Stock market optimism continues, but it’s not about corporate earnings or data on the U.S. economy. Although the stock market is still fairly priced, if the main indices keep ticking higher, share prices will get ahead of economic fundamentals.
The third quarter will soon be at an end and fourth-quarter earnings season will be upon us. Large corporations continue to have great balance sheets, and they are loaded with big cash balances. While it’s fair to expect little in the way of earnings growth, we should see some further increases in dividends. Dividend increases would go a long way in justifying the stock market’s recent advance.
Dividend paying stocks have led the stock market’s advance all year (and last year), and this trend should continue right into 2013. Corporate dividends have been the most certain aspect of the investing landscape since 2009. There is a downside, however, to increasing dividends and it’s stock market specific. Many argue that increased dividends in the technology sector actually reveal weakness, with top-line growth no longer as easy to generate. According to Bloomberg, U.S. technology companies are now paying out a record amount in dividends. Bloomberg also reported on Intel Corporation (NASDAQ/INTC), which increased its dividend to shareholders three times in the last 18 months. Intel recently cut its third-quarter forecast.
But on the other side, Cisco Systems, Inc. (NASDAQ/CSCO) jumped significantly after hiking up its dividend. In a sense, we are seeing the largest technology companies at mature stages of their growth cycles become more like utility stocks with increasing dividend payouts.
It’s fair to assume that we’re going to get more dividend hikes in the third and fourth quarters. And for the most part, the strategy works on the part of corporations. Earnings growth is minimal in a world of slowing economies. And for stock market investors, the relative certainty of dividend payments is, in fact, the only certainty available in a world awash in sovereign debt.
The real bonus with dividend income comes when you reinvest those dividends in more shares of the company. Dividends then create the same effect as compound interest; with more shares every year, you get more dividends and the wealth compounds.
I would say that this is a difficult stock market in which to be a new buyer. Many higher paying dividend stocks are trading right at their 52-week highs and corporate earnings growth is expected to be flat. If I had a material amount of money with which to create a new stock market portfolio, I’d be practical and wait until the next major stock market correction. This should coincide with the next U.S. recession, which is likely at the outset of 2013 or 2014.