By: Dividend Sensei
Click here to read up on the intro to this portfolio, the theory behind it, and its methodology.
Due to time constraints I’m forced to update the DVDGI on a monthly basis. But rest assured that I’ve been maintaining it and its system, per the strategy rules, the entire time.
This marks the 1 year anniversary of me launching this test portfolio, to see whether or not a contrarian approach to value investing in dividend growth stocks could beat the market.
It worked, and it was spectacular. Read on to find out just how well we did, despite four months with brutal volatility that only ended up fueling the portfolio’s ultimate greatness.
But first, here’s what you need to know about the economy, corporate earnings, and what 25 undervalued dividend growth stocks are worth buying today.
Monthly Economic/Market/Earnings Data Review
The labor market continues to roar, with 261,000 jobs created in October, which drove the official unemployment rate down to 4.1% (down 0.7% so far this year).
Of course in reality what most people feel in the economy is the U6 “underemployment” rate, which is down to 7.9%, a 1.3% decrease from October of 2016, and the lowest we’ve seen in 17 years.
Also good news? The employment/population ratio continues to steadily rise (up 0.5% this year) from its recent lows hit in 2011. Of course it would take many more years, assuming it’s possible at all (due to so many boomers retiring) to get back to its all time high of 64.5% back in 2000.
The only downside is that wages grew 2.4%, down from last month’s 2.8% spike, which was the first figure above 2.5% where wage growth has been most of the year.
On the plus side the number of jobs available is near an all time high of about 6.5 million, which means the ratio of unemployed to available jobs continues moving in the right direction, showing no indications that the red hot labor market is about to start cooling down.
Meanwhile in corporate earnings, with 91% of S&P 500 companies now reporting, 66% of companies have beaten revenue expectations, with 74% beating earnings expectations.
Thanks to stronger global growth (75% of major economies around the world are growing right now), multi-nationals led the way, with double digit sales and earnings growth.
And while overall earnings and revenue growth were slower this quarter than last, for the full year analysts expect S&P 500 companies to report 6.2%, and 9.4% sales and EPS growth, respectively.
Better yet? In the first half of 2018, even without tax reform (which might not lower corporate rates until 2019) analysts are now expecting 6.4% and 10.3%, sales and earnings growth, respectively.
In other words, corporate America continues to not just thrive, but growth is accelerating. A corporate rate cut to 20% is expected to raise taxes by 8% in the year it occurs, which means that, even if it occurs in 2019, we’d likely to see accelerating corporate earnings for three straight years, which means that the fundamental driver of the bull market remains intact.
But wait, it gets better!
Both the Atlanta and New York Feds are now predicting essentially the same Q4 GDP growth rate, and it is strong.
Now some people will scoff at 3.2% GDP growth BUT keep in mind that we’ve been mired at 2% for eight years, and many people claimed this was “the new normal”, for structural reasons, such as so many baby boomers retiring, (and presumably spending less).
Now we’ve had two consecutive quarters of 3+% GDP growth and on track for a third, AND that’s without tax cuts. Of course, the actual amount of stimulus that lower taxes would produce is debatable and dependent on what the final package looks like.
However, some additional growth is likely and that could potentially mean a return to 3.5% growth at some point.
If we continue to see strong job creation that at some point wages will likely rise to more historical growth rates, further spurring consumption, corporate earnings, (as will global growth) and thus give even further fuel to keep the bull running for a few more years.
How long could the economy and the market keep rising? Well no one knows for sure, but the meta data shows little risk of an economic slowdown anytime soon.
For example, while inflation expectations remain muted (a good thing, because it means wage growth is outpacing inflation), the 10 year yield, the proxy for long-term interest rates, continues to steadily, but slowly rise (which is what we want).
That’s because it indicates the bond market is gaining optimism about future growth prospects, and also because we need to prevent the yield curve from inverting.
The difference between 2 and 10 year Treasury yields is a proxy of the difference between short-term corporate borrowing costs, and what companies (like banks) can invest at.
A steeper curve indicates stronger profit potential, and a sign that the bond market is bullish on the future. That’s because if you don’t expect any growth at all, you’d demand no premium for longer-term bonds (no opportunity cost).
And what happens if short-term rates go above long-term ones, a so called yield curve inversion? That indicates the market is predicting a recession, and indeed the last 7 recessions were all predicted by yield curve inversions, on average by about six months.
With the Fed planning to raise rates six or seven times through 2019, it’s important that long-term rates keep up in order to steepen the curve and allow the US economic recovery to not just continue, but potentially accelerate.
That in turn, could create a sweet spot, in which inflation remains mild (2%) allowing rates to remain historically low, and the economy to grow modestly (3% to 3.5%) for a long time, such as occurred in Australia, where they haven’t had a recession in a quarter century.