Looking Ahead to 2012—It’s Dividend Paying Stocks or Zero Returns

What investors can expect from the stock market heading into 2012.The stock market has not been trading on corporate fundamentals lately; investors have been trading on fear and uncertainty. Making predictions in this environment is kind of foolish, but I want to lay out a near-term scenario for the stock market if we get more certainty in the marketplace. Trading action next year is likely to be very similar to this year and I expect dividend paying stocks to be the understated stock market leaders once again.

Excluding shocks like a euro currency breakdown or a new war, for example, I think the stock market can move higher going into the first quarter of 2012. Corporate earnings are strong enough, valuations are fair enough, and current economic data are showing improvement. Higher dividend paying stocks and the Dow Jones Industrial Average will continue to be outperformers in the stock market. Technology, retailers and more cyclical industries will be vulnerable later in the year as the economy toys with recession again.

The Federal Reserve is doing all it can to prop up the economy by increasing the money supply and keeping interest rates artificially low. Yet, theU.S.national debt and deficit are not being addressed. In a sense, there is too much monetary policy action in the system at this time and not enough fiscal policy action, which, in my view, is a recipe for disaster. It’s a formula for long-term economic stagnation, while sowing the seeds of inflation.

This is why I only see positive trading action in the stock market not lasting much past the first quarter of 2012 given the current information. Accordingly, investors still need to be extremely cautious considering new positions and buyers should be focused on dividend paying stocks.

Blue-chips are the best stocks to own in this environment, as are higher dividend paying stocks in a lackluster economy (see The Stock Market’s New Best Friend—Buffett Will Be Pleased). Because I find it unreasonable to expect a new bull market to develop in the stock market, generating any rate of return on equities is a crapshoot at best. Accordingly, dividend paying stocks and cash are the only paper plays for investors. Precious metals are the best stocks for speculators, of course, but that is a sector that trades off the spot prices of the underlying commodities.

Dividend paying stocks have good potential in 2012 because institutional investors will be chasing any kind of certain returns they can find. And, while most big-cap companies have tons of cash on their books, the likelihood of dividend paying stocks increasing their payouts to shareholders is improving. Corporations are acting like investors; they are reticent to step up to the plate and invest in new employees, plants and equipment. As their earnings continue to be robust, these companies will be increasingly inclined to pay more dividends to stockholders.

So, if the world and the stock market don’t fall apart over the next several weeks, I think it’s reasonable to expect incremental stock market gains in the first quarter of 2012. I also think it’s fair to assume that higher dividend paying stocks will outperform in an environment of low expectations for capital gains.