For over two years the warnings of a “potential recession” have filled the financial print and TV media. The discussion of “hard landings”, “soft landings”, or “no landings” have arguably been enough to make even air traffic controllers scratch their heads. Nevertheless, stocks have continued their broad-based ascent through the first half of 2024. While often stocks may “feel risky”, the last 18 months of the equity markets are the perfect response for why “just earning 4-5% in a savings account” may not be the (only) strategy worth considering. For the 12 months ending June 30, 2024, the S&P 500 index advanced 24.41%! (State Street) While dividend producing companies, which are the subject of this letter, trailed the S&P, the Morningstar US Dividend Growth Index still posted +14.7% one-year returns through quarter-end. (ishares)
Looking through the lens of the equity markets, we continue to experience an environment of very narrow breadth with relatively few stocks supporting the advance of the markets. A market dynamic that is most reminiscent of the late 1990’s. What has made this a bit more unique is that the “winners” of today were already some of the largest companies in the world. This has led indices and managers owning those names to significantly outperform. A great way to highlight this dynamic is to look at the difference between the S&P 500 Index and that of the S&P 500 equal weight index which weights each company evenly rather than by market cap. Year-to-Date through June 30 the difference between the two was over 10%! The tech darlings of Nvidia, Microsoft, Apple, Amazon, Alphabet, and Apple have undoubtedly led this market. These 6 companies now represent nearly 1/3 of the weight in the market cap weighted S&P 500. Thankfully, we own a few of these in good measure across our strategies as well.
Looking ahead, our view turns, as the subject of this note suggests, to “playing the long game”. We would not be surprised to see volatility pick up after a near straight line upward from the lows of October 2022. We additionally would not be surprised to see a disappointing quarter from one of the current darlings lead to a painful correction, but our focus remains on 3 main areas for our dividend strategies:
- What is the path of the businesses we own or research over the next 3-5 years?
- What are investors being paid to own the stock (dividend yield)?
- How much do we expect that payment to grow (dividend growth)?
We have taken the opportunity in the first half of the year to add to new names as well as eliminate others that we felt missed the mark on the “3-step test” above. We even added back to a name we sold a few years ago after seeing improvement in the business. Returns will likely prove a bit scarcer in the quarters ahead, but we believe the strategies stand to benefit should optimism on the path of the economy or fed rate cuts allow more sectors to see share price growth. Moreover, the beauty of dividend growth investing provides a mechanism for investors to be “paid to wait” via dividends until share prices match underlying value.
Closing this quarter’s note, I wanted to provide some commentary around the hottest topic of today: Artificial Intelligence. The truth is I’m not smart enough to say with certainty whether “Generative AI” will prove to be as transformational as the Railroad or the Internet, but we DO believe it matters. That being said, there is a lot of exuberance built into current prices for the companies currently at the “tip of the spear” in AI. Best articulating this, I’ve provided a quote below from a recent commentary from a portfolio manager of a mutual fund we follow closely and have a lot of respect for:
“Key parts of the technology world have entered an AI arms race of staggering proportions. To put this in context, the US has spent around $250 billion/annum on data center buildouts over the past five years. Investors anticipate this outlay progressing to $1 trillion/annum by 2027. If correct, this would consume almost all of the free cash flow of today’s leading spenders, a small group of mega-caps (Meta,Amazon,Google,Microsoft). Meanwhile, there is no line of sight on the revenues or business models to support this. Many of the great investment themes of times past can be judged as “good bubbles” [railroads, ’00 tech, electrification]. All of these [also] generated an enormous misallocation of capital because the pace and nature of how these technologies would evolve were unclear in their respective times. These same uncertainties confront AI. We are optimistic that AI will lead to an eventual tailwind for economic productivity. Yet, it will take time and the business cycle has not been suspended.”
- Michael Grant, Portfolio Manager at Calamos Investments
We continue to look long-term at the sectors and individual securities we own and research to best position for sustainable dividend growth in a world that is changing fast, and likely to evolve even quicker in the future.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
