INSIGHTS

On February 03, 2014

Viewpoints from AAM - 2014: Ask yourself one question: “Do I feel lucky? Well, do you?”

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By: Matthew McCormick, Bahl & Gaynor

Especially non-dividend investors.

In the 1971 classic film, Dirty Harry, actor Clint Eastwood played San Francisco Police Department Inspector “Dirty” Harry Callahan. He was called “Dirty Harry” by his peers due to his reputation of handling homicides in decisive and often violent methods. Callahan would get results. However, he rarely played by the rules. The movie’s tagline: “You don't assign him to murder cases. You just turn him loose,” summed him up - and the entire movie.

 

The iconic scene where the famous quote occurred starts out when Harry single-handedly stops a bank robbery by killing two and wounding a third. The last living robber is about to reach for a loaded shotgun when Harry confronts him with a challenge:

 

“I know what you’re thinking, ‘Did he fire six shots or only five?’ Well, to tell you the truth, in all this excitement, I’ve kind of lost track myself. But being this is a .44 Magnum – the most powerful handgun in the world and would blow your head clean off – you’ve got to ask yourself one question, ‘Do I feel lucky?’ Well, do you, punk?”

 

The thief gives up. Callahan takes his gun and begins to walk away. After a second, the bad guy yells ‘Hey! I gots to know!’ Harry aims the gun and fires. However, the gun clicks harmlessly as it is empty. Harry then grins, laughs and walks away. The criminal utters an unkind oath in despair.

 

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Investors today can probably relate with the bank robber who “gots to know” about what the stock market will do in 2014. They also have to decide “if they feel lucky.” Currently, investors appear fully ensconced in the “press my luck” camp. Modest economic and earnings per share (EPS) growth seemingly placate any concerns and are turning once-reluctant bears into bulls.

 

It was good to be a stock investor in 2013 as the S&P 500 had its best year since 1997 and increased 32.39% (after a 16.00% pop in 2012). Cyclical sectors, small caps, low-quality and non-dividend paying stocks led. Though it was a decidedly “risk-on” year, even conservative investors like Bahl & Gaynor were up over 20% in 2013.

 

The question on every investor’s mind is, “Will it last?” Bahl & Gaynor is in the camp that some will continue to chase returns and “invest” in low-quality stocks that lack consistent EPS and dividend growth – and driving the indices higher. They do so because they have been constantly rewarded (and encouraged by the Fed’s massive liquidity programs) for adding more “risk” to their portfolios since the market bottom of 2009.

 

At Bahl & Gaynor, we have a mantra that is worth repeating: “valuations, fundamentals and dividends do not matter – until they are all that matters!” Could seasonal upward bias, positive political news and lack of geopolitical unrest propel stocks higher? The answer is: “sure.” However, we cannot condone paying triple-digit Price-to-Earnings ratios for companies with little or no earnings, no dividend yields and questionable business models. This market environment reminds us somewhat of 1999 or 2007 when investors seemingly threw caution to the wind and bought into “bubbles” like dot coms and housing. Bubbles seem awfully easy to find after they burst.

 

2014 could be a bumpy ride as volatility is likely to increase, not decrease. The sense of euphoria is evident and it appears all the “cool kids” are uber-bullish. We believe this is when investors should consider an alternative path and not press their luck. Thus, we would not be surprised to see a correction of 10% or more. Accordingly, high-quality, dividend-paying stocks could be (and would be) one of the more predictable opportunities in a very unpredictable investment world. Though we are realistic about our economic/market outlook, we are extremely optimistic about the opportunity within the high-quality dividend space now and for the next several years.

 

The police have a motto: “To protect and to serve.” Dividend stocks have a similar role for investors. They protect by historically being beaten up less in difficult markets. They serve by providing income and less volatile returns. Unfortunately, for the past two years they have not had a chance to excel in their job. Investors in non-dividend-paying stocks should ask, "Do I feel lucky?" They should also ask, “Well, do I want to risk my portfolio getting ‘punked’?” Most know to never bet against Dirty Harry, Clint – or dividends for the long term.

 

Bottom line: Non-dividend stocks have had a long run and have valuations on par - or in excess - of 2007. Their luck could run out in 2014.

 

 

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com

The information contained herein is obtained from Bahl & Gaynor and believed to be reliable. The information is not warranted as to completeness and accuracy and is subject to change without notice. The foregoing has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security.

The views expressed in this commentary are not necessarily that of AAM.