Volatility has been a reliable theme this year as investors grappled with uncertainty about the slowing global economy, how long inflation will persist, and the impact of the Federal Reserve raising rates. Having tumbled more than 20% from the start of the year, equities had a reprieve from the selling in October. The Dow Jones Industrial Average had its best month since 1976. The primary lift to the markets has been the expectation or hope that the Fed will pivot from its tightening policy, given the increasing odds of a recession.
The market’s temporary upbeat vibe was justified in part as the U.S. economy reported its second consecutive quarter of negative GDP growth, seen as a potential incentive for the Fed to loosen the reins. Other economic data during the period showed mixed signs that growth is slowing further as inflation continues to erode household budgets.
Fed officials remain unmoved, however, focusing on bringing inflation down even at the expense of economic growth. With U.S. inflation continuing to hover near its highest levels since 1980, the Fed delivered another 75-basis point increase at the recent November meeting, making clear that it will keep hiking as needed to bring inflation down. Even with a lack of clarity on the economic outlook, equities are trying to find support as investors anticipate that the Fed will eventually slow the rate of hikes.
As inflationary pressures persist, it is an ideal time to re-emphasize the benefits of investing in companies that pay dividends. Dividend-paying companies have historically participated in up markets and helped mitigate risk during periods of heightened volatility. The income provided by dividends is essential to a strong capital appreciation strategy, may limit volatility, and contribute to a stock’s total return over time. Indeed, dividends have contributed significantly to equity total return over the decades. From 1930 to 2021, 40% of the annualized total return of the S&P 500 was derived from the payment of dividends, with capital appreciation contributing the rest. Source: Ned David Research
We favor companies that offer the combination of attractive valuations and fundamental strength to support dividend payments to help mitigate inflationary pressures and the impact of higher interest rates. A good example is Microsoft, one of our core U.S. large-cap companies that recently announced an increase to its quarterly dividend, now amounting to $0.68/ share for an increase of nearly 9.7%. During the call, the management team explicitly mentioned that the increase is “in line with inflation.” We continue to seek opportunities to invest in quality companies with healthy cash flows, attractive earnings growth potential, and pricing power that can help overcome inflation and maintain margins.
In this challenging environment, we remain committed to helping our clients reach their long-term financial goals. We realize the angst from volatile times like this and appreciate your trust. Communicating with you remains a top priority, and we encourage you to contact us with any questions or comments you may have. Thank you for your trust in Cardinal Capital.