No stock is a buy at any price. Although this caveat doesn’t apply to momentum-chasing traders who buy what’s rising and sell what’s falling, valuation is a critical component of the investment strategy underpinning our Lifelong Income Portfolio.
When we launched Capitalist Times two weeks ago, valuations in traditional dividend-paying equity groups looked frothy. With the Federal Reserve keeping the benchmark interest rate near zero and pursuing an aggressive program of quantitative easing, investors had piled into stocks that offered superior yields to corporate bonds and Treasury notes.
Fortunately, dividend-paying equities have pulled back in recent weeks, reflecting fears that the Fed’s plan to phase out quantitative easing will spell the end of the rally for stocks that conventional wisdom regards as sensitive to interest rates.
Ironically, utilities, real estate investment trusts (REIT), master limited partnerships (MLP) and other dividend-paying securities have traded with little or no correlation to interest rates since the 2008 crash. In fact, these stocks have rallied when economic data improve and interest rates tick up.
Nevertheless, dividend-paying equities have retreated over the past several weeks, as the yield on 10-year Treasury notes has climbed to 2.7 percent from a low of 1.6 percent in May 2013.
For example, the Dow Jones Utilities Average, a price-weighted index comprising shares of 15 US electric utilities, has pulled back by about 7.5 percent since mid-May. The Bloomberg North American REIT Index has fared even worse, losing almost 10.9 percent of its value over the same period. In contrast, the Alerian MLP Index has dropped by only 1.8 percent. The relative strength of this capitalization-weighted index of 50 energy-focused MLPs reflects the group’s superior outlook for distribution growth.
Meanwhile, the recent strength exhibited by the US dollar has contributed to the S&P/TSX Income Trust Index’s 11 percent swoon over the past month and a half.
Although this retrenchment has hurt undisciplined investors who bought at the top, a number of dividend-paying names now trade at favorable valuations.