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How to Play a Yellen-Led Fed With Dividends 

Ben Fischer 



Portfolio manager Ben Fischer explains the role dividend-paying stocks play in portfolios at a time when the Fed’s unwinding QE and a bull run in equities is maturing. Plus, how NFJ should perform if there’s a correction and where he’s finding bargains.
With the stock-market rally now in its sixth year and the Federal Reserve tapering its bond-buying program, investors should brace for more modest returns, says Ben Fischer, portfolio manager of the AllianzGI NFJ Dividend Value Fund. In addition, a recovery that’s only slowly grinding its way higher may be susceptible to setbacks.

In this climate, investors should seek positive real returns by avoiding low-yielding bonds, but also be more cautious in stocks by investing in high-quality companies with solid earnings growth, strong balance sheets and lots of cash. Specifically, dividend-paying stocks tend to hold up better when there’s a correction than speculative stocks, which have been bid up during the momentum trade, he says. The steady income from dividends can also help cushion the blow of a pullback.

In an interview, Fischer, a longtime value investor, discusses the Fed’s monetary policy under Janet Yellen, what it means for stocks—specifically dividend payers—and how NFJ portfolios should perform. Plus, he highlights where he’s finding bargains in a market that may be fairly valued.

How will the Fed’s commitment to tapering under Janet Yellen impact the markets? What does it mean for interest rates?

The gradual removal of liquidity from the financial system is going to have a negative effect. It’s already a drag on the economy. And bad weather hasn’t helped. We’ll probably see the economy improve, but it’s going to be slower than it would have been had the Fed continued buying bonds at the same pace. Will there be continued tapering? For now, yes. However, Janet Yellen needs more clarity on economic conditions in order to assess the consequences of the Fed’s actions. Yellen will keep her options open. For example, if employment continues to disappoint, then there’s a chance that tapering could be interrupted. It’s too soon to tell.

Forward guidance on rates is pretty well in place, however. The Fed is going to keep short-term interest rates near zero until 2016. It’s probably the market’s biggest driver. Investors need to know that the Fed can keep the economy growing. Yellen would prefer to have higher inflation than higher interest rates. If you had a gradual increase in inflation and long-term interest rates, then that would be good for dividend-paying stocks. Why? Because we’ve found that, even in high-inflation environments, dividend payers did better than non-dividend payers due to their upfront income payments.

Beating Inflation
Since 1957, dividend-paying stocks have
outpaced inflation by a wide margin.

Dividend Chart
Source: Bureau of Labor Statistics and Yale School of Management.
Data from 12/31/1957-12/31/2013.

Are stocks overvalued? What’s your outlook for equities?

Valuations aren’t real cheap, but they’re not real expensive either. They’re probably fairly valued. I think the market is poised to go up assuming we see improving fundamentals. That includes small-cap stocks. But if things don’t go as well as expected, then we could have a correction. The market is trying to make headway at a time when we don’t have a lot of visibility. It’s more likely that we’ll see single-digit returns for 2014. This rally has taken the market up three-fold in five years. And it’s starting to flatten out.

We’re probably looking at 0% to 7% upside with higher volatility between now and September. We need to get past the next month or two to gain more clarity. But a slowdown might be more of a risk than people think. Government bond yields were expected to rise because the economy was strengthening. But the 10-year Treasury yield has actually gone down since January. That tells me that conditions aren’t improving as much as investors might think.
Tech Is Worth the Weight
The tech sector is one area of the market where NFJ is finding value, yield and room for dividend increases.

We favor the technology sector, which hasn’t outperformed, but we believe there’s good upside potential because tech companies have strong balance sheets, lots of cash and room to grow dividends. We’ve done well in some tech stocks, not so well in others. But these companies should pay higher dividends so we’re staying overweight.”

— Ben Fischer

  S&P 500 Technology Index AllianzGI NFJ Dividend Value Fund Tech Holdings
P/E Ratio 16.6 12.0
Average Dividend Yield 2.09% 2.85%
Dividend Payout Ratio 52.54 50.43

Source: Ned Davis Research as of 2/28/14.

View 30-day SEC yield and quarter-end performance »
View fund’s prospectus »

How should equity investors respond now that we’re on track to end the easy money in the second half of 2014?

Investors should be more cautious, but stay fully invested. In an environment of financial repression, they’re not going to get good yields in traditional safe havens like bank deposits or bonds. Investors haven’t been too worried about quality in stocks, riding a junk-led rally. They should seek a positive real return, by avoiding fixed-income, but still have the comfort of owning shares of companies that have the balance-sheet strength to pay an increasing dividend. That’s a compromise that helps them avoid taking a chance with speculative stocks like we saw in 2013. Higher-quality stocks should hold up better than speculative stocks this year.

As a value investor, I would invest in companies that have good balance sheets and the ability to raise their dividends, rather than chasing speculative companies that have already gone up—that’s dangerous. It’s a lot easier for investors to benefit from P/E multiple expansion early in a bull market than when it’s in its sixth year. At NFJ, we’d rather be in a stock with an 11 or 12 P/E multiple and a good dividend yield at this point in the cycle. Aggressive momentum stocks have posted significant gains; they may be the first stocks to go down if there’s a correction. We haven’t seen a big correction yet, but I feel safer being more conservative. Investors should get back to fundamentals and dividends, and ride through any market turbulence.

What’s your outlook for dividend-paying stocks? What signs do you see, if any, that would indicate high-quality companies will be rewarded in 2014, shifting away from a junk-led rally?

The modest $10 billion-per-month reduction in bond purchases is consistent with a less-speculative equity market on the upside, but also consistent with one that should still move in a positive direction. But if the tapering continues to zero, it raises the question of who will finance the $550-billion federal deficit if the Fed isn’t willing to? In our view, without the Fed propping up the bond market, stocks could come under pressure. In that scenario, higher-quality dividend-paying stocks are likely to demonstrate much better relative performance. Accordingly, we believe that the stocks we hold in our portfolios—high-quality, low P/E dividend payers—are well-positioned to outperform lower-quality stocks on a relative basis.

If you have continual up-and-down volatility, then people should gravitate toward dividends. If we have another year like 2013, then equity investors will have strong absolute performance. The market was up 32% last year. But it would be hard for NFJ to have really good relative performance in that type of environment. We require every stock in the portfolio to pay a dividend. It’s a deal breaker if they don’t. Low P/E, high dividend yields. That’s who we are. Combining a value strategy with a dividend focus prevents investors from just stretching for yield. I’m very comfortable with using dividends as a guide for the way we invest. But you’ve got to make sure you have reasonably good quality companies that can raise their dividends with room to run up their balance sheets—and plenty of cash. Over time, the dividend hikes will provide a higher floor for the market. Dividends are probably where you want to be.

The Dividend Effect in Dollars
Companies that pay dividends have historically posted
stronger total returns—in percentage and dollar terms—with less risk than non-dividend payers.

Dividend Effect in Dollars

*Equal Weighted Total Return
Source: Ned Davis Research. Data as of 2/28/14. Past performance is not a guarantee of future results. Chart shows the growth of a hypothetical $100 in the S&P 500 Index, S&P 500 Dividend Payers and S&P 500 Non-Dividend Payers (equal weighted), with dividends reinvested. Dividend payers (companies that paid a quarterly or annual dividend in the calendar year) and non-dividend payers included among the S&P 500 Index universe. It is not possible to invest directly in an index. Investing in stocks involves risk, including possible loss of principal investment.

How will NFJ portfolios perform if the economy continues to pick up steam? What about a pullback?

Generally, we have good relative performance in flat to down markets, like 2011. 2014 seems to be the obvious year for people to take a few steps back. We’re more defensive on the downside. We’re hoping that we have a less ebullient environment—a sideways direction in the markets—so that dividends, which can bring quality and safety to the portfolio, are deemed more desirable. Our relative performance is improving because we’re right on top of the index. We tend to benefit from higher volatility. When people get cautious, they turn to higher-quality companies.

I don’t think there’s a catalyst to drive the markets much higher from here. But I also don’t think we’ll have a bear market. The stock market is likely to generate returns of 0% to 7%. And in that scenario, we are poised to do well. Additionally, if the Fed keeps tapering because the economy is strong, then our stocks should start outperforming because investors will buy cyclicals and industrials. If the economy isn’t as strong as people think, then you probably won’t see a lot of capital spending. The companies that we’re interested in have tremendous balance sheet strength. They can pay out dividends and buy back stock. They can keep their stocks moving up through financial engineering.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

Investors should consider the investment objectives, risks, charges and expenses of any mutual fund carefully before investing. This and other information is contained in the fund’s prospectus and summary prospectus, which may be obtained by contacting your financial advisor. Click here for a complete list of the Allianz Funds prospectuses and summary prospectuses. Please read them carefully before you invest.

Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. It is not possible to invest directly in an index.

The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the U.S. stock market.

A Word About Risk: Investing involves risk and you can lose money. Equities have tended to be volatile and, unlike bonds, do not offer a fixed rate of return. Dividend-paying stocks are not guaranteed to continue to pay dividends. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. US government bonds and Treasury bills are guaranteed by the US government and, if held to maturity, offer a fixed rate of return and fixed principal value. Bond prices will normally decline as interest rates rise.


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