Stock Market Trading Action Signals Breakout Coming

Stock Market Trading ActionEver since the beginning of June, when the stock market came out of its correction, there has been seesaw-trading action with three meaningful peaks and valleys in the S&P 500 Index. We’re now working on the fourth, and who knows where it will lead.

Expectations for corporate profits continue to come down, and any positive investor sentiment is likely due to the lingering hope for additional monetary stimulus from the Federal Reserve. It really is a wacky stock market these days, because there is no certainty. Stock market investors don’t have any reasonable expectation of what their holdings might do, and therefore, investment risk remains very high.

The only thing that’s reasonable for equity investors to feel certain about is the outlook for dividends. Corporations continue to hoard cash, because they too feel the uncertainty in their operations. So why invest in new plant equipment or employees when the global picture is so cloudy? And even if dividend payments aren’t going up, there is so much cash on corporate balance sheets that most large-cap companies are assured of continued dividend rates through the worst of recessions.

Because expectations for corporate profits are falling, so are expectations for increased dividends. Even though corporations can afford it, we’re likely to see fewer companies raising their dividends to shareholders, particularly if general economic growth remains weak. You know you’re in tough times when the stock market goes up after second-quarter economic growth is reported at 1.5% on an annualized basis.

Dividends have been a stock market investor’s best friend for the last decade, and if you think the U.S. economy will toy with its next recession in 2013 or 2014, dividends will be your only friend. If you look at the simple returns generated by a handful of large-cap, brand-name companies on the stock market, then compare this to include dividend payments that have been reinvested in additional shares, you’ll notice that total investment returns change dramatically (www.morningstar.com is a good resource for doing this). The power of reinvested dividends is like compound interest, and they can even turn a negative stock market position into a positive result.

Dividend investing is important in this kind of market—a market with slow economic growth in the age of austerity. Institutional investors have been chasing higher dividend paying stocks, and this is why many of the brand-name companies we recognize are trading at their 52-week or all-time highs. (See “The Blue-Chips Hitting New All-time Highs in Spite of Market Correction.”) Going forward, you can’t really expect much from the stock market because of all the uncertainty out there. You can, however, expect that most large-cap companies will continue to pay their quarterly dividends, and this may be the only positive returns we get over the next couple of years.