Market comment from Sherlock Holmes
In the fall of 2007, rapidly deteriorating financial conditions led the Federal Reserve to cut the bank discount rate from 6.25% to 5.75%. It continued a record series of interest rate cuts, ultimately taking short-term rates to nearly zero, helping put the brakes on a steep slide in stocks. Recently, it stopped this series, raising this rate from 0.5% to 0.75% and a curious event took place. Nothing happened.
In Dr. Watson’s memoir, “Silver Blaze,” involving the strange disappearance of a race horse, Sherlock Holmes called the attention of Inspector Gregory “To the curious incident of the dog in the night-time.” The inspector said, “The dog did nothing in the night-time” and Holmes responded, “That was the curious incident.”
In the story, Holmes realizes that the dog made no noise because the horse thief was no stranger. In our financial markets, stocks sold off abruptly in after hours trading on fears of higher interest rates then rallied nicely as traders adjusted to the beginnings of what is probably a return toward calmer conditions.
Like the dog that did not bark, investors accepted without alarm this first increase in rates. After all, rates were much higher in 2007 when the Dow went through 14,000. Interest rates are still low and stock prices as well as other parts of the economy will improve as the global recovery continues its frustratingly slow pace. Investor reaction to this first increase is encouraging.
Holmes also said that when you eliminate all other factors, whatever remains must be the solution. Many traditional stock investments are unappealing now. Short-term bonds offer absurdly low rates; long-term bonds are subject to price weakness upon rises in interest rates. Commodities, even energy and gold, are weak on rebounding strength in the dollar and most consumer stocks rely too much on revived consumer buying. Stagnant markets are holding back real estate and related stocks.
One remaining sector includes growing industrial companies who offer not only above average earnings growth but solid dividends that exceed the returns coming from less agile fixed-rate investments. Sysco (SYY-$29), a new recommendation, is exemplary. This is the leading company in the food service business with $35 billion sales. Growth in sales and earnings are in the low single digit range and its dividend yield is 3.4%. This is not dramatic growth and the most recent dividend increase was “only” a penny, but it’s increased its dividend annually since 1970.
Technological stocks are in a sweet spot with valuations moderate and business spending increasing for equipment and software. Intel (INTC-$20) yields 3% and IBM (IBM-$126) 1.7%. Both have a steady record of rewarding shareholders through annual dividend increases.
The recession broke the streaks of some companies for annual increases, among them GE and Bank of America. Those that are maintaining their annual increases include those with rising earnings like 3M (MMM-$80, 2,6% yield), Waste Management (WM-$33, 3.5%), Aflac (AFL-$48, 2.3%), Coca-Cola (KO-$55, 2.9%), Manulife (MFC-$18, 2.6%) and even Clorox (CLX-$61, 3.3%) in the battered consumer sector.
Dividends may seem like details but details count and in the case of dividend champs like these stocks, they tend to multiply. As Mr. Holmes said, “I am glad of all details, whether they seem to be relevant or not.” I believe Holmes would be cautiously bullish today.