Riding the stock market cycle in search of dividend yields
This Canadian analyst discusses the major cycles in the stock market and how investors can profit, using six stocks to illustrate his case.
The stock market may seem to change crazily from day to day.
But in a sense, it’s not going anywhere. It’s stuck in the middle of a long cycle.
As one Canadian analyst tells us, the stock market tends to take these long journeys, up, down or sideways.
And the best way to profit is to understand where the market is in its cycle and act accordingly.
Mr. Dave Skarica is both an online analyst and fund manager. He examines the great stock market cycles of the past in Investor's Digest of Canada and puts today’s market in context.
It takes about 10 years after the end of a bull market for value to resurface. That’s about where we are now, this analyst says.
His approach to riding the cycle in today’s circumstance, he says, is to keep his compass fixed on dividend yields.
Three long cycles
Mr. Skarica goes all the way back to 1900 to survey the stock market. Three times in the past century, he says, stocks have performed very well for a long period of time.
The first was from 1921 to 1929 at which point, of course, it all came tumbling down. The second came in the wake of the post-World War II boom, from 1949 to 1966.
The third began in 1982 after the last big recession and lasted until 2000, when the dot-com bubble burst.
Following each one, there was a lengthy bear market — 1929 to 1949, 1966 to 1982, and 2000 to the present.
But what really defines these cycles? Stock valuations, says this analyst. Look at the top of each of the three bull market cycles, in 1929, 1966 and 2000, and one thing stands out.
Stocks were “extremely overvalued by historical standards,” he says. Stocks on the S&P 500 Index were trading at over 20 times their earnings in each of those three years.
An individual stock is generally considered fully valued at 20 times earnings. When 500 of them are averaging that number, they have nowhere to go but down.
Overvalued to fairly valued
“Those periods were followed by long time frames when stocks did nothing as they again got cheap,” states Mr. Skarica. Then, at the bottom of the bear market cycles — 1921, 1949 and 1982 — “stocks got extremely cheap.”
In each of these years, the stocks on the S&P 500 were trading at less than 10 times earnings. When the price/earnings ratio on the index was over 20, stocks did not perform well for 15 to 20 years. When it has been down in single digits, the market “soared in the future.”
We are right in the middle of this “value compression,” says Mr. Skarica. Overall, the market hasn’t gone anywhere in ten years. The Dow Jones Industrial Average is about where it was in 2000.
“Stocks have gone from overvalued to fairly valued.” The price/earnings ratio on the S&P500 is just above 18.
In short, the stock market is going sideways. There is value to be had, but investors must know where to look.
At this point, Mr. Skarica states frankly, “you want income, because capital gains are not there.”
In 2000, there was no income and yields were low, he explains. Because yields in general have moved up, there is solid value in some stocks.
Real value in bank stocks
Take the Canadian banks, the analyst says. Most of them are yielding between 3.3 and 4.6 per cent. Toronto-Dominion Bank (TSX-TN) is at 3.4 per cent. Bank of Montreal (TSX-BMO) is at the higher end at 4.6 per cent. Royal Bank (TSX-RY) stands at 3.6 per cent.
A real estate bubble in Canada could hurt these stocks, adds the analyst, but right now “we are seeing real value in these bank stocks.”
Recovering from the spring correction, the shares are moving up. TD is trading at $72.37, Bank of Montreal at $61.34 and Royal at $54.69.
There are also strong yields in some telecom stocks. Mr. Skarica likes two American stocks, Verizon Communications (NYSE-VZ), which yields a rich 7.1 per cent, and AT&T (NYSE-T), which is yielding 6.7 per cent.
These stocks may have great capital gains potential in the future, says the analyst, but in today’s market “getting over six per cent in yield from top-tier, safe companies is a lot better than getting three per cent in a 10-year bond from the near-bankrupt U.S. government.”
We should add that one conservative U.S. editor we follow admired Verizon’s yield, but let go of the stock several months ago because its shares were doing poorly. It trades at $26.78, about $5 off its December high. AT&T has been a bit more stable, trading at $24.96.
Then there’s a high-yielding stock that is not nearly as famous as the five above, but it could profit from a famous mess.
Crude oil carriers
Knightsbridge Tankers Ltd. (NASDQ-VLCCF) is yielding almost 9 per cent on its $1.60 dividend. Mr. Skarica contends that BP’s notorious oil spill in the Gulf of Mexico will help this company considerably.
The sheer extent of the disaster means that oil drilling will be “put on hold in the United States for the foreseeable future,” in this analyst’s opinion. Inevitably that means more oil must be imported and more oil tankers will be pulling into American ports.
Knightsbridge, a Bermuda-incorporated company, owns five large crude oil carriers. It bills itself, by the way, as a transportation and environmental services company.
The stock is trading at $18.10, about $1.75 off its May high.
We are in the beginning of a long bear market, this analyst tells his readers in Investor's Digest of Canada. But we need not despair.
Whereas stocks were overvalued and low in income a decade ago, today at least we have strong dividend yields. It’s still an uphill cycle, but there are rewards within reach.
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