Market's Recovery Similar To Past Cycles

Interestingly, the market's recovery since the March 9th low is following a similar path as 10 prior bear market recoveries. These recoveries occurred after so called waterfall declines.

(click to enlarge)

Chart Courtesy of: Schwab & Ned Davis Research

Liz Ann Sonders, Chief Investment Strategist at Charles Schwab (SCHW) notes:

In waterfall declines, the Dow loses more than 20% in a short period, and near the end, the 10-day average of NYSE total volume rises to two times its average seen just a few months earlier. In the majority of cases, the end of the waterfall decline wasn't the end of the bear market.

However, in the composite average, the lows were tested but not broken, followed by a basing phase of up to three months before a breakout to a new bull market. The chart below shows the performance of the Dow as averaged from the 10 waterfall declines between 1929 and 2002.

The market's strong advance is now running into technical resistance. The market's close on Friday at 919 is near the 200-day moving average of 928. Additionally, volume has been declining and the MACD is negative with the 12-day moving average below the 26-day moving average.

(click to enlarge)

The market seems to be in a phase where "less bad" economic and corporate news is viewed positively. In order for the advance to be more than a cyclical bull market and turn into a secular one, some of this "less bad" data will likely need to become "good" data.

Stocks With Improved Quality Rankings

Standard & Poor's upgraded the quality ranking on the stocks noted below. S&P's quality ranking looks at a company's growth and stability of earnings and dividends over the past 10 years.

Over the long run, higher quality stocks tend to outperform lower quality ones. In the short run though, lower quality stocks can achieve higher performance. This has been the case so far in 2009.

Full Screen View

Source:

Quality Ranking Upgrades ($)
The Outlook
Standard & Poor's
By: Beth Piskora, Managing Editor
June 3, 2009
http://www.outlook.standardandpoors.com/NASApp/NetAdvantage/servlet/login?url=/NASApp/NetAdvantage/index.do

The Latest In Dividend Research

For investors interested in the latest research on the factors impacting dividend policy for corporations, Harry DeAngela (Marshall School of Business-USC), Linda DeAngela (Marshall School of Business-USC) and Doulas J. Skinner (University of Chicago Booth School of Business), recently published a paper titled, Corporate Payout Policy. In this recent research the authors' have incorporated recent corporate dividend activity and related it back to prior dividend research by Lintner, Miller and Modigliani, Fama and French, just to name a few.

The paper begins with a discussion on the distribution of free cash flow and just a few of the topics reviewed are:

• Are Dividends Disappearing
• Why Do Dividends Survive
• Signaling and the Information Content of Dividends
• Taxes and Payout Policy
• The Advantages of Stock Repurchases
  

As the authors note, the paper is organized:

...around a simple asymmetric information-based theoretical framework that moves beyond MM (1961) to determine optimal payout policy as a time-varying trade-off of the security valuation problems in Myers and Majluf (1984), which encourage retention, versus the agency costs of free cash flow (FCF) in Jensen (1986), which encourage payouts. The latter two path-breaking studies trail only Jensen and Meckling (1976) in terms of their importance to the post-MM (1958, 1961) corporate finance literature; thus, they provide solid building blocks for a theory that can explain the main features of real-world payout policies including, e.g., why payouts become increasingly likely (and retention less so) over the corporate lifecycle. The foundation of this framework is the need to distribute FCF to make investors as well off as possible — a principle that drives optimal payout policies even in the absence of frictions, but whose fundamental importance only became clear with Jensen’s (1986) analysis of the stockholder welfare consequences of managerial failures to distribute full value.

An example of one portion of the research publication is the recent desire of corporations to institute stock buybacks in place of higher dividend payments. The paper notes, historically, companies would payout excess earnings in the form of specially designated dividends (SDDs). The current research suggests many companies now implement stock buyback programs instead of SDDs. In the past these so-called SDDs were counted as dividends.

Finally, Grullon et al. (2008) find that firms’ overall net propensity to distribute cash to stockholders—defined as the fraction of firms with positive net payouts measured as dividends plus stock repurchase payouts minus equity issues — has not in fact declined over the past three decades. Their analysis suggests that the simplest explanation for the secular decline in the incidence of firms that pay dividends is that most firms continue to distribute cash when their earnings and investment opportunities indicate that it is appropriate to do so, but that they now rely increasingly on stock repurchases to deliver those distributions to investors, consistent with the results in Grullon and Michaely (2002) and Skinner (2008). It is still early to accept this explanation as the definitive factor driving the decline in the propensity to pay dividends initially identified by Fama and French (2001), but the explanation does have a strong ring of plausibility to it, especially given the tectonic shift in the population of publicly traded firms toward firms that are currently unprofitable and/or as yet unable to generate positive earnings for stockholders on a consistent basis.

The research paper contains a great deal of useful dividend data that incorporates recent dividend and buyback activity. It is a worthwhile reading for the serious dividend investor.

(H/T: Douglas J. Skinner)

Source:

Corporate Payout Policy
DeAngelo, DeAngelo and Skinner
May 2009
http://ssrn.com/abstract=1400682

Investor Bullish Sentiment Below Long Term Average

The American Association of Individual Investors reported this week that investor bullish sentiment of 33.72% was below the long term average bullish sentiment level of 39%. This technical indicator is a contrarian one and would point to potentially higher stock gains if looked at on a standalone basis. This week's reading saw a nearly 10 percentage point drop in bullishness from the prior week's level of 43.81%. The bull/bear spread widened to -12% versus last weeks +9% spread.

(click to enlarge)

Source: American Association of Individual Investors

Focus On ROE To Avoid Dividend Cuts

One certainty in this market is dividend paying companies are finding it palatable to cut their payout to investors.

Charles Schwab & Co. (SCHW) recently issued a research report that evaluated a number of different financial factors and found companies that have higher ROE's (return on equity) are less likely to cut their dividend. Schwab reviewed the characteristics of dividend-paying stocks within the top 3,200 stocks by market capitalization, from 1990 through February 2009.

The result of the research noted:

• A firm with high ROE is more likely to be able to generate income in excess of expenses and, thus, support its dividend.

• To examine ROE’s ability to predict future dividend changes, SCHW calculated each dividend-paying stock’s trailing 12-month ROE at the end of each month from 1990 to February 2009. They then calculated each stock’s subsequent 12-month change in dividends at the end of each month, and used this change number to split their dividend-paying universe into three groups: those that cut dividends, those that raised them and stocks with no change. Then, they examined the success of ROE in identifying safer dividend payers.

• What they found was stocks in the lowest 20% of ROE were twice as likely, on average, to cut dividends as the other 80% over the subsequent 12 months, as noted on the below chart.
  

They also found that companies with a high ROE had more dividend increases.

• Stocks in the top 20% of ROE increased dividends, on average, more than 60% of the time during the subsequent 12 months, as the chart below details.
  

In the end, the research concluded, "investors could have minimized their risk of experiencing a dividend cut by focusing on dividend payers with higher ROE." They also found the higher ROE dividend payers had higher total returns compared to the dividend paying universe of 3,200 stocks.

Lastly, I recently wrote a post noting how ROE is a component of the dividend discount model (DDM). Although the dividend discount model may seem simplistic, when looking at the variables that are at play in this model, an investor will get a better understanding of the financial factors behind the DDM.

Source:

Are Your Stock Dividends Safe?
Charles Schwab & Co.
By: John Wightkin
April 13, 2009
http://www.schwabinsights.com/2009_04/stocks.html

Dividend Aristocrats Underperforming Broader Market

S&P's Dividend Aristocrats are underperforming the broader market through May 15, 2009. On a market cap weighted basis the Aristocrats are down 5.7% while the S&P 500 Index is down 2.3% and the NASDAQ Index is actually up 6.5%. The Aristocrat stocks are slightly outperforming the Dow Industrial Index, -5.7% versus -5.8%. Year to date financials continue to be a drag on performance.

Dividend Aristocrats

Publish at Scribd or explore others: Finance Business & Law corporate annual reports

Retail Sales Decline Triggers Market Sell Off

Today's April retail sales release seems to be cited as the cause of today's market sell off. I am not sure the .4% decline in April is the only reason for the market pullback. Retail sales were expected to show a .1% increase so the April sales figure did fall short of the estimate.

(click to enlarge)

Inventory related data was also released for the period ending in March. Inventory levels declined by almost 1%, but the inventory to sales ratio has remained at 1.44 for the past two months. Sales continue to decline at a faster pace, falling 1.6%.

(click to enlarge)

I believe the slightly negative results contained in the above two economic data points provided the catalyst for the sell off. As noted in yesterday's post, stocks had advanced in a nearly uninterrupted pace since early March. The market needed to consolidate these recent gains.

(click to enlarge)

The percentage of stocks trading above their 50 day moving average fell to about 86%. As the above chart indicates. This percentage has been above 90% since late April/early May. Additionally, the MACD has turned slightly negative at -.707 so is the market setting up for a bigger consolidation?

All of the above data points are rear view mirror looking. On a going forward basis what might impact the direction of the market?

• investors still have large amounts of cash on the sidelines. A large number of these investors will use the pullback to add to equities. The market decline has resulted in investor's equity allocation to fall below target levels; consequently, this pullback could be short lived and a more significant contraction could occur in mid to late summer after the cash has been pulled off the sideline.
  

• On a longer term basis, the yield curve suggests positive market returns ahead. I have written several earlier posts on the predictive power of the yield curve. Today, a post appeared at Crossing Wall Street that discussed market returns and the shape of the yield curve. Embedded in the post was a link to a Bloomberg article written by Caroline Baum (Dr. Yield Curve) titled Curve Watching Beats Room Full of Forecasters. It is an interesting article and I suppose, using the new terminology, could be called a green shoot.

It would have been nice to go all in on March 9th, but that activity goes against the emotional side of investor behavior. At this point in the cycle, being selective and focusing on high quality dividend paying stocks for the foundation of ones equity portfolio should pay off in the longer term.

At A Turning Point?

On March 9th many investors were glad to be holding sizable cash balances in their investment portfolio when the S&P 500 Index hit an intra day low of 667. Since that time the S&P has moved higher by nearly 36%. Now investors are lamenting the fact they are holding cash that is earning very little interest. Keep in mind, the Fed's goal is to get investors to move out of cash into more risky investments.

We are at the point where the "less bad" news is viewed as good by the market. Appropriately, economic data that is getting less worse is a positive, but data, like unemployment, needs to turn into employment growth. Losing 500,000 jobs is still bad although it isn't as bad as losing 600,000 job like we have seen recently.

Several discouraging pieces of data in the short term are related to consumers. Consumer revolving credit continues to decline. Record job losses are contributing to the credit decline.

Source: Federal Reserve Bank & Argus Research

In the long run, reducing consumer debt is a positive as the consumer is too leveraged at the moment. However, short term, reduced consumer spending is a drag on GDP growth since consumer spending has accounted for 70% of GDP growth. So where does economic growth come from?

The level of inventory remains bleak, but additional data will be released on Wednesday regarding inventory levels.

(click to enlarge)

Source: Federal Reserve Bank St. Louis

As I have noted in earlier post, once inventory gets down to a low enough level relative to sales, companies will need to produce additional goods. This will stimulate some economic growth.

Lastly, the bull market run has seen a majority of stock prices move higher. The percentage of NYSE stocks that are trading above their 50 day moving average is over 90%.

(click to enlarge)

Today's market action saw a rotation into some of the defensive sectors in the S&P 500 Index. The health care sector was up 4.08% and the staples sector increased 3.08%. The economically sensitive sectors saw declines: industrials down 2.46% and technology down 1.64%.

A market correction at this point that consolidates recent gains would certainly be healthy.

Sell In May? Not After Bear Markets

Many investors are familiar with the adage, "sell in May and go away," as superior market returns have been achieved in the November to April period. This adage has not always worked though. Standard & Poor's notes the sell in May approach would have been correct in two out of three years. After bear markets though the May to October period is generally a strong one.

(click to enlarge)

In investing, few strategies are certain. Given the market's strong advance since early March, consolidating some of the recent gains would be healthy: perhaps a near retesting of some earlier technical lows, like the 50 day moving average around 812.

Source:

Sell in May? ($)
The Outlook
Standard & Poor's
By: Sam Stovall, Chief Investment Strategist
May 13, 2009
http://www.outlook.standardandpoors.com/NASApp/NetAdvantage/servlet/login?url=/NASApp/NetAdvantage/index.do

Pepsico Increases Dividend By 6%

Pepsico (PEP) announced a 5.88% increase in the company's third quarter dividend to 45 cents per share. This compares to a quarterly dividend of 42.5 cents per share in the same quarter last year. The rate of dividend increase for the company is declining from the 5-year historical dividend growth rate of 14%.

• The projected payout ratio based on the new dividend is 44% based on 2010 estimated earnings per share of $4.02.

• The 5-year average payout ratio is approximately 41%.

• PEP carries a S&P Earnings and Dividend Quality Ranking of A+.

Dividend Increases Becoming More Scarce

Standard & Poor's tracks monthly dividend information for more than 30,000 firms and provides dividend detail in their monthly dividend action report. For the period ending April 2009 it is evident that dividends are becoming less sacred for those companies that paid and increased dividends in the past.

The chart data below shows decreased and omitted dividends surged to 480 for the four months ending April 2009 versus 111 for the same period last year. Increases fell to 252 versus 632 for this same time period.

(click to enlarge)

Some of the major dividend actions for April:

Full Screen View

Source: Standard & Poor's Dividend Action Report (xls)

Just A Bear Rally?

Could the market's recent advance simply be one of several bear rallies we can expect to experience in this secular bear market that began in 2000? As the below chart notes, the current rally in the Dow is shorter in duration and magnitude than the average 1929-1932 bear market rally.

Source: Chart of the Day

It is not uncommon to have these bull runs in secular bear markets. Crestmont Research has a nice table of past secular bear and bull markets that detail the intermediate bull and bear periods within each cycle. Even in bear markets, such as in the bear market of 1966-1981, there were nine positive years that generated an average return of 13%. The entire 16 year period saw the market return -10% from the beginning to the end of the bear period.

Secular Bear Market Table

Publish at Scribd or explore others: Law & Government Business & Law secular bull markets secular bear markets

I noted in an earlier post today that investor cash now exceeds the value of assets invested in equities. So maybe this sideline cash is warranted and won't find its way into equities?

Sideline Cash May Drive Equity Prices Higher

November of last year marked the first year in over 15 that investors had more of their assets allocated to cash than to equity. Not surprisingly this cash is beginning to find its way into the market.

“Most investors have missed the rally” in U.S. stocks, so further gains are likely as they spend some of their cash to buy shares, according to Andrew Garthwaite, a global strategist at Credit Suisse Group.

Garthwaite believes the S&P 500 Index could reach 1,000 before settling at 920 at year end.

(click to enlarge)

Source:

Catch-Up Buying May Lift S&P 500 as High as 1,000
Bloomberg
By: David Wilson
May 1, 2009
http://www.bloomberg.com/apps/news?pid=20601109&sid=aDP38XCc.mzU&refer=home

Dividend Payers Make Up Ground On S&P 500 Index

For the month of April, the dividend payers in the S&P 500 Index ($INX) generated a return of 17.87% versus the S&P 500 return of 9.57%. The non payers in the index did outperform the payers by generating a return of 20.21%. Over time though, dividend payers are less volatile and tend to have a better risk adjusted return.

Source: Standard & Poor's (xls)

Bullish Investor Sentiment Stuck In A Range

This week's sentiment survey released by the American Association of Individual Investors indicated an increase in individual investor bullish sentiment. The bullishness level increased to 36.09% versus last week's level of 31.82%. For the week of April 16th, the bullishness level stood at 44.14%.

The bull/bear spread was reported at -8% versus last week's spread of -7%. The spread became more bearish as more investors indicated a bearish view of the market: 43.61% versus 38.64% last week.

The chart of the market and sentiment for the current period is beginning to play out like the June 2002 - March 2003 period. Maybe a coincidence or maybe the current market needs to come close to retesting the early March 2009 low.

(click to enlarge)

Data Source: American Association of Individual Investors

The Market Is Definitely Overbought, But...

What to do now is the question of the day for those investors with cash on the sidelines: and it is a lot of cash. Now is the time to take a step back and evaluate where the market was in early March and where it is today.

In early March, investors were selling. The media was talking about a major economic and market meltdown at that time. And I will be the first to admit, I was not too constructive on the market in early March either. Since that time though, the market has embarked on a significant advance. Some cautionary technicals noted in the below chart are the MACD is negative and volume has been declining.

(click to enlarge)

Today the S&P 500 Index closed at 873 which is above its 150 day moving average of 869. The 50 day moving average appears to have bottomed and started to move higher. These factors are just a couple of positive technical factors.

Additional cautionary data is the fact that over 90% of the NYSE stocks are trading above their 50 day moving average. At the March 9th low only 7% of NYSE stocks were trading above their 50 day moving average. As the below chart notes, when the 50 day percentage gets into single digits, it is generally a good time to begin building positions in stocks. On the other hand, when this average is above 80%, the S&P does have a tendency to sell off or at least consolidate some recent gains.

(click to enlarge
1-year chart)

(click to enlarge
3-year chart)

Now is the time to be selective in the stocks that are being purchased. There are companies trading at attractive values, but paying attention to stock fundamentals and dividend characteristics are important at this juncture in the market.

Credit Markets Slowly Improving

Efficiently functioning credit markets are integral to sustaining growth for the economy. Certainly, the Fed and Treasury are doing their part in pushing this improvement forward. There will be consequences down the road, i.e., higher inflation? For the time being though, getting the economy (GDP) growing again is the Fed's primary goal.

The TED spread, the difference between 3-month LIBOR and the 3-month Treasury bill rate, has narrowed significantly from its peak in October of last year.

(click to enlarge)

One outcome of the improved credit markets has been an improvement in the performance of high yield debt. One measure of the high yield debt market is the iShares iBoxx $ High Yield Corporate Bond ETF (HYG). High yield bonds tend to have volatility characteristics not to dissimilar from stocks. The recent improvement in the performance of the HYG ETF is also an indication of a better functioning credit market.

And what a difference a year makes. The high yield market was one of the worst performing segments of the fixed income markets in 2008, but, the first 3 months of this year have high yield leading the fixed income performance segment.

(click to enlarge)

Source: T. Rowe Price Report (pdf)

And lastly, a look at some spread data.

Source: Dallas Federal Reserve (pdf)

The economy could certainly be at an inflection point where "less bad" economic data is viewed as a positive. In other words the rate of change or second derivative of a number of data points is now positive. If the economy continues to show improvement, just maybe, stocks can finish the year in positive territory. That is not to say their won't be pullbacks along the way. The market has bounced hard off the early March lows.

(click to enlarge)

But, if an investor is looking for some "equity like" diversification, high yield might be considered as a part of ones investment portfolio.

(Disclosure: I hold a long position in HYG)

Dividend Increases Keep Coming: Johnson & Johnson & Kellogg

Not all dividend paying companies are reducing their dividend or forgoing dividend increases.

Today Johnson & Johnson (JNJ) announced a 6.52% increase in the company's quarterly dividend. The new quarterly dividend is 49 cents per share versus 46 cents per share paid in the same quarter last year. The estimated payout ratio is 40% based on 2010 estimated earnings of $4.86. The 5-year average payout ratio is 40%. The company carries an S&P Earnings & Dividend Quality Ranking of A+.

In addition to JNJ's announcement, Kellogg (K) stated they would be increasing the company's 3rd quarter 2009 dividend 10.29%. The new quarterly rate of 37.5 cents per share compares to 34 cents per share paid in the 3rd quarter of 2008. The estimated payout ratio is 48% based on 2010 estimated earnings of $3.10. The 5-year average payout ratio is 49%. The company carries an S&P Earnings & Dividend Quality Ranking of A.

(click table/chart to enlarge)

J. M. Smucker Co. Increases Dividend 9.4%

Today, The J. M. Smucker Co. (SJM) announced a 9.38% increase in the company's quarterly dividend. In the 4th quarter of 2008, SJM acquired Procter & Gamble's Folgers coffee business. Near that same time, Standard & Poor's added SJM to the S&P 500 Index.

Smucker does not technically meet my definition of a dividend growth stock since the company has not maintained uninterrupted dividend growth over the course of the past 10-years. SJM went from June 2000 through June 2002 without increasing the dividend. On the other hand, over the course of the last five years, the company has grown the dividend just under 7% per year.

• The most recent announcement has the company increasing the quarterly dividend to 35 cents per share payable June 2009 versus 32 cents per share in the same quarter last year.

• The projected payout ratio is approximately 41% based on estimated April 2010 year end earnings of $3.36 per share. The 5-year average payout ratio is 38%.

• The company has a S&P Earnings & Dividend Ranking of A+
  

Festival of Stocks #137

Welcome to the April 20, 2009 edition of festival of stocks. I received a fairly large number of article submissions and included most of them below.

STOCKS

Ben Graham NCAV formula stocks, Cheap Graham Stock Ideas posted at Old School Value.

A southeast utility stock analysis, Progress Energy, Inc. (PGN) posted at Dividends Value.

ChinaMed - Retooling and Rebounding posted at ZachStocks.

Research In Motion Has Growth posted at FastSwings.com - Steve Patterson.

Stock price comparison and Fair Value Estimates for Best Small Companies posted at Old School Value.

Thor Industries Company Update posted at Bootstrap Investing.

INVESTING

There are Bullish Days Ahead But Bear Is Lying In Wait For The Kill posted at Jeflin's Investment Blog.

When Will The Economy Turn? posted at The Penny Daily.

On the Repeal of Mark-To-Market Accounting posted at The Iconoclast Investor.

The Importance of Return on Capital posted at MagicDiligence - Optimizing Joel Greenblatts Value Stock Strategy.

An example of distressed debt investing with regards to valuing Six Flags and their debt Distressed Debt Analysis - Six Flags posted at Distressed Debt Investing.

The Japanese Banking Crisis of the 1990's: Are We Facing a Similar Stagnation? posted at The Personal Financier.

Why have bank shares risen so far, so fast? posted at Monevator.com.

Investing Tips For The Beginning Stock Picker posted at The Digerati Life.

S & P Index and Crude Oil Market Trends: Next Steps? posted at The Smarter Wallet.

A Reminder on Why I Shouldn't Buy Ultrashort ETFs posted at My Wealth Builder.

Volatility Index Continues to Fall posted at FastSwings.

Do Americans Support Capitalism, and Which Capitalism? posted at Britannica Blog.

Vanguard Launched FTSE All-World ex-US Small-Cap ETF posted at The Sun’s Financial Diary.

How Municipal Bond Investors Have Avoided the Recession posted at Fine-Tuned Finances.

Advanta High Yield Notes: 8.5% - 11% Yield Worth the Risk? posted at Darwin's Finance.

An argument against reinvesting dividends posted at Make me money.

TRADING

A video on How Day Trading Works According to Einstein posted at Top Dog Trading.

What Is Forex Trading? posted at Investment-For-Beginners Blog.

Consumer Reports America’s Best Brokers posted at Blueprint for Financial Prosperity.

Global Watch List monitor to track trades around the globe posted at Internet Stock Trading for Beginners.

Zecco, TradeKing and ShareBuilder Review posted at Cash Money Life.

Transfer an account to TradeKing and receive up to $150 in Transfer Fees posted at Cash Money Life Deals.

FINANCIAL PLANNING

What is the Rule of 72? posted at FIRE Finance.

Learning to be Happy with Less posted at KCLau's Money Tips.

In order to fix ones debt problems there are 25 Debt Reduction Tips For Your Immediate Action Plan posted at Money Ning.

Being prepared for retirement means Leaving Your Money in Your Retirement Accounts! posted at Cash Money Life.

If you are a big spender on a budget Here's the "Naked Truth" About Money posted at SectorMatic Money Journal.

REAL ESTATE

New home buyers receive Free Money from the Government posted at Out of Debt Christian.

Bidding on foreclosed property then you need to know How To Make An Offer In Today’s Real Estate Market posted at Tallahassee Real Estate Blog.

How To Construct A Well-Written Real Estate Offer posted at Really Better Real Estate.

That concludes this edition of the Festival of Stocks. Submit your blog article to the next edition of festival of stocks using our carnival submission form. Past posts and future hosts can be found on our blog carnival index page.

Market Signaling Better Economic Environment Ahead?

The Chart of the Day charting service published a chart last week noting market performance two months before the start of a recession and the period following a recession. As noted on the chart, the stock market (S&P 500 Index) tends to begin its decline several months before the onset of a recession. The chart illustrates the average performance of the S&P 500 since 1945 following the beginning of a recession (blue line). The extend of the market's decline following the start of the recession for the 2001 recession and the most recent recession that began in December 2007 has been more severe.

Source: Chart of the Day

I am not sure I would go all in based on this chart, but an investor should note the market will anticipate an improving economic environment.

Diversification and Correlation During Market Crisis Periods

One factor that has been painfully clear in this market downturn is the high correlation of nearly all asset classes. The result for investors is nearly all the asset classes experienced significant declines during the recent market contraction. So what is the purpose of diversification if it does not minimize the negative portfolio returns during stress market periods? The answer begins with the question as to what are investors trying to diversify.

During periods of market stress there tends to be two factors that influence the price of investments:

• there is a flight to quality and
  
• a high demand for liquidity

This flight to quality and demand for liquidity causes investors to flock to the safest investments. For fixed income this tends to be government bonds and for equities it tends to be high quality equities. These high qulaity equities tend to be large cap blue chip dividend growth stocks.

A recent paper by Barclays Global Investors titled, Is Diversification Dead?, provides more detail on the conundrum for investors as it relates to the diversification issue.

Is Diversification Dead

Publish at Scribd or explore others: Business & Economics Research correlation diversification

In the end though, it is difficult to predict when the market will experience these significant drawdowns. For investors, building the foundation of the equity portion of their investment portfolio in high quality dividend paying stocks is one way to potentially gain some assurance they will not experience significant market value erosion in market downdrafts.

As I have written several times before, when the market rallies off of a bottom during these corrective phases, the higher quality equity investments will likely lag the broader market returns though.

Procter & Gamble Announces 10% Dividend Increase

After the market close today, Procter & Gamble (PG) announced the company's quarterly dividend will be increased 10% to 44 cents per share versus 40 cents per share in the same quarter last year. The increase is in line with the company's 10-year historical dividend growth rate of 9.8%.

• The projected payout ratio is 43% based on the June 2010 year end earnings estimate of $4.07. The company is estimated to earn $4.23 per share for the year ending June 2009. The 5-year average payout ratio is approximately 40%.

• P&G carries an A+ S&P Earnings and Dividend Quality Ranking.

(click to enlarge)

Consumer Sentiment and Spending Positively Correlated

It is not surprising that a recent paper published by the Chicago Federal Reserve notes a high positive correlation between consumer spending and consumer sentiment. Keep in mind this does not mean there is a causal relationship, merely a correlated one.

The spending data detailed in the below chart is through 2006. The most recent BLS data is through 2007 and notes a 2.6% increase in 2007 which was lower than the 4.3% increase in 2006.

The paper notes the top household income quartile is most impacted by changes in the stock market (i.e., S&P 500 Index).

"Higher income consumers are more sensitive to associated changes in the stock market, as reflected in the Standard and Poor’s (S&P) 500 Index; a 1 percentage point increase in the index is associated with a 0.43 percentage point increase in consumption spending for this group."

Additionally, the policies out of Washington are likely having an impact on consumer sentiment as it relates to the top two income quartiles. Policies that are not favorable for corporate earnings; thus, negatively impacting the stock market, are likely to constrain consumer sentiment and spending. The paper notes:

"...it might be useful for policymakers to understand the differences in the macroeconomic indicators for different groups...sentiment is particularly informative with regard to consumption spending in a context of greater uncertainty in income..."

Source:

Trends in Consumer Sentiment and Spending
Chicago Fed Letter
By: Maude Toussaint-Comeau, economist, and Daniel DiFranco, associate economist
May 2009
http://www.chicagofed.org/publications/fedletter/cflmay2009_262.pdf

Market Volume In Downtrend

The market's recent move higher since March 9th has certainly been impressive. A number of technical indicators are supporting this positive trend; however, volume continues in a downtrend. The more pronounced volume decline can be seen on the below chart of the weekly S&P 500 Index ($INX), keeping in mind this past week was a holiday shortened one.

(click to enlarge)

The daily chart shows resistance at the 875 level for the S&P 500 Index ($INX). Additionally, the Money Flow Index has been trending lower since reaching near 80 on March 26th.

(click to enlarge)

Given the improvement in investor sentiment, the declining MFI and the lower trending volume, I would not be surprised to see the market digest some of the recent gains near term. Earnings reporting season swings into full gear and some reports could trigger some corrective action.

Investor Bullish Sentiment Trend Moving Higher

Although the American Association of Individual Investors sentiment survey reported a drop in bullish sentiment (35.71% vs. 42.66%) this week, the 8-period moving average continues to trend higher. This 8-period average of the bullish sentiment came in at 29.2% this week versus last week's reading of 27.4%.

(click to enlarge)

Data Source: American Association of Individual Investors

In addition to the improving trend in bullish sentiment, investors seem to be putting their feelings into action. The Investment Company Institute reports money market cash levels have declined to $3.834 trillion for the period ending April 1, 2009 versus the March 4, 2009 level of $3,903 trillion.

First Quarter Not Kind To Dividends

Today Standard & Poor's reported first quarter dividend activity and it certainly was not favorable. Not only were a record number of companies slashing their dividends, other payers were not increasing dividends as well. Howard Silverblatt, Senior Index Analyst at Standard & Poor’s notes:

"...since 1955, the average has been 15 increases for every decrease. Now its three increases for every four decreases.”

Following are some statistics on the first quarter dividend activity:

• a record 367 of the approximately 7,000 publicly owned companies that report dividend information to Standard & Poor’s Dividend Record decreased their dividend payment. This represents a 332% increase from the 83 issues that decreased their dividend during the first quarter of 2008.
  

• a record low 283 issues announced they will increase their dividend payment – a 52.7% drop from the 598 issues that reported dividend increases during the first quarter of 2008.

Source:

S&P: Q1 Worst Quarter for Dividends Since 1955;
Companies Reduce Shareholder Payments by $77 Billion
Standard & Poor's
By: Howard Silverblatt & David R. Guarino
April 7, 2009
http://www2.standardandpoors.com/spf/pdf/index/040709_US-Dividends.pdf

Dividend Aristocrats Mostly Underperforming Year To Date

Standard & Poor's Dividend Aristocrats are underperforming the broader U.S. domestic indexes. on a year to date basis. Through April 4th, the Aristocrats have generated a return of -7.20% compared to the S&P 500 Index return of -6.70% and the Nasdaq Index return of +2.80%. The Aristocrats have managed to outperform the Dow Jones Industrial Average Index that has returned -8.60% so far this year. Although financials are the worst perming sector in the S&P 500 Index year to date, only four of the bottom ten performers are financial stocks.

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Dividend Aristocrat Universe Shrinking

Given the difficult economic environment, stocks of companies that pay a dividend have increasingly elected to reduce or eliminate dividends in order to conserve cash.

S&P reports actual first quarter dividend payments for companies in the S&P 500 Index were down 15.99% and this is the worst rate of decline since the -24.44% decline in the third quarter of 1958. David Blitzer, chairman of S&P's index committee, indicates S&P may need to loosen the criteria used to judge whether companies qualify for the Aristocrats Index. The big hurdle is a company has to have demonstrated annual increases in the dividend for at least 25 years.

S&P makes adjustments to the Aristocrats Index in December and only companies that paid more this year compared with 2008 will be retained . S&P's Aristocrats list currently contains 52 companies. Based on dividend cuts by some of the Aristocrats and "no increase" by companies in 2008, the potential list of firms that will be eligible for the index could fall below 40. This would be the lowest number of firms since 1992.

The 2009 Dividend Aristocrats list is detailed below.

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Bloomberg reports, "the Dividend Aristocrats Index returned an annualized 9.1 percent a year since 1989, compared with 6.6 percent for the S&P 500 Index, the main benchmark for American equities. It lost as much as 49 percent from its 2007 peak, while investors in the S&P 500 retreated as much as 57 percent." In spite of the fact the markets have declined by a significant amount, the Aristocrats have outperformed the S&P 500 Index.

Consequently, I believe S&P should not reduce the criteria used to determine the eligibility of companies for the Aristocrats membership. Companies that can increase their dividend every year over at least 25 years tend to be firms that have or project a strong earnings and cash flow profile. In the end it isn't the number of stocks you own, but owning the right stocks.

S&P ‘Dividend Aristocrats’ Dwindle as Payouts Are Cut
Bloomberg
By: Elizabeth Stanton
April 2, 2009
http://www.bloomberg.com/apps/news?pid=20601213&sid=a4VGpAMPzUy0&refer=home