Trade concerns? Consider dividend stocks

Trade concerns? Consider dividend stocks

Dividend stocks in defensive sectors, which exhibit lower overall beta and less vulnerability to drawdowns, could be useful to many investors in the current environment.


On January 22, 2018, President Donald Trump implemented steep tariffs on foreign washing machines and solar energy cells and panels, marking the beginning of the current trade tensions between the U.S. and China. While the implementation of new tariffs has been delayed, it is clear that the persistent and prolonged trade uncertainty is having an impact on both equity markets and growth prospects of the global economy. The potential for higher market volatility and softer economic growth (expected and realized) increases as the trade war rhetoric continues. In fact, central banks in several developed markets have started to brace for softer economic growth by pivoting to a more accommodative monetary policy, pushing interest rates lower.

Since the onset of trade issues in late January, the S&P 500 Index has returned 4.97%1 despite reaching a historical market high on July 26, 2019. Prior to that, between President Trump’s inauguration and the last stock session before tariffs were announced, the S&P 500 Index was up 26.21%.2 However, not all sectors were affected equally by recent developments. The impact has been particularly pronounced on multi-national, cyclically oriented stocks, especially those with exposure to China. As a result, and bolstered by yet lower interest rates, dividend paying stocks such as Utilities and Real Estate have outpaced Information Technology and Consumer Discretionary stocks. 

U.S. Equities Pre-Trade War and Ongoing Trade War Returns by Sector

Source: Bloomberg. Pre-Trade War period is January 20, 2017 through January 21, 2018. Ongoing Trade War period is January 22, 2018 through August 12, 2019. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Sectors such as Information Technology and Materials remain far more exposed to the ongoing trade tensions, with the U.S. making up less than 45% of their geographic revenue and China making up 15% and 8% of their revenue, respectively. In contrast, Utilities and Real Estate have close to 90% of their geographic revenue exposure to the U.S. and less than 1% revenue exposure from China.

Geographic Revenue Exposure by Sector

Source: MSCI, as of 6/30/19. *Includes all countries excluding China and the USA. Based on the MSCI USA Index as of June 30, 2019. Sectors based on GICS classification. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

U.S. equities broadly remain quite vulnerable to the ongoing tariff dispute and global uncertainty at large. Currently the five largest stocks make up over 15% of the S&P 500 Index. On average, these companies generate less than 50% of their revenue domestically.

Top 5 S&P 500 Security Geographic Revenue Exposure

Source: MSCI, as of 6/30/19. *Includes all countries excluding China and the USA. Based on the MSCI USA Index as of June 30, 2019. Sectors based on GICS classification. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

The escalating market volatility, up nearly 50% since the onset of trade tensions, as measured by the CBOE Volatility Index (VIX), coupled with the potentially lengthy resolution of negotiations does not bode well for cyclical equities. In contrast, the current environment seems to be more suited for sustainable dividend stocks in defensive sectors, with lower overall beta and less vulnerability to drawdowns.

Additionally, as increased risks are associated with every asset class, it is important to consider alternative allocations such as Equity Market Neutral. Maintaining exposure to an uncorrelated source of returns, distinct from traditional stocks and bonds, becomes more and more crucial against this backdrop.


Footnotes:

1 Source: Bloomberg. January 22, 2018 through August 12, 2019

2 Source: Bloomberg. January 20, 2017 through January 21, 2018

Definitions:

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.

Beta measures the sensitivity of an investment to the movement of its benchmark.  A beta higher than 1.0 indicates the investment has been more volatile than the benchmark and a beta of less than 1.0 indicates that the investment has been less volatile than the benchmark.

Correlation is a statistical measure of the relationship between two sets of data. When asset prices move together, they are described as positively correlated; when they move opposite to each other, the correlation is described as negative or inverse. If price movements have no relationship to each other, they are described as uncorrelated.

Equity market neutral describes an investment strategy where the manager attempts to exploit differences in stock prices by being long and short an equal amount in closely related stocks.

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