The combination of the past two weeks’ $1.94 trillion equity wipeout, record cash levels and rising dividends means the Standard & Poor’s 500 Index is offering comparable values to Treasuries.
The plunge from July 22 to Aug. 5 erased 11 percent from the benchmark gauge for American equities as Congress and President Barack Obama battled over the deficit and borrowing limits that prompted S&P to downgrade the U.S. government’s AAA credit rating for the first time. At the same time, 10-year Treasuries have returned 3.6 percent as investors sought the refuge of government bonds, pushing yields down 40 basis points to 2.56 percent, according to data compiled by Bloomberg.
While the U.S. government is running record deficits, chief executive officers have more money than ever after boosting cash for 10 straight quarters to $963.3 billion, 58 percent more than in December 2007 near the start of the credit crisis, S&P data show. More than 160 companies in the gauge pay dividend yields above the 10-year note, according to data compiled by Bloomberg.
“Many corporations are in better shape than even the United States,” E. William Stone, who helps oversee $109 billion as chief investment strategist at PNC Wealth Management in Philadelphia, said in a telephone interview Aug. 6. “These companies are in a position to weather pretty much any sort of financial storm. Hopefully we won’t see that again. It certainly would argue for that tilt towards larger, stable companies with sustainable dividends.”
Stocks slumped as reports on manufacturing and consumer spending showed the world’s largest economy is slowing. The S&P 500 had its biggest weekly loss in 32 months, falling 7.2 percent to 1,199.38, the lowest level since Nov. 30, 2010. After markets closed for the week on Aug. 5, S&P lowered the U.S. credit rating one level to AA+ and said it may be reduced further in the absence of spending cuts and amid a refusal by Congress to let the Bush-era tax cuts expire.
The retreat has pushed the index’s valuation to 13.1 times profits in the last year as of Aug. 5, the lowest level since the month the bull market began in 2009, according to data compiled by Bloomberg. Concern about weakening economic data has overshadowed an earnings season that has seen per-share profits grow 18 percent and sales increase 13 percent at companies in the S&P 500 that reported second-quarter results since July 11.
While the loss of the top credit rating is unlikely to damage short-term financing sources, it adds to the cycle of events that has erased $5.4 trillion from the value of shares worldwide since July 26, according to Paul Zemsky, the New York- based head of asset allocation for ING Investment Management, which oversees $550 billion.
“Markets were already under pressure and this adds fuel to the fire,” he said in an e-mailed statement Aug. 6. “There is little positive news to counteract this event. The real risk is that falling equity prices spook the consumer and cause them to pull back further. This is how this type of event gets transferred into the real economy.”
Zemsky said he cut investments in equities before last week’s decline. He recommended buying companies whose earnings are most-tied to economic growth such as industrials on expectations they fell too far. The S&P 500 Industrials Index has lost 14 percent since July 22, compared with the full gauge’s 11 percent retreat.
Owning companies with the highest payouts did little to preserve capital during the last recession. From the market’s peak on Oct. 9, 2007, the S&P 500 dropped 55 percent including reinvested dividends to its low on March 9, 2009. S&P’s Dividend Aristocrats index, tracking companies that have raised payouts for 25 years, slid 47 percent over the same period.
Returning money to shareholders means companies have less to spend on capital equipment and hiring. Orders for durable goods unexpectedly fell 1.9 percent in June as demand for machinery, computers and business equipment slipped, the Commerce Department said July 27. Employers have added an average of 108,000 jobs a month in April through July, down from 162,000 in the previous four months, Labor Department data show.
S&P 500 Performance
The S&P 500 has lost 9.2 percent since June 30, when the U.S. Federal Reserve’s bond-purchase program expired. Fed policy makers will meet tomorrow. Euro-region central bank governors held emergency talks yesterday aimed at stopping Spain and Italy from becoming victims of the sovereign crisis.
The U.S. downgrade “is one more reason that leads me to believe that we are in a cyclical bear market,” Thomas O’Halloran, a fund manager at Jersey City, New Jersey-based Lord Abbett & Co., which manages about $114 billion, said in a telephone interview Aug. 6. “The issue that the market was worried about was the sovereign crisis in the U.S. and Europe. The debt downgrade is just another negative data point that suggests we are in an over-leveraged state in the developed world, including the U.S.”
Moody’s Investors Service and Fitch Ratings affirmed their AAA credit ratings Aug. 2, the day Obama signed the bill that ended the debt-ceiling impasse.
European Bond Yields
Italian and Spanish bond yields rose relative to benchmark German bunds for a second week. The yield on 10-year Italian securities increased to 6.09 percent from 5.87 percent a week earlier and the yield gap with bunds reached a high of 416 basis points. The Spanish yield spread reached a high of 418 basis points, before the 10-year note pared losses.
S&P 500 companies have put money aside and paid down debt after the worst financial crisis since the Great Depression. Cash on corporate balance sheets excluding financial, utility and transportation stocks represented about 9.7 percent of market value as of March 31, up from the 20-year average of 6.7 percent, S&P data show.
U.S. companies have authorized $331.8 billion in buybacks this year and carried out $182 billion, data compiled by Birinyi Associates Inc. show. They bought back $342.7 billion in 2010, the most since 2008, when they repurchased $387.2 billion, according to data from the Westport, Connecticut-based money- management and research firm.
“If you actually put that money to work in some form, share repurchases or dividends, it says you have less anxiety about the future,” Mike Ryan, the New York-based chief investment strategist at UBS Wealth Management Americas, said in an Aug. 5 telephone interview. His firm oversees $774 billion.
“It’s shareholder-based cash deployment that we’ll see, because I don’t think visibility on the economy is so strong that corporate treasurers and CFOs are going to start throwing money at either acquisitions or building new plants and technology,” he said.
DirecTV (DTV) in El Segundo, California, Oak Brook, Illinois- based McDonald’s Corp. (MCD) and 38 other companies with a history of repurchasing shares are recommended holdings in a “balanced global portfolio,” according to a note Aug. 3 from Robert Buckland, Citigroup Inc.’s chief global equity strategist. The stocks may provide relative value during periods when equity demand is limited, he wrote.
The S&P 500 dividend yield reached 2.13 percent on Aug. 4, the highest since August 2010. The average payout on 100 of its biggest companies is 2.23 percent, within 0.33 percentage point of the yield on 10-year notes. Of the 162 companies with dividends higher than the bond’s yield, 31 are utilities such as Duke Energy Corp. and 29 are financials including BlackRock Inc. and Aflac Inc.
“Dividend investing is an excellent strategy for the current market environment,” Brian Belski, Oppenheimer & Co.’s New York-based chief investment strategist, wrote in a note today. “We focus not only on growth in dividend payouts, but also on cash levels and earnings growth” in recommending 23 stocks in the note, because “we have found that trends in these factors make dividend yields more believable.”
The drop in Treasury yields and the rise in the S&P 500 dividend payout have lowered the spread between the two to 43 basis points as of Aug. 5, the narrowest it has been since the 2008 financial crisis, Bloomberg data show. Verizon Communications Inc. (VZ), the second-largest U.S. phone carrier, and 14 other S&P 500 stocks that offer a dividend yield greater than the current 10-year Treasury note are projected to boost their dividend payouts, according to a Bloomberg forecast.
Chief strategists at 13 banks from Barclays Plc to UBS AG say the S&P 500 will surge 17 percent through Dec. 31, the average estimate in a Bloomberg survey. Their projection that the index will reach 1,401 hasn’t budged in four weeks.
“We have been looking to invest in companies with higher cash balances because they are able to either reinvest for growth or make distributions to shareholders,” Brian Jacobsen, chief portfolio strategist at San Francisco-based Wells Fargo Funds Management, said in a telephone interview Aug. 6. His firm manages $228 billion. “Investors are tired of getting very low interests on their savings accounts and on their bond holdings, and they will start to stretch for yield.”
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