When you look at the tagline for ValueTrend, you might note that our motto is to “Limit your risk. Keep your money”. That’s been our philosophy for over 30 years. Its of particular importance when markets get overheated. I suspect we are in that “overheated” environment right now.
I’ve been addressing the subject of structuring one’s portfolio towards the lower risk end of the curve over the past couple of months. For example: In my last blog, I noted that the pipelines might be a reasonable sector to examine to play the high dividend, lower beta (lower volatility) trade. In prior blogs, I noted that we at ValueTrend have not only raised some cash recently, but we have also been shifting into very selectively chosen staples, utilities, and other value sectors. This, as we continue to bring down the beta of our holdings. Why do I favor these sectors?
To answer that question – allow me to ask you a question first: Beyond the base/breakout chart formations that you know I am on the lookout for: What fundamental factors do all of these sectors have in common? Well, two things, actually. These are:
- Strong (not over leveraged) balance sheets and/or predictable cashflow
- Historically dependable dividends with growth.
A couple of charts supporting the argument to move into these sectors, if you feel, as I do, that markets may be subject to some volatility in the summer months.
Balance sheet strength- chart courtesy BearTraps
Balance sheet strength was hot pre COVID crash…but post-crash, the world fanatically bid up stocks with weak balance sheets. Stay-inside growth stocks prevailed, aided by next-to zero interest rates against their leveraged books. But that’s changing.
Despite US stock indices at all-time high levels, strong balance sheet equities have widely outperformed weak balance sheet equities over the past 5 weeks. As inflationary pressures continue to build up and the threat of rising rates in the future increases, investors are going to shy away from levered / weak-balance sheet corporations WELL before the Fed brings up tapering. In a rising interest rate environment, investors may want to be overweight stocks with strong balance sheets.
Balance sheet strength inspires dividend growth
Strong balance sheets tend to inspire regular increases in shareholder rewards in mature companies – aka: dividend growth. The chart below, courtesy Franklin Templeton, shows us that such stocks are lower risk vs the SPX index and non-dividend paying (aka FAANG’S, growth, etc) stocks. True, indices leveraged to growth stocks and non-div. stocks (think NASDAQ) do end up making better returns when growth prevails. But…. its clear where you want to be when market risk is higher. Dividends matter when times get tough on the market.
Cash is king in a falling market. But markets don’t always decline in order to correct an overbought market. Sometimes they trade sideways for a while as the 200 day moving average catches up, bringing the market back in alignment. When the SPX hit its peak last week, I discussed how far above that indicator the market was (and is) – and why we should be concerned. If the market grinds sideways rather than sell off 10% or so as I suggested in that blog, we have a good case for staying largely invested – with a focus on dividend growth type stocks with great financials.
I will confess we are taking the middle-ground by raising some cash, while also swapping out some of our beta. We’re roughly 12% cash in our primary Equity model right now, with a little more in the Aggressive Strategy. Either way, by holding a good chunk of strong, low beta stocks, you will usually end up seeing less downside and more predictability in any kind of market volatility.
Globe & Mail interview with Keith Richards
Here is an article in the Globe interviewing myself and 2 other Portfolio Managers to discuss value idea’s.