The tortoise moves forward The tortoise moves forward http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\running-track-small.jpg April 29 2022 March 16 2022

The tortoise moves forward

Facing inflation and other market headwinds, defensive dividend-paying stocks may offer some protection.

Published March 16 2022
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Podcast Transcript
00:00
Linda Duessel: Hello, and welcome to the Hear & Now podcast from Federated Hermes, I'm Linda Duessel senior equity strategist. Today, I'm joined by Daniel Peris, senior portfolio manager, and head of the strategic value dividend team here at Federated Hermes. Daniel is the author of three books on dividend investing, The Strategic Dividend Investor, The Dividend Imperative, and Getting Back To Business. So who better to discuss the compelling opportunities of dividend-paying stocks? Thank you, Daniel, for joining me today.
00:33
Daniel Peris: Thank you Linda, for having me on the show.
00:36
Linda Duessel: Just dive in here now with a quick look back. Happily, the mandates, it looks like for masks have been lifted, and maybe, maybe we can put COVID behind us, but the 2020 lockdown that we suffered and the rocky markets are still fresh in a lot of people's minds.
01:13
Daniel Peris: That's a really good question. And it's a fair question. And societies and business processes and investor preferences do change. And the reality is that while dividend investing is sort of the norm, the what you do when you're doing things normally, that normal changed during work from home. And frankly, a lot of the work from home stocks were businesses were doing very, very well. And some of the traditional business practices, transactions, things purchased, things used, were not, and that was reflected temporarily during work from home.
01:49
Daniel Peris: Over the long stretch of time though, dividend investing has worked out well because it aligns with people's everyday activities, and that we are beginning to see come back into normal fashion, into fashion, or just back to normal.
02:07
Linda Duessel: Yeah, I thought it was also curious, all that stimulus money that came at us and people did tend to run towards the biggest names like you said, they were working very, very well. And so what happened to the relative price-to-earnings multiples of the higher quality dividends stocks in that period of time?
02:24
Daniel Peris: Yeah. So the types of dividend stocks that a dividend investor would tend to focus on generally are going to be a little less expensive than the market, because we do give up, generally speaking, a little bit of growth and that's standard. But that gap opened between what the price was paying for an income stream, and what was paying for certain types of growth prospects, maybe not realities, but prospects, that opened up enormously. It actually began opening in 2016 and then during COVID in 2020, it opened up to extraordinary statistically-challenging levels. And that now is beginning to close. And we're seeing sort of a mean reversion, which bodes well.
03:09
Linda Duessel: Yes, we'll peek in on that tier next, but I'd seen a statistic that said the relative PE multiples for the high quality dividend stocks were trading near all time lows you hadn't seen since 1950 in the course of these past two years. And indeed, as you suggested, it's been a growth market. I think it's been a growth market for maybe 13 years.
03:30
Linda Duessel: Okay, here we are today, the economy's booming and we have a big inflation problem and interest rates look like they're set to rise. So what's becoming of what I think you've called those so-called fancy stocks?
03:43
Daniel Peris: Yeah, not to get too complicated, but I would draw your attention to both inflation, interest rates, and what I call risk rates. And there are a lot of moving parts there which we wouldn't get into in this setting, but I'll simply say when risk rates are rising, that is people's perception of real world risk, then the type of old fashioned cash flow steady-Eddie businesses that we have are welcome.
04:06
Daniel Peris: And what's important about dividend-paying stocks is that they're equities, the businesses can raise their dividends, they're not bonds. So on the inflation front, dividend-paying stocks offer some inflation protection, it may not be dollar-for-dollar, but it's close. And on the risk rate perspective, dividend-paying stocks tend to be less risk, more stable businesses. And so as investors' perception of risk rises, there's kind of a tailwind to the dividend-paying universe that might not have existed during those years when risk was exceptionally in fashion.
04:42
Linda Duessel: Right. And of course, I guess that as discount rates go up, that's a problem for those buying growth stocks that are counting on a long stream of earnings way, way out there, as versus the dividend itself, right?
04:56
Daniel Peris: Yeah. I'm struck by a technical term, duration, which again, we won't get into, but usually it's just a measure of time. And when discount rates move up, you want to get your money up front, and dividend-paying stocks by definition have lower duration than all of those, what I call fancy stocks, fancy stocks are a term from the 19th century of stocks that had no business associated with them.
05:17
Daniel Peris: But you do want to have your money up front when discount rates are rising, and that's what dividend stocks offer.
05:24
Linda Duessel: And exactly what the growth stocks do not offer. So now it looks as if the dividend strategy, I like the way you are describing what's happening; it's starting to perform well now. And you've described it as coming out of the wilderness. I think that's pretty powerful. Can you explain and take us... How long has it been in the wilderness Daniel?
05:47
Daniel Peris: Not a biblical 40 years, but investor time horizons are so much shorter, that for four years, from 2016 to 2020, roughly depending on your flavor of dividend-paying strategy, but during that period, four years, which for many investors is a lifetime, dividend stocks were generally underappreciated. Even though they were paying their dividends, growing their dividends, suffering the normal tailwinds and benefits of whatever their business cycle was, they were out of favor for four years, a very long period of time. That does appear to be coming to an end, that being out of the woods, they appear to have come back onto the investor's horizons and investor's worldviews.
06:31
Linda Duessel: And you can remember a particular date, can't you Daniel?
06:34
Daniel Peris: Yeah. If you do want to put a flag in the ground and say, This is when it changed, you can take a look at your portfolios, you can take a look at any major market indices, you can take a look at sentiment indicators, take a look at September 1st, 2020. That's actually from this time of taping is 18 months ago. This tape presumably will have some shelf life, but 18 months ago from taping, and that's a notable time that we appear to be seeing, during that period, mean reversion back to more normal approaches to investment, and investment characteristics of dividend focused strategies.
07:13
Linda Duessel: September of 2020, and of course as I've traveled the country, and I've always been a big fan of the high quality dividend strategy for at least some portion of everybody's portfolio, and we looked at how very, very strong has been that growth run. I find it's interesting you say it started in '20, because it did seem to be five years in that wilderness there. And back in the fourth quarter of 2020, I remember seeing a chart running around that showed that the energy patch, which is a good dividend-oriented sector, was trading at price-to-book levels that were at least 94 years inexpensive, what a sale there.
07:55
Linda Duessel: And I used to run around saying to people, With all the stimulus money, it seems like every stone's been turned over, we're buying everything, stocks and bonds, US, international, cryptos, NFTs... The only stone not turned over, the only one was the high quality dividend.
08:10
Linda Duessel: Now today, obviously energy had a great year last year, it's having a great year this year. Staples, I think doing pretty well in here and some of the others. But are there in any sectors that you might want to point out to the group that stand out, still may be hated out there, that might still be on pretty good sale in the high quality space?
08:30
Daniel Peris: Yeah. The dividend investor tends to be pretty stable, low turnover, and not rotate among sectors as much, which, it's a fair question. But I would say that the whole space is still under-intellectually appreciated. I acknowledge that energy, as you pointed out Linda, has gotten a lot of attention recently.
08:51
Daniel Peris: But really the whole space, we continue to be very comfortable in our skins doing what we're doing, given the combination of the dividend yield of the individual securities, and of portfolios generated upon them, and the dividend growth prospects. Even in difficult times with inflation, with various crises, the supply chain issues resulting from COVID remain to this day. But even with all of those headwinds, the combination of value that we're seeing and the income stream and growth, importantly, the growth in the income stream, is very, very comfortable acknowledging that the price of energy-linked businesses tomorrow, or a week ago, or a week from now can be dramatically different and investors need to be careful about that.
09:34
Daniel Peris: Among this sectors that have been, how shall we say, not particularly loved over the last several years, a lot of the dividend-paying space meets that category. But I have to say among those, the telecoms have particularly been, how shall I say, left aside. And that creates opportunities for investors going forward, who are interested in high income streams.
10:00
Daniel Peris: And we'll see how that plays out in volatile markets, meaning some sectors moving up sharply, others being ignored, creates some profit taking opportunities as well. And we'll see, eventually I expect the valuations of the telcos to mean revert, and that bodes well for the dividend investor.
10:19
Linda Duessel: Okay. All right, excellent. Okay, so here we are in 2022 and as general strategists at Federated Hermes, we took note towards the end of last year, that was almost a straight upward move in the market. We could only have put together just one 5% pullback, and we expected a more volatile year this year with catalysts, including the midterms, persistent inflation, the Fed's trying to walk a tight rope here, always in the back of our mind, potentially another new variant. And now of course, geopolitical risk has taken center stage, and volatility has shown itself strong so far year-to-date. So Daniel, how has the high quality dividend strategy held up in volatile markets historically?
11:08
Daniel Peris: Yeah. Again, this is sort of the tortoise versus the hare. And we have over, in many ways, two centuries of data show the attributes of being the tortoise. And it looks like 2022 is showing up as one of those incidents where there's a lot of pressure on asset prices. And in that case, people turn to safer securities.
11:32
Daniel Peris: And again, these are assets that are involved in everyday transactions. They're not really discretionary, often not discretionary, usually not discretionary, small ticket items. And it's that type of environment in challenging times that people turn to, and we are seeing that again in 2022.
11:49
Daniel Peris: It was not the case in 2020, because people moved to the newer and, I have to acknowledge, functioning work from home businesses, all credit to them, but we have a more traditional crisis right now, not crisis but challenge right now, and people seem to be moving to what they have over the past two centuries moved to, which is more defensive businesses.
12:11
Linda Duessel: And what's the sort of historical behavior of high quality dividend stocks when the S&P 500, for example, is correcting.
12:21
Daniel Peris: I don't want to go out on a limb and make a performance claim, but we do have instances in the past of negative downside capture, which if you know what that means, basically the very defensive sectors go up, holdings go up, when the rest of the market goes down. But at a minimum, they tend to go down less than the market. But we have had episodes of negative downside capture, and investors shouldn't be surprised if that happens again in the future, it has happened in the past. Meaning, again, the defensive dividend-oriented securities hold their value when the rest of the market is not doing so.
12:52
Linda Duessel: I also saw a statistic about the staples sector in particular, which I know is one of sectors that are favored in this type of a process, since 1975 staples outperformed when interest rates rise. So it really does seem like in a number of ways, the stars are aligning for the high quality dividend-oriented strategy. It's been shunned for some time, looks like it's been inexpensive for that reason, interest rates look like they're coming back, and a volatile market, does seem to be, seems like '22 will be a long year.
13:31
Linda Duessel: But of course, high quality does usually underperform when you're coming out of recessions and bear markets. And I guess that's to be expected, the turtle wins the race when the economy's doing well, everything, all the boats are rising, why not go to those more cyclically-oriented stocks?
13:53
Linda Duessel: But wow, it seems, as if when big monetary policy, when you're seeing lots of stimulus out there, they really do underperform. People really do turn their backs on high quality, Why should I buy a high quality stock when money's just showing up in my bank account? That type of an idea.
14:12
Linda Duessel: And so are we now, do you think, after the low quality stocks have shown outsized out performance in these last several years, are we now moving into an environment you believe where high quality will start to really shine?
14:30
Daniel Peris: Again, hard for me to... I don't want to be in a position of belittling the opposition or the alternatives. I'll simply say that the tortoise moves whether the hare is running around him or her regardless, the tortoise moves forward. The tortoise always moves forward, slow and steady, moving forward when the weather's good, moving forward when the weather's bad, moving forward when the hare is taking a break, moving forward, when the hare is sprinting.
14:54
Daniel Peris: And in those environments, over literally centuries of investment history, this type of approach has done well. There will be times during, again, monetary stimulus, monetary non-stimulus, economic contraction, economic expansion, when the hare will pull ahead, but the tortoise never falls out of the race in particular. So we're very, very comfortable given what you were referring to, that valuation advantage that the tortoise now has, and kind of picked up from 2016 to 2020, that we will be continuing to move forward very, very comfortably over the next several years.
15:33
Linda Duessel: I like that comment about the tortoise, and it reminds me of something that a financial advisor shared long ago, looking at the tortoise versus the hare. And why does the tortoise walk so slowly? It's because the dividends weigh so heavily in the wallet on its back. And I just thought that was an excellent... Which actually is very, very interesting also, another as we consider perhaps the stars are aligning for defensive value here, lots of data I've seen that suggest that the vast majority of the money out there is held by people age 55 and older, people that are looking to retire, that are looking to have a more stable source of an income strategy. They really would love a tortoise, and the tortoise has been historically high-yield government bonds, excuse me government bonds, sovereign bonds, particularly the US bonds here.
16:30
Linda Duessel: Now we've seen a strong stock market really since 2009, just interrupted ever so slightly by COVID before the stimulus came. And what I found so curious is that the love affair with government bonds has continued uninterrupted since 2009, even as equities have done so very well, but the 10 year has been stubbornly low, around 2%.
16:56
Linda Duessel: And what is an income-oriented investor to do? And I would like to ask you this question, Daniel, because it is by far and away the most common question I have had from advisors in the last 13 years, How do I get high quality defensive income for my clients? Where do I go with a government bond giving us very paltry income?
17:18
Daniel Peris: It's a great question. And your clients, I think, are right to be challenged because the yield of the US stock market has been at or below 2% for more than 30 years, so longer than basically most of your advisor clients have been looking at it. So they're not used to seeing the stock market as an equity income platform.
17:37
Daniel Peris: Prior to the 1990s, you could get a good income stream from the US stock market. In fact, stocks historically were viewed as income, rising income mechanisms, and bonds were perceived to be safer, but the returns from stocks were higher. You took extra risks, got extra return in cash.
17:57
Daniel Peris: For a variety of reasons, mostly due to 40 years of declining interest rates, and I would argue 40 years of declining risk rates, individuals got used to treating the stock market as a buy low, sell high, repeat frequently, but don't expect a check. If you get your winnings, you can collect them at the door, nothing wrong with that. Lots of businesses are run that way, but it used to be a business ownership platform where the rewards were measured in cash that went away over the last 30, 40 years with declining interest rates, and the declining yield of the market and the payout ratio.
18:28
Daniel Peris: We dividend investors, focused dividend investors, have quietly been laboring tortoise-like in our corner of the market where we have been treating our investments and the strategy, that is high dividend strategies, in a more traditional business ownership format, and delivering a high and rising income stream from high quality business assets.
18:49
Daniel Peris: It's not impossible, it's hard. That's why it's a career, as it were, but it's going to take a while to get investors, advisors, home office, people, gatekeepers, analysts, whoever, to, Huh? You mean you can make a meaningful income stream from stocks?
19:07
Daniel Peris: Yes, the answer is yes, but it's not what they're used to. So thank you for spreading the word, as it were, that it can be done. Equity income is a legitimate intellectual category and a legitimate solution to client problems. It's just not how the US stock market has been treated in the last 30 years, but it can be done, it has been done.
19:31
Linda Duessel: I think that's very powerful what you said, particularly in amongst these last comments, 40 years of declining interest rates means there's two whole generations that have never seen rising interest rates. Those looking for high quality income then are getting a yield that's paltry, and rates are going up, and they may see a negative sign in their returns, which brings me to my final question to you, as our time got away so quickly today Daniel, indeed, hasn't the high quality dividend-oriented strategy kept its dividend promise over many years?
20:09
Daniel Peris: Yeah. And this is one of the things, that again, I'm going to use the metaphor of the tortoise, when you look at dividend payment records, either from investment strategies, or individual securities, or dividend-focused metrics over the past 20, 25 years, payments are made because the income streams have risen.
20:28
Daniel Peris: Now, there may be times when those strategies from a total return perspective are ahead or behind the market and so forth, but in terms of cutting checks to grandma, it has, as you say, the covenant, a financial covenant, not a religious one, but a financial covenant has been made and been kept. There were times when dividends were under pressure during various crises, but they tended to be brief and shallow.
20:53
Daniel Peris: And the dividend stream has been maintained for those investors who have chosen to go down this path. And it's been tested by various crises over the past 25 years and really shown to be a persistent income stream for investors. So we're very pleased with that record, and we think that has every reason to continue.
21:16
Linda Duessel: Well, thank you Daniel so much for your fascinating insights. And thank you to our listeners, we look forward to you joining us again on the Federated Hermes Hear & Now podcast. If you enjoyed this episode, please, we invite you to subscribe to the Federated Hermes channel to get every Hear & Now podcast, plus our other series, Amplified and Fundamentals, for a global perspective on the issues, challenges, and trends shaping the investment landscape.
21:46
Linda Duessel: I also encourage you to subscribe our Insights email updates for the latest market commentary from the many great minds at Federated Hermes, and follow us on LinkedIn and Twitter.
22:00
Disclosures: Views are as of March 3, 2022 and subject to change based on market conditions and other factors. This should not be viewed as a recommendation for any specific security or sector. 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. Duration is a measure of a securitys price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations. Bond prices are sensitive to changes in interest rates and a rise in interest rates can cause a decline in their prices. Due to their relatively high valuations, growth stocks are typically more volatile than value stocks. Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance, particularly in late stages of a market advance. NFT stands for Non-Fungible Token. S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index. Credit ratings of A or better are considered to be high credit quality; credit ratings of BBB are good credit quality and the lowest category of investment grade; credit ratings BB and below are lower-rated securities (junk bonds); and credit ratings of CCC or below have high default risk. FAANG is an acronym referring to the stocks of the five most popular and best-performing American technology companies: Meta (formerly known as Facebook), Amazon, Apple, Netflix, and Alphabet (formerly known as Google). Past performance is no guarantee of future results. 22-40101 (3/22) Federated Equity Management Company of Pennsylvania
Tags Markets/Economy . Responsible Investing .
DISCLOSURES

Views are as of the date above 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.

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.

Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices.

Due to their relatively high valuations, growth stocks are typically more volatile than value stocks.

Value stocks tend to have higher dividends and thus have a higher income-related component in their total return than growth stocks. Value stocks also may lag growth stocks in performance at times, particularly in late stages of a market advance.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Credit ratings of A or better are considered to be high credit quality; credit ratings of BBB are good credit quality and the lowest category of investment grade; credit ratings BB and below are lower-rated securities ("junk bonds"); and credit ratings of CCC or below have high default risk.

FAANGs is the acronym for Facebook, Amazon, Apple, Netflix and Google aka Alphabet stocks.

Past performance is no guarantee of future results.

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Federated Equity Management Company of Pennsylvania