said, interest rates at the current levels and coming down I think do have an impact on our style of investing with the style of investing reflected in dividend investing.
Linda Duessel: Amen.
Daniel Peris: In terms of basic supply and demand. I don't like to discuss the, or get into debates about how it affects share prices in any given day. But there is a basic supply and demand issue when interest rates for financial assets are as low as they are. People need income, grandma needs income, retirees, baby boomers need income. For reasons and you know, not necessarily related to their need for income, income has kind of disappeared from traditional asset sources.
Daniel Peris: Rates, cash rates on name your products. CDs, overnight grades, money market rates, whatever product you're looking at over the last five, 10 years, interest rates have come way, way down. Yet the need for income from retirees has not come way, way down. It's probably moved up, and so we are probably benefiting from a supply and demand, and again not discussing stock market dynamics, but from a supply and demand perspective.
Daniel Peris: Ownership in businesses, which pay, make cash distributions quarterly and for publicly traded ones. Those are called dividends have probably benefited, clearly benefited from the fact that a dividend approach to investing in the stock market can meet a client's real-world need for income that might've been met by other types of assets a decade ago and just can't be met by other types of assets right now.
Linda Duessel: Yes, in the stock market of course has done very well this year making new recent record highs even as the more defensive areas have done better and better, haven't they? As the market probably is reflecting the fact that we're at the back half of an economic cycle, and history shows these are the very kinds of stocks that work best at this stage of the cycle. Now Dan, how do you think the rate affects the supply and demand for dividends stock?
Daniel Peris: Well, again, I think that there's a limited supply, and we see demand go up and down based on how the combination of retirees needing income, or stock market investors moving out of different sectors, because they think they're going to be in favor. And there have been a couple periods, 2016 you could argue for parts of 2019 when just from a stock market perspective, the lower interest rates have led dividend paying stocks to be in favor. But in general, quite ironically, we've had 10 years of a strong market rally, dividend paying stocks have historically been out of favor during this last 10 year period. There have been exceptions, blips and then we'll continue to be.
Daniel Peris: The net result is, you know, where we stand right now, late 2019 given where yields for the types of investments we like to make are, given what the dividend growth rates are, given what the interest rate structure is, given the demand for income right now, and give it in relative levels of performance. Again, not dividend performance but stock market performance. We focused on dividend performance, but a lot of other people focused on stock market performance.
Daniel Peris: Given all those factors, very, very comfortable where we sit. We have these ownership stakes in businesses, we have income, we have dividend growth, we have conservative businesses in a kind of unconservative times, and the interest rate structure, and I would say demographic structure is kind of leaning in our direction. So it's from our perspective, a good time to be inclined in this direction.
Linda Duessel: And as you say, all those aging baby boomers need income, but always go to the government bond. But just as you said, the rates can go on down, don't they? And where else can they turn for high quality income?
Daniel Peris: Yeah. Investment grade bonds are great. They are investment grade bonds, and that's wonderful, but their rates, the cash rates of return are low, government securities in theory, risk-free though that's a debatable point. We can save that for the next podcast.
Linda Duessel: Yes.
Daniel Peris: But their rates of return are very low. Interest rates from fixed income securities outside the United States are even lower, government bonds outside the United States trading at negative levels that we can discuss that again another time. So the U.S. stock market, whatever its issues and however you may feel about it when approach in a kind of conservative dividend focused manner can meet a real world need, and that's what we try to do.
Linda Duessel: Well now as you look into 2020 Dan, what is your main concern, if any, as you survey the investment landscape?
Daniel Peris: Yeah, and this is kind of a little bit inside baseball for dividend investing, but the hard part about dividend investing is not necessarily a higher yield, it's dividend growth, and you're facing all sorts of challenges, tailwinds or headwinds, but you know, I'm paid to worry about the headwinds, not so much to claim the tailwinds. And the headwinds at any given point of time or about economic growth, they can be about the dollar, probably the dollar has been rising. That makes it harder to generate dollar based dividend growth.
Daniel Peris: Economic growth is what it is. Low single digit, always a struggle. But you know, a struggle we've been managing through for nearly two decades now. Number one issue I worry about is actually deflation, which is just prices going down, not up for goods and services in real terms, and that's something that makes it harder to deliver nominal dividend growth. But again, that's what we're paid for as active managers, active business owners to deliver dividend growth.
Daniel Peris: And that is our mandate I keep when we look at all of our companies, I look at pricing, how significant are the deflationary pressures, is there pricing power, is there modest inflation, and trying to modulate that so we can achieve our goal of delivering dividend growth. But if you ask me what keeps me up at night, it is the broad notion of deflation.
Linda Duessel: Deflation, even harder to find income and even more interesting for the dividends stock. Well, what sectors do you currently think offer some of the best opportunities for dividend growth? Any promising new areas that you're finding out there?
Daniel Peris: Yeah. Then I would go back into what you just... How you introduced that comment. It's a headwind for dividend growth, but actual deflation will make the dividends in even greater demand. So that is both a tailwind and a headwind. It will make basic income producing securities attractive, but it will make the technical goal of dividend growth harder. So it's a bit of a mixed blessing shall we say.
Daniel Peris: Where are we seeing opportunities? Dividend investors in general and our products particularly tend to be a lower turnover business ownership, is business ownership not flipping stocks. So we tend to be at the low end of the broad spectrum of turnover. So there's not a constant motion in and out. And the sectors or spaces or companies that we operate tend to be fairly consistent. We tend to have the usual suspects. It's a usual suspects crowd, both at a sectorial level and at individual holdings. You can see some shifts in the portfolio over longer periods of time. We've seen some health care come back into the portfolio again, come back in. We've previously had many of these names, but they tend to cycle in and out.
Daniel Peris: The businesses are the same. It's just the share prices move up or down dramatically. It changes the income level in the yield and the attraction to us, so we can move in and out. That's the benefit of an active manager. So we've seen 2019 a bit more on healthcare. It's basically large cap pharma, a bit of integrated energy and then bits and pieces, just miscellaneous individual companies that have become attractive to us during the course of the year. In general, the portfolio profiles of dividend to kind of dividend products haven't really changed much in years. There hasn't been any dramatic change. It's the usual suspects just in different measures at various points in time.
Linda Duessel: Yes, but you remind us even as a high quality dividend investors how important it is to have a manager who knows when to move in and out as valuations can move all over the place, can't they?
Daniel Peris: And dividend growth rates, dividend cuts, new companies. It was a fascinating year. We won't get into it, because we don't want to make the product stale. But 2019 was actually an outstanding year to look at the difference between active versus passive management in dividend investing. There were lots of zigs and zags in the marketplace concerning dividends and I have no idea how passive structures engage those zigs and zags. But we have a tale to tell about that.
Linda Duessel: Yeah. Excellent. So now as we look into 2020 Dan, what is your outlook for dividend?
Daniel Peris: Historically we seek and we'll continue to seek in this kind of the bland generic phrase of dividend yield, dividend growth and from high quality companies, and that continues to be our goal. See no reason despite the headwinds and including some tailwinds we hope to see in 2019 that we should be able to deliver on our goals of dividend growth and a high yield consistent with what we have in the past.
Daniel Peris: You kind of get to start with a clean slate. In January one heading into 2019, we actually didn't have much of a clean slate. It was kind of rather busy, and it became a busy year. In 2020, we're going to continue to strive as we have in the past to deliver a high, and rising income stream from high quality business assets. That's what we do.
Linda Duessel: As in any year, the turtle wins the race, doesn't it Dan?
Daniel Peris: The turtle will trundle along, moving very slowly, but very consistently. That's what we do.
Linda Duessel: Well, thank you so much Dan, and thank you to our listeners. We look forward to you joining us again on the Federated Hear & Now podcast.
Disclosure: Views are as of 10/28/2019 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector. Past performance is no guarantee of future results. There can be no guarantee that any investment strategy will be successful.
There are no guarantees that dividend paying stocks will continue to pay dividends. In addition, dividend paying stocks may not experience the same capital appreciation potential as non-dividend paying stocks. Stocks are subject to risk and fluctuate in value. Principal loss is possible. Stocks offer higher return potential, but their prices are more volatile than those of bonds. U.S. government bonds, unlike stocks, are guaranteed as to the timely payment of principal and interest. Unlike stocks, bank savings accounts and CDs are FDIC insured and offer stable principal. Federated Equity Management Company of Pennsylvania 19-30154 (11/19)