Why this Market’s Poised for Another 10% Gain

dividend paying stocksWe’ve seen a lot of increases in dividends lately and it’s a trend that should last throughout the next couple of quarters. The stock market has also been bolstered this year by a strong performance from the financials. U.S. bank stocks were beaten down hard (as they deserved), but their resurgence is a very positive sign for equities. The stock market needs leadership from technology and financials if it’s going to move higher in a meaningful way.

While the NASDAQ has been shining since the beginning of the year, large-cap companies that pay dividends have also been a big part of the story. (See Why the NASDAQ Blasting by the Dow Jones Is Another Positive Signal.) I continue to think that large-cap, dividend paying stocks are the place to be in this stock market—a market that is fairly priced but still vulnerable to all kinds of shocks.

The recovery in the U.S. economy is happening, but it’s happening slowly. If you are a large corporation that’s sitting on piles of cash, you likely are going to use a mixed strategy going forward that includes modest business investment combined with increased dividends and/or share buybacks. Recent data on durable goods orders illustrates this point perfectly.

There is a lot of anticipation now in the stock market regarding first-quarter earnings and corporate visibility. Don’t be surprised if the stock market sells off on good financial news—that’s what the stock market does—investors buy on anticipation and sell on reality. The stock market is due for a bit of a correction after its strong run since the beginning of the year and this would be a healthy development.

Most of the large-cap companies that recently announced dividends increases experienced heavy buying in their shares. Institutional investors (like many individual investors) are craving higher income from dividend paying stocks, because they can’t get any income from bonds or cash that is above the rate of inflation. This is why I’m so fond of large-cap, dividend paying stocks this year—it’s what the stock market wants.

The decision of Apple Inc. (NASDAQ/AAPL) to start paying dividends is exactly what institutional investors were craving. And while Apple is a standout considering its $30.0 billion in cash equivalents, there are a lot of other companies out there sitting on cash, because they’ve been so risk averse since the subprime financial crisis. With the prospect of a recession in 2013 or 2014, I’d choose higher dividend paying stocks over any other equity security the stock market has to offer. Things are going better now, but, make no mistake; investment risk in all capital markets remains very high at this time.

My near-term outlook for the stock market is positive. Expect stocks to sell off on good news, only because they’ve risen in anticipation. Second-half corporate visibility is the key to sustaining the current rally. With a combination of good earnings, solid visibility, and increases in dividends, this market has another 10% to the upside.