Dividend Value Investing: No Time for Suspension of Disbelief, Part 3
As previously explained in this series, investors who follow Hollywood’s lead and suspend disbelief may very well overlook the potential downside risk of a profit cycle in its later stages. But to avoid misunderstanding the market, it’s important to balance the concerns I’ve previously addressed in the first two parts of this series with supporting factors for the market.
Closing credits: Managements, margins, metrics
We believe these factors will contribute to supporting the market over the next several years:
- Management teams have generally been conservative this cycle. Profits have been strong despite weak top-line growth, which reflects better management execution, in our view.
- Today’s lower capital intensity of domestic corporate America may lend itself to a more sustainable margin profile than in previous cycles.
- “Cheap cash” from low interest rates led to increased merger and acquisition activity in 2014, and we could be in the early stages of this trend.
- Potential broadening of the consumer recovery — particularly among lower-wage earners as they start to see employment and wage gains — may solve the puzzle of why wages have not been keeping up this far into the cycle.
- Many metrics indicate that the deleveraging process is nearly complete. For example:
- The debt-to-disposable income ratio is now back to pre-bubble levels at roughly 103% versus the peak of 130% in 2008.1
- Consumer delinquencies continue to decline. The 90- day total delinquency rate is currently 4.3%, the lowest since early 2008.2 This also indicates that consumers have remained very cautious about adding debt, so there should be capacity to take on debt as they become more confident in the sustainability of their job situations.
- The financial obligation ratio — total fixed payments expressed as a percentage of disposable income — is also at levels not seen since the early 1980s,3 largely because of historically low interest rates on fixed-rate mortgages.
- Finally, consistent observations over the last four months indicate that the employment cycle has turned and the improving employment picture appears sustainable. We anticipate that wage inflation will pick up as well, which would support consumer spending patterns.
Now isn’t the time for investors to suspend disbelief when it comes to mounting evidence that the profit cycle is maturing. That necessitates rigorous evaluation of the risk-reward profiles of our holdings as we seek to add value for investors with less risk than the market over a full cycle.
For a more comprehensive analysis, please see the Insights titled Dividend Value Investing: No Time for Suspension of Disbelief. You may also be interested in information about Invesco Diversified Dividend Fund and Invesco Dividend Income Fund.
This is the third blog post of a three-part series. Part 1, Keeping Our Eyes Open, discussed indicators that we’re in the later stages of this profit cycle. Part 2, Watching for the Plot Twist, looked at where we see vulnerabilities in the marketplace.
1 Source: Ned Davis Research, Department of Commerce, as of Sept. 30, 2014
2 Source: US Federal Reserve
3 Source: US Department of Labor
Important information
Common stocks do not assure dividend payments. Dividends are paid only when declared by an issuer’s board of directors, and the amount of any dividend may vary over time.
A value style of investing is subject to the risk that the valuations never improve or that the returns will trail other styles of investing or the overall stock markets.
The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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