If the S&P 500 Index consolidates around the 1,350 level, then I think it’s fair to argue that the stock market is appropriately valued given all the information we have right now. I’m thinking that this will happen as investors digest news about Greece’s sovereign debt crisis and other economic news.
So, if you think the stock market is close to being fairly valued like I do, then the big question is: what does the future hold for your equity investments? From my perspective, the answer is very little, and that’s why dividends are so fundamentally important.
Dividends have been instrumental in providing returns greater than the rate of inflation since the bear market began 11 years ago. Just pull up a long-term chart on any of the major indices and you’ll see the enormous volatility and lack of trend in the stock market. If fact, looking at a chart of the S&P 500 Index, the volatility since the technology bubble burst in 2000 has been gut-wrenching. Perhaps these are ideal conditions for index traders, but for investors, it’s been a nightmare.
Because of this recent history in the stock market and the modest outlook for the future, I’m only really keen on big-cap companies that pay dividends. Owning the right basket of higher dividend paying stocks is the only way I would approach the stock market today. Investment risk is just too high to be betting a good portion of an equity portfolio on high flyers.
The stock market has eaten through a lot of sector trends over the last few years. Alternative energy stocks, specifically solar panel equipment makers, were very hot for a short period of time. Then the sector was decimated. After that, U.S.-listed Chinese stocks were big moneymakers, only to be annihilated as a group due to weak accounting standards. (See What You Can Learn From the Solar Energy Market Meltdown.) Finally, gold stocks were the cat’s meow; they generated solid capital gains on the stock market, but also corrected significantly.
The point of this analysis is that it’s been a very difficult environment for stock market speculators, pretty much for the entire last decade. Instead of trading the stock market for small capital gains, most investors would probably have been better off just investing in Union Pacific Corp. (NYSE/UNP), a boring railroad stock that’s up over fivefold (not including dividends) over the last decade—and it would have been easier to sleep at night with less work.
My stock market outlook reflects the times that we’re in and the difficult trading environment we’ve experienced in recent history. At the end of the day, I’ve learned over the years that investment risk is as equally important as potential return. In a slow growth global economy (Europe’s basically in recession now), I’d choose large-cap, dividend paying stocks for the bulk of an equity portfolio. Corporate dividends are likely to continue being the only way to beat the rate of inflation for several years to come.