Strategy for Uncertainty? Raise Quality
What happened last week?
The S&P 500, Dow and Nasdaq shed -4.25%, -2.93% and -5.77% on weaker-than-expected labor market data. In August, the economy added 142K jobs, but the prior two months saw combined downward revisions of 86K. Small business hiring plans also point to a cooling labor market.
This week, Vice President Harris and former President Trump are scheduled to square off in their first and maybe only debate in Philadelphia on Tuesday September 10. Then the market will scrutinize the August Consumer Price Index (CPI) release on Wednesday.
3 Things to Know
September Is Historically Negative for the S&P 500
First, we would note that a skittish performance of markets about two months ahead of an uncertain US presidential election is entirely normal.
Weak data and weak markets frequently go hand in hand in late summer. Since 1930, the only month that averages a negative return for the broad US market is September (though many positives and negative have been experienced in particular years).
When one includes only US presidential election year uncertainty, the weakness extends to October.
We are cautious of depending on historic patterns without assessing wider factors. But to date, it is notable that the composition of market activity is also following historic, election year norms.
Defensive industries such as utilities, healthcare, and staples have typically outperformed a downwardly biased equity market in the six-months before US elections.
On average, they go on to underperform a rising US equity market in the six months after US elections are out of the way.
Allocate to Higher Quality to Deal with Uncertainty
But what is a standout that may potentially endure through a variety of uncertain scenarios? The discipline of managing a firm to pay a higher dividend over many years “screens out” most firms, leaving a high-quality bias.
This is not always what produces the highest return over short periods. Over cycles, it tends to eliminate heavily indebted firms.
Heavily indebted cyclical firms that survived economic crashes historically produced large “bounce-backs” in the year following the start of new economic cycles.
While we often wish we could tell investors a more exciting story, no economic crash appears at hand, and certainly none has already happened. Without a large drop first, a stronger burst of performance for low quality leveraged cyclicals is not at hand.
Dividend Growers Have Consistently Outperformed
What are some wider factors one should consider to understand markets now? For one, tech shares posted one of the five strongest outperformance periods in the past 25 years through early July.
With just three US tech mega-caps rising to nearly $10 trillion in aggregate value in 1H 2024, returns were “sucked” out of other industries.
Until 2Q of this year, EPS gains were sparce for most sectors. AI promises beckoned until the momentum faded. But since July, equity investors have turned to the tangible returns of high dividend yielders such as utilities as interest rates fell.
With tech correcting lower “high current yield” shares reaching record high levels, we would emphasize the left-behind dividend growth shares that have lagged. Tech (offense) and utilities (defense) are necessary components of a diversified equity portfolio. But even together, the two sectors wouldn’t make for a complete portfolio.
Election and economic policy uncertainty is likely to remain high until early November at a minimum. This should not stop investors from assessing if their portfolios are positioned to best suit their needs.
The days of a 5% cash yield are nearly over with the Fed set to cut policy rates on September 18. So are the days when a single stock drove nearly a third of US equity market returns as Nvidia did this spring.
Intermediate duration bonds are still yielding more than the Fed’s own expected policy rate over the next few years and can still benefit from Fed rate cuts, if marginally.
Most global equities — apart from US tech — trade near long-term historic valuations.
See our weekly CIO Strategy Bulletin for more details