Why Equity Income Strategies Perform Well in Volatile Markets

Equity Income Strategy

FOMO (“fear of missing out”) is a common malady among Instagram posters and social media mavens. It can afflict individual investors too, especially those who focus too much on price appreciation trends and not enough on the actual drivers of investment performance.

 FOMO feelings can spread quickly and easily thanks to the financial media—from old-school print journals (e.g., the WSJ), to cable broadcasters (e.g., CNBC), to social platforms (e.g., Twitter). They’re all in the attention business—the more visitors and viewers they can attract, the more money they can extract from advertisers.

 Moreover, nothing attracts investor attention like volatility. It’s no wonder that there’s an inverse relationship between CNBC ratings and stock market performance—when stocks are in freefall, their viewer numbers go through the roof. (CNBC’s best day ever—September 29, 2008—coincided with the Dow Jones Industrial Average most significant point drop to date.) On the flip side, when the market moves to higher elevations, all investors seem to hear from the financial press is Growth! Growth!! Growth!!!

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Break the emotional cycle

FOMO works against individual investors by amplifying their emotions and distorting their perception of risk. When times are good, investors get more daring than they otherwise would or should. Conversely, when times are bad, investors make a mad dash for the exits. Then, it’s not FOMO at work but FONGO—fear of not getting out.

Many individual investors do not appreciate the role that risk control can play in their portfolios. As a result, they suffer from FOMO and FONGO time and time again. Breaking this cycle requires a disciplined and fundamental-driven strategy and a filter to help tune out the noise of the financial media. This approach is part of the value a professional manager like Lighthouse Financial brings to the table.

 A disciplined, focused approach seems more critical than ever in our current market environment, where market trends seem to shift direction from one day to the next and investors end up feeling more uncertain and anxious than they should be.

Mixed signals from the market

Right now, there are a lot of mixed signals about the state of the financial markets and the economy. Stocks are having a good year so far—the benchmark S&P 500 Index is up over 17% through June. However, there’s also been a lot of volatility in the equity market—stocks whipsawed through June after the S&P 500 reached a new all-time high on June 20th.

Stay up-to-date on the market.  We release regular updates every week on important concerns in the economy

 On the economic front, the strong jobs market has pushed the unemployment rate to generational lows—3.6% as reported in the April jobs report. Tight labor supply has spurred wage growth, which has been largely absent throughout the current economic expansion. That’s all good news for the U.S. economy—when people feel confident about their job prospects, they’re more inclined to go shopping. Moreover, consumer spending remains the primary driver of the U.S. economic engine.

 However, there are also warning signs about the current business cycle; economic growth appears to be decelerating from last year’s torrid pace, and company earnings for Q1 2019 declined for the first time in nearly three years. Even this “bad news” isn’t all that bad--GDP growth may be trending downward, but it’s still positive growth. Moreover, the earnings slowdown appears to be selective; the high-flying technology and energy sectors experienced earnings declines in Q1 according to FactSet, while the more “boring” health care and utilities sectors enjoyed earnings increases in Q1.

End of good times

The financial media feeds off of this jumble of good news/bad news and creates stories that either accentuate the positive or underscore the negative. By swinging from hope to fear and back again, the financial press only seems to confuse investors or heighten their anxiety. Whatever the sentiment, the decisions most investors end up making are often irrational and contrary to their long-term interests.

 Right now, the question that’s top of mind among tuned-in investors is, are we nearing the end of the business cycle? The truthful answer is, yes. No cycle goes on forever. The current expansion is going to end eventually. When it will end is another matter. We’re not into making predictions about the next recession or market downturn, but we can draw some inferences from the economic evidence.

 We are closer to the end than the midpoint of the current cycle; the economy still has room to run, and stocks may continue to appreciate, but the window of opportunity is closing. We believe market volatility is likely to increase—that’s what happened in the late stages of previous economic expansions, so there’s a high probability it will happen again as the current business cycle winds down.

 In a tenuous market climate, nearly any action can drive stocks lower. We have seen it lately in the market reactions to rising geopolitical tensions in Iran and Venezuela and the on-again/off-again U.S.-China trade negotiations. Stocks rally or drop after nearly every pronouncement President Trump makes on Twitter—a social communications environment that’s fueled almost exclusively by emotion. In our view, trade and geopolitical tensions are nominal drivers of market activity—they’ll lead to a good day here and a bad day there, but they can’t sustain a longer-term market trend in either direction. Only business fundamentals—sales, profits, costs, and investments—can do that.

A potential solution for shaky markets

Some companies are in better positions than others to deliver these fundamentals when the economic cycle turns. Discovering opportunities among these companies is the aim of our Equity Income strategy.

 Equity Income isn’t for investors who want to swing for the fences. Our objective is to control our clients’ exposure to risk but still offer the ability to participate in equity growth and capture dividend income.

 We like stocks with yields above current market averages but seek to avoid the highest dividend payers, because they usually come with too much risk. Rather than reaching for yield at any cost, we prefer large companies with durable business models and good balance sheets. Think AT&T, Johnson & Johnson and Procter & Gamble. These are the stocks that are likely to continue paying dividends even in a weak economy.

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Dividend-paying stocks also tend to hold up better in tough economic environments because dividends act as a valuation buffer—when the stock price falls, the yield rises and makes the stock more attractive to investors. Proctor & Gamble presents a good example of this; we’ve noticed in PG’s past performance that investors step in and buy the stock when its dividend yield reaches 3.5%.

 We believe our Equity Income strategy is poised to perform well as the business cycle ages and stock volatility increases. In a rising market, investors may be attracted to hot growth companies and high-flying IPOs, but they also don’t want to get burned when these go-go stocks go bust. Equity Income is a suitable strategy in an uncertain and changing stock market climate.

Find out how Lighthouse Financial Services, Inc. approaches investment management. Interested in setting up a free consultation? Contact us below to schedule your appointment.

*The foregoing content reflects the author's personal opinions which may not coincide with the opinions of the firm, and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. All investing involves risk. Asset allocation and diversification does not ensure a profit or protect against a loss. Finally, please understand that–as with other social media–if you leave a comment, it will be made public.