The US economy isn’t ready for an end to the Fed’s brand of liquidity. In fact, without the punch bowl, companies won’t be able to grow, says Ben Fischer, NFJ’s CIO and portfolio manager of Allianz NFJ Dividend Value Fund. At some point, the Fed will start tapering its asset purchases and interest rates could rise, a scenario the markets have had a tough time digesting. The uncertainty around monetary policy coupled with low bond yields and the perception that stocks are too richly valued has left many investors scratching their heads.
But for investors who seek income and returns above inflation, the best route for them to take is to invest in dividend-paying stocks, Fischer says. Simply put, because companies can increase their dividends faster than interest rates can rise, taper or no taper. In a recent interview, Fischer discusses what the Fed’s approach means for investors and where he’s finding attractively priced dividend payers—including why he likes tech, Sallie Mae and Ford.
Everyone’s talking about the Fed taper. When will it happen and how will it affect markets?
The Fed and other central banks hold the key to which way the markets go. Even talk about possible policy decisions is finding its way into the market. Maybe we’ll see some tapering in December but only a small amount. And I bet the Fed ends up having to reverse the move later.
If the Fed withdrew quantitative easing altogether, the economy would not be able to make much progress on its own. You can see that in current earnings. If it weren’t for buybacks and lower interest rates, then there would be no growth. Top-line growth is just not there. And we’re a long way from seeing aggressive job creation. Companies are hitting their earnings targets by having no interest expense. It’s about being able to use the extra cash to buy back stock. It has nothing to do with boosting the economy.
So it’s really all about the Fed. There are always going to be extreme reactions to what Chairman Ben Bernanke says. But if he pulls back too much, we’ll have a recession. Ultimately, I think it all works out to stagflation—higher inflation and little growth. We’ll probably end up with 1% to 2% GDP growth for 2013 and a gradually higher inflation rate. I don’t see how the Fed can withdraw liquidity in any meaningful sense. I think we’re stuck in this mode of creating more and more liquidity for years.
How should investors respond?
Bernanke has effectively put a billboard on top of the Hollywood hills that says, “Buy risk assets.” Essentially, the Fed’s forcing us to go into higher-risk investments that pay some income. Logically, it pushed everyone into dividend-paying stocks. And dividends are likely where you want to be for some time. If that seems counterintuitive given the market’s initial response to the Fed taper talk, then think back to 2009. At that time, dividends were the way to go and everyone said, “No, go to bonds.” Since then, the market’s up 180%. Now you’ve got billions of dollars leaving bonds, but you haven’t had a stampede into equities. In fact, a lot of people still want to avoid risk.
For long-term investors who seek income and returns above inflation, the best argument for dividends is their ability to grow. And in this type of market—one with heaps of central-bank stimulus—dividend increases are pretty much a lock. Specifically, financial repression enables companies to strengthen their balance sheets and create liquidity, which leads to higher dividends. Ultimately, long-term interest rates will rise with inflation and bond investors are likely to suffer as bonds lose value. Stocks, on the other hand, can increase dividends faster than interest rates rise.
Since 1957, dividend-paying stocks have
outpaced inflation by a wide margin.
Source: Bureau of Labor Statistics and Yale School of Management.
Data from 12/31/1957-6/30/2013.
So when the Fed tapers, do you expect dividend payers to outperform?
There’s no easy answer. If the Fed starts to taper because the economy is strong, and the market catches fire, then our stocks will start outperforming because investors will buy cyclicals and industrials. All of a sudden we’re back in the saddle because economics are great. However, sharply rising rates in a fragile system could kill the recovery. There’s no top-line growth, so a lot of stocks could drop. At NFJ, we’re invested in dividend-paying, economically sensitive companies that have been depressed, so we may be able to hold up better in a down market.
I’d like to see central banks offer more certainty and detail around liquidity over the longer term. You have to keep short-term rates low; it’s one of the drivers. Market participants need to feel there’s a determination by the central bank to keep the economy growing. 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 because of their upfront income payments.
We’ve seen a rotation from defensive companies to cyclicals. What’s driving that trend and how are you positioning your portfolios?
How you deal with that decision tactically is a tough question. Strategically, there's no problem—go with dividends. But there’s going to be periods when they underperform from a tactical standpoint. At the moment, non-dividend-paying stocks have been doing better than dividend-paying stocks. Indeed, leadership of the market rally has shifted decisively from defensive stocks to cyclicals. Sometimes, in a real strong upward trend like we’ve seen in recent months, we lag. But when you look out five years, dividend payers are still likely to do better than non-dividend paying stocks and bonds.
As far as dividend-paying stocks holding up in a cyclical rally, I’m not worried. Leadership to date has been coming from interest-rate-sensitive sectors like telephone companies and electric utilities, as well as high-quality consumer staples. There are a lot of good high-yielding cyclicals that have lagged on a relative basis. At NFJ, we can invest in cyclical stocks that pay dividends and, generally, we do well. So far, in 2013, we own Ford. We own a lot of tech too, which is relatively cyclical.
But when you talk about which asset class will outperform over a short-term period, sometimes high-quality dividend payers won’t—it could be junk stocks; it could be high-quality consumer staples; it could be cyclicals if there’s enough excitement that the economy is strengthening. Or, if there are stagflation concerns, then commodities will probably outperform. It’s hard to know what short-term performance will bring, especially because in the next five to 10 months so much could go wrong because of investor psychology.
Three market segments where NFJ is finding value, yield
and room for dividend increases.
Source: FactSet, Standard & Poor's, Yahoo! Finance, Company filings.
|S&P 500 Sector/Industry
of Sector Holdings
Average Dividend Yield
of Sector Holdings
Dividend Payout Ratio
of Sector Holdings
| AllianzGI NFJ Dividend Value Fund
||S&P 500 Index
||AllianzGI NFJ Dividend Value Fund
||S&P 500 Index
||AllianzGI NFJ Dividend Value Fund
|| S&P 500 Index
|Automobile & Component
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As a low P/E value investor, where are you finding attractively priced stocks right now?
In AllianzGI Dividend Value Fund, technology, autos and financials are three areas where we’re adding exposure. In tech, we’re comfortable with our Intel position. The knock on Intel has been that PC markets are depressed. But Intel is investing in chips for tablets so we still like the company. Microsoft is another tech company we like. It was pricing its tablet at almost $500 whereas the iPad is only $300. So Microsoft cut the price, earnings suffered and the stock dropped 12%. But that’s just short-term sentiment driving the stock lower. Despite cheaper tablet prices, the overall strength of the company is still solid. So we’re happy to add to our position at a discount.
We also doubled our position in Ford because we think higher liquidity leads to better auto results. We’ve cut back in places where we were disappointed, Freeport-McMoRan for example, because copper prices went south. If we see more growth in China, then commodity prices could go back up, although there’s some skepticism around that scenario. We recently sold Kimberly-Clark and bought Sallie Mae. If long-term interest rates rise, and the Fed keeps short-term rates low, then Sallie Mae should do well. A good rule of thumb is that if the Fed keeps short-term rates low for several years and then raises rates, then financials and industrials are poised to outperform.