A Simple Strategy to Benefit from the Fed's Late and Telegraphed Shift Back Toward Neutral
3min read Recent economic data and Fed policy messaging both suggest rates across the treasury yield curve are heading lower.
As fixed income returns dwindle, asset allocation tends to shift capital into the Dividend Aristocrats.
The S&P 500 Dividend Aristocrats ETF ($NOBL(NOBL)) offers a simple basket approach to take advantage.
The Ground is Tipping
The message from Fed Chair Powell couldn't have been more clear at Jackson Hole last month: The time has come for policy to adjust.
Since then, we have seen a number of data points that reinforce this view, including a drop in six-month annualized core PCE inflation from above 2.8% to below 2.3% and a JOLTS number that suggests we have genuine slack building in the labor market—a key indicator of disinflation.
As such, market-driven rates have slid lower in anticipation of a stair-stepping process of rate cuts from policy makers.
The pace of policy adjustment is still a key wildcard, but we can take some hints from the Fed Funds Futures market, as summarized by the CME FedWatch Tool.
At present, the market is looking for 100 basis points of rate cuts from the Fed during the remainder of 2024, with another 125 basis points of cuts in 2025 from January to June, leaving us at approximately 3.00-3.25% on Fed Funds, which is also where most Fed economists seem to believe neutrality lies.
While Fed Funds Futures are often wrong over the medium to longer term, the present case appears to be somewhat unique in that the Fed has openly stated that it sees its current policy stance as well above neutrality.
In other words, without a reinvigoration of serious inflationary pressure, policy rates are coming down in the months ahead. And every data point we have been seeing over the past several months are increasingly singing in harmony against the odds of such a U-Turn on the inflation front.
That means prospective returns for new capital targeting money market funds, CDs, Bills, Notes, Bonds, and savings accounts will all be heading lower. For investors seeking that niche of return at better levels, dividend paying stocks offer a lifeline.
For Clarity
It should be noted here that dividend paying stocks have, and will continue to have, plenty of competition at this point in the cycle.
Even a 2-yr T-note still pays 3.9%. You can easily find top yielding accounts and instruments that pay over 4-5% with little default risk.
That said, as the Fed cuts, those yields will fall. It may be gradual at first. But the scale of the adjustment that likely stands before the Fed at this point suggests the shift in yields for many of these products will pick up steam.
This should funnel capital into the top yielding areas of the dividend landscape in the stock market, including utilities, REITs, staples, and energy stocks, which often sport the best paydays and growth in yields.
It Pays to Pick
Seeing the investment landscape from this perspective, the opportunity is clear. However, it will still be important to be selective and follow some basic guidelines.
At the sector level, top dividend paying sectors will struggle to eclipse the risk-free rate on the 2-yr T-Note.
That said, Chevron ($CVX(CVX)) pays nearly 4.5% in annual dividend yield. In other words, it pays to be picky.
An S&P 500 index fund isn't the best option for income generation. The dividend yield on the SPDR S&P 500 ETF (), for instance, is just 1.25%. Naturally, that is largely a consequence of the fact that the S&P 500 is trading near a record high at present.
Still, the point remains.
Slackening
In fact, this point of stock selection is all the more relevant because the economy is expected to slow. How much? That remains to be seen.
But the jobs market will largely hold the key to that answer. This week's JOLTS (Job Openings and Labor Turnover Survey) data was an eye opener, with real slack starting to emerge. The report (for July data) showed that total job openings fell to 7.673 million, below the consensus estimate of 8.1 million and marking the lowest level since February 2021.
On Friday, we will get the August Employment Situation report, which will tell still more of the story.
This is especially true as the last Jobs number popped the unemployment rate up to 4.3%, which triggered the Sahm Rule.
The Sahm Rule measures the three-month average of the national unemployment rate against the previous 12-month low. The rule is triggered when unemployment rises 0.5% from that level. This rule has successfully predicted recessions 100% of the time since the early 1970s.
Friday's data will be a key point in either confirming that shift or undermining it.
Conclusion: NOBL Should Add Value to Any Portfolio
A slowdown across the economy will inevitably lead to a slowdown in earnings growth. But a recession will generally lead to a contraction on the earnings side as well.
Most importantly, in either case, exposure to high-quality dividend paying stocks is more than prudent.
Focus on companies with a strong track record of paying and increasing dividends during any and all phases of the business or market cycle.
A simple and effective starting point for this approach is the S&P 500 Dividend Aristocrats Index. The index is composed of all stocks that are: 1. in the S&P 500 and 2. have raised dividend payouts every year for at least the past 25 years.
There are currently 66 components. You will have heard of most or all of these names. The advice here is to either pick and choose among them or simply allocate capital to the basket: The S&P 500 Dividend Aristocrats ETF (NOBL).
These stocks tend to outperform when either the economy suffers or rates fall for any reason. From where we stand now, these conditions look very hard to avoid.