DIVIDEND APRECIATION ETFS OFFER CONSERVATIVE ENTRY FOR NERVOUS BOND HOLDERS -- VANGUARD DIVIDEND APPRECIATION ETF VERSUS DVY -- PROCTER & GAMBLE HITS 52-WEEK HIGH -- PEPSICO AND WAL-MART MAY BE NEXT
WHERE CAN BOND HOLDERS GO... We wrote several messages during the fourth quarter about the breakdown in bond prices (and rise in bond yields). The fall in most bond categories was the result of a stronger economy and rising inflation expectations. That stronger environment is good for holders of stocks and commodities, but bad for bond holders. Chart 1 shows the National Muni Bond iShares (MUB) tumbling more than 7% during the fourth quarter. Only long-term Treasury bonds did worse (-11%). The only bond category that didn't lose ground was high yield corporates which gained 4%. [That's because high yield bonds (or junk) are considered a riskier asset and are more closely tied to stocks than bonds]. The resulting rotation from bonds to stocks has been one of the driving forces leading into the new year. Among the strongest January stock groups have been those tied to commodities like agriculture, energy, and materials. [Gold shares have sold off based on lesser need for that safe haven asset]. One of my recent message suggested that new money moving into stocks at this point should focus on undervalued groups like banks and homebuilders. That's because stocks in general appear overextended. What can bond holders do at this point? If they ignore stocks, they risk missing out on potential profits. If they jump into stocks here, they risk buying into an overbought market. One way conservative bond holders might resolve that dilemma is to look at mutual funds, ETFs, or stocks that pay consistent dividends.
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Chart 1
TWO DIVIDEND PAYING ETFS... Two ETFs that focus on dividend-paying stocks are shown below. Chart 2 shows DJ Dividend Index iShares (DVY) trading near a new 52-week high, while Chart 3 shows Vanguard Dividend Appreciation (VIG) doing the same. Their relative strength lines (below charts) show both ETFs underperforming the S&P 500 since September (as stock prices rose) after outperforming from April through August (as stocks fell). Although dividend paying stocks usually trend in the same direction as the stock market, they lag behind during an uptrend but do better in a market downturn or correction. The fact that they pay dividends offer added protection during periods of market weakness. As a result, they're ideal for conservative investors (especially those being forced to abandon conservative bond funds). Although the relative performance of both ETFs is relatively similar over the last year, VIG has done relatively better over the last two and three year periods. Chart 4 shows the Vanguard ETF gaining 5% since the start of 2007 versus a -17% loss for the DVY. The VIG also did better over the last two years (37% versus 29%), and rose more than the DVY since mid-year when stocks bottomed (21% versus 18%). Morningstar gives the Vanguard ETF a higher rating for a long-term holding based on factors like expense, index construction, tax efficiency, and diversification. For all of those reasons, that's the ETF that I'm going to focus on today.
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Chart 2
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Chart 3
Chart 4
WEIGHTINGS MATTER ... One explanation for the stronger performance of the VIG can be found in its sector weightings. The highest weighted sectors for the VIG are consumer staples (24%), industrials (20%), health care (13%), consumer discretionary (11%), and energy (5%). Discretionary, energy, and industrials have been among the stronger groups over the last year. The smallest VIG weighting is utilities (1%). By contrast, utilities are the biggest weighting in the DVY (32%). That alone may explain the stronger performance of the VIG. Chart 5 shows stronger relative performance of industrials (blue line), consumer discretionary (red line) and energy (green line) over the last year versus underperforming utilities (pink line). A comparison of their respective top ten holdings also helps explain their relative performance.
Chart 5
VIG HAS MORE STOCK LEADERS THAN DVY... Of the top ten stock holdings in the DVY, only three have recently hit new 52-week highs. Chart 7 shows those DVY leaders to be Eaton (black line), CenturyLink (blue line), and Chevron (red line). By contrast, Chart 8 shows no less than six VIG stocks that have recently hit new 52 week highs -- Chevron, United Technologies, IBM, Exxon Mobil, Coca Cola, and Procter & Gamble. PG is actually breaking out to a new high today. A couple of others not mentioned here are close to doing so.
Chart 6
Chart 7
PROCTER & GAMBLE BREAKS OUT... Chart 8 shows Procter & Gamble breaking out to a new two-year high today. Two other stocks that may be close to doing so are Pepsico and Wal-Mart. Chart 9 shows PEP nearing a test of its October high, while Chart 10 shows Wal-Mart challenging its 52 week highs. All three have been market laggards that are just starting to play catch-up. And all three are in the top ten holdings of the Vanguard Dividend Appreciation ETF. There are three ways to participate in dividend paying stocks. One is through an ETF like the DVY or the VIG. A second way is through a mutual fund. The mutual fund equivalent of the VIG is the Vanguard Dividend Appreciation (VDAIX). The third way is through individual stocks included in those funds.
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Chart 8
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Chart 9
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Chart 10
BANK OF AMERICA AND RYLAND TURN UP ... Two underperforming groups that turned up in December are banks and homebuilders. I've shown a lot of stocks in both groups that recently achieved upside breakouts. Here are a couple more. Chart 11 shows Bank of America surging to a new six-month high and, more importantly, clearing its (red) 200-day in the process. Chart 12 shows Ryland also clearing its October high and its 200-day line. Both of their relative strength lines (below charts) have recently turned up. Add both to the list of banks and homebuilders that have achieved bullish breakouts. One of the attractions to bank stocks is the expectation that they may be increasing dividends in the near future. It also seems clear that any hint of a stronger housing market (signaled by rising homebuilders) should have a positive impact on mortgage-lending banks.
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Chart 11
