“My, what a difference a year makes.” – For dividend investors, and all investors more broadly, this quote encapsulates the markets over the last 12+ months. From the depths of an economic shutdown to broad-based new highs, the last year has seen tremendous swings. Providing an added ballast in rough waters, we are pleased that we did not experience a dividend cut from our dividend growth portfolios.
In this quarter’s note, we will continue expanding upon the two sets of companies we’ve discussed in our prior letters: “Secular COVID Opportunities” and “Cyclical Rebound Opportunities”.
Starting with the latter, cyclical companies, loosely defined as those in the Materials, Industrials, Financials, and Energy Sectors of the markets, saw continued resurgence in the First Quarter. After bouncing from depressed lows in Q4 2020, The S&P 500 Select Sector Industrials, Financials, Materials, and Energy indices rallied 11.6%, 16.4%, 9.4%, and 30.1% respectively (Thomson One).
The transition from “expected improvements” for companies that began to take place in the 4th quarter with news on vaccines, into “actual improvements” in the 1st quarter of 2021 has powered the most recent leg higher for markets. As vaccines began circulating widely in early 2021, economic activity rebounded. This can be seen at the Country level through expectations for First Quarter GDP, which just posted at +6.4% (US Commerce Dept.). On the industry level, this can be seen in daily TSA checkpoint numbers which are up 10X from a year ago. Daily air travelers are still down about 40% from 2019 (pre-COVID) levels, but the recovery has begun. (TSA.gov)
Importantly, for many businesses this recovery is being seen earlier than expected (we had forecasted strong growth not beginning at this scale until summer). Additionally, the growth is showing up not only in profits, but also in top-line sales, which are largely regarded as more sustainable growth.
This is important as it means it’s not just short-term cost cutting or labor reduction that is powering profits higher, but a general pickup in activity. We anticipate this leg of growth may have a decent runway ahead of it as many parts of the US are still restricted and Global Companies are still grappling with a difficult environment in parts of Europe and India. For these reasons, it appears likely to us that the numbers in the 2nd quarter will surpass the high bar set in Q1.
Importantly, owning companies with “quality balance sheets” has allowed us to wait for this recovery to materialize, and likewise enabled some of our portfolio to take advantage of depressed markets with either buying back stock or opportunistic acquisitions at attractive valuations.
In our desire to provide a balanced picture, we also wanted to touch on a recurring concern for economies experiencing such a large positive jolt in growth… inflation.
It is absolutely true that prices are rising in the economy, particularly for “materials” like steel, lumber, and copper. Lumber Futures have risen nearly 3X in the last 6 months (Nasdaq) and Copper is at all-time highs. (macrotrends). However, a similar dynamic played out in the aftermath of the Financial Crisis in 2011. While the recovery has been swifter this time (largely because of a dramatic rise in government spending), we believe there is a strong comparison to 2011 at this point. We expect inflation to drift higher over the next year or so before supply and demand come back into balance between 2022 and 2023.
Keying off the previous cycle from Jan. to Sept. 2011, the Consumer Price Index, a common measure of inflation, rose from 1.6% to 3.9% before reverting back to 1.7% by the following August. After bottoming at just about 0% last May, the CPI today stands at +2.6% year-over-year. (US Dept. of Labor)
While negative for higher valuation “Secular COVID Winners” in the quarter, our focus on owning companies with pricing power in their products also helps to protect against the impacts of higher inflation in the portfolio. Finally, for those needing income, owning companies who have the ability to grow their dividend on a regular basis, have the opportunity to earn an income that can keep up with inflation relative to traditional fixed income where the income is usually fixed over the lifetime of the holding. For reference, the goal for our dividend portfolios is to provide an increase in yield of 6-10% on a yearly basis.
As we’ve written about before, a key part of our investment process is analyzing our companies’ quarterly earnings calls, which is led by Dr. Lyle Bowlin. The take-away has been simple, confidence across Corporate America continues to rise. Below are a few examples that have caught our eye in the past few months:
Commercial Aerospace and Defense Company, Raytheon, Increases Dividend by 7%
Polaris see Off-Road Vehicle/Snowmobile sales up +29% year-over—year
General Dynamics see Aerospace Revenue rise 12%
Waste Management sees 2021 revenue growth of +12.5-13%
*** Content in this material is for general information only and 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.
No strategy assures success or protects against loss. Investing involves risk including loss of principal. Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company
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