Crisis-fatigued investors are more afraid these days of missing the boat than being tossed overboard. This was underscored by their reaction last week to developments that a year ago might well have sent them fleeing for the exits.
After weeks of warnings by all sides that $85-billion (U.S.) of automatic federal budget cuts could wreak havoc on the U.S. recovery, a politically paralyzed Washington failed in last-ditch talks Friday to halt or mitigate the dreaded sequestration. The market reaction? A big yawn.
Earlier in the week, Italian voters agreed on only one thing: Austerity sucks. So they threw enough support to anti-austerity movements led by a famous comedian and scandal-plagued former prime minister Silvio Berlusconi to ensure political deadlock, deepening worries about the sliding Italian economy and posing a new threat to the euro.
Yet the markets’ reaction was remarkably tame.
“Even though the investing community faces economic and legislative hurdles in the near and long term, equity prices have risen in both January and February signalling … that many of these worries are unwarranted,” Sam Stovall, Standard & Poor’s chief equity strategist, said in a note last week that highlighted an interesting bit of market history: In the 26 times since 1945 that the S&P 500 has climbed in each of the first two months of the year, as it did again this year, the average annual return has been 24 per cent. What’s more, the annual gains have only fallen to single digits twice – 5 per cent in 1987 and 2 per cent in 2011 – and soared above 30 per cent nine times.
That does not mean investors have locked up their fears and thrown away the key. Nor have they abandoned their search for safety. They just want it to come with some sort of return.
“The world’s still an uncertain place and it’s going to be an uncertain place for the foreseeable future,” says global equities veteran Patrick Ryan. “The scars of the crisis remain in terms of both corporate and investor sentiment.”
His own safety-first solution is a diverse global portfolio of dividend-paying value stocks. That way, investors can continue amassing their 5-per-cent returns while waiting for the world to improve, Mr. Ryan, a director and portfolio manager with Lazard Asset Management in New York, said during a visit to Toronto last week.
It’s a strategy that works under just about any market conditions short of a disaster. “If we have the slow, grinding situation we’ve been in, these companies can still pay their dividends, considering how well-covered they are. If we have the truly ugly scenario, then dividends will be cut and corporate bonds will default. So you’re exposed in both asset classes.”
Asking Mr. Ryan about the shift from bonds to stocks – known as the Great Rotation – that began in earnest last year prompts a brief history lesson that makes the thundering herd seem more like a swarm of locusts laying waste to one asset class after another.
People shattered by the crisis “initially moved to government bonds and they drove those to unappealing valuations. Then they moved to quality corporate bonds and drove those to unappealing valuations. Then they moved to the high-yield market and they did the same. And now they’ve moved to very stable, high-yielding businesses in the equity markets and they’ve driven them to unattractive valuations.”
The first stage of the rotation started with cautious forays into equities that most resembled bonds in terms of risk. Which meant plowing money mainly into a handful of large-cap, dividend-paying blue-chips in developed markets. “In a sense, they were seeking bond proxies.”
But the next stage of the rotation was set in motion last September when European Central Bank chief Mario Draghi vowed that the ECB would do whatever was necessary to safeguard the euro. “His speech really triggered a rotation into the more attractively valued part of the market.”
Now, Mr. Ryan says, “we are looking far afield to find [dividend-paying] opportunities.” That search includes a particular focus on emerging markets. He notes that 90 per cent of listed emerging companies pay some sort of dividends, up from 35 per cent as recently as 2000. That compares favourably with the U.S. total of about 75 per cent. This welcome trend obviously stems from rising profits in expanding markets, but also from the maturing of many companies “to the point where they’ve built the telecom networks, they’ve constructed the factories and they’re now generating cash they don’t need for capital projects.”
Emerging markets have taken a beating over the past 18 months, leaving more pickings for value hunters. “People think of the emerging markets as a place to buy stocks that go up quickly. We feel that it’s a very under-appreciated source of income. Sometimes, those boring income stocks get left out of the party and stay inexpensive.”