by Bryan Perry

December 8, 2020

Once the market is past the highly charged Georgia runoff election on January 5, investors and fund managers will likely focus on forward earnings growth relative to where the market currently trades.

By historical standards, the S&P 500 is fully valued up here around 3,700. If the S&P earns $140 for 2020, then it trades at a current P/E of 26.4, which is clearly rich.

According to FactSet, the bottoms-up EPS estimate for 2021 (which reflects an aggregation of the median EPS estimates for CY 2021 for all of the companies in the index) is $169.20. If $169.20 is the final number for the year, it will also mark a record-high forward EPS for the index.

Standard and Poor's 500 Bottom-up Earnings per Share Bar Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Even if we assume the S&P hits its 2021 earnings forecast of around $170, as modeled by FactSet, that would imply a forward P/E of nearly 22, which is also at the high end of the range going back to when this metric for measuring the market’s undervaluation, fair valuation, or overvaluation was created.

This topic gets a lot of commentary by the talking heads in the financial media, but it doesn’t seem to set off any alarm bells at the largest trading desks around the globe, which raises the question of … Why?

I think most would agree that the explanation that most easily satisfies this question is the cost of money. While Treasury yields have moved up in the past month from the 5-year to 30-year maturities, short-term rates from 1-month to 3-years have remained steady at extremely low levels, as targeted by the Fed.

Treasury Yields Table

Since most of the Fed’s debt and investment-grade debt is conducted in maturities of under five years, the cost to finance the Fed’s growing balance sheet, now at $7.2 trillion, is considered manageable.

Federal Reserve Total Assets Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The same thinking holds true for S&P 500 companies that can issue A-rated or higher debt at 1.5% for bonds that mature in 2030. This is almost “free money” that can fuel expansion or organic operations, or spur accretive acquisitions or expand stock buy-backs. Even junk bonds with maturities averaging about four years are paying below 5% yields in today’s market.

High Yield Corporate Bond Exchange Traded Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Shares of iShares iBoxx $ High Yield Corporate Bond ETF (HYG), the largest junk bond ETF traded, with over $27.5 billion in assets, has some amazing data that provides a big-picture view of just how bullish the debt markets are in light of how huge they have grown. As the 12-month price chart (above) shows, HYG is almost back to trading at its pre-pandemic high, while paying 4.86% yield.

Junk Bond Breakdowns Table

Be aware that we’re talking junk ratings paying under 5% in a rising-rate market where income received is taxed at one’s ordinary income tax rate. This is not a great investment proposition vs. other alternatives.

When looking for income assets to own when inflation and bond yields are rising, we want to steer our focus toward equities in companies that can raise prices for their goods and services. As money comes out of low-yielding fixed income, it will rotate into inflation- and rate-sensitive equities.

As such, ETFs like the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) would be a solid example of both attractive yield and capital appreciation potential. With assets of $2.2 billion, this broadly diversified ETF is made up of the S&P 500 best blue-chip stocks that throw off hefty dividend payouts.

The fund has 49 total holdings, including utilities, real estate, information technology, materials, communications services, consumer staples, energy, financials, healthcare, and consumer discretionary. It’s a real “who’s who” of big dividend-paying companies.

This is a made-for-income-investor ETF that is seeking blue-chip income and growth, trading at a 17% discount to its February high. There is no leverage, short-term gains, long-term gains, or return of capital contributing to the monthly dividend payments – just dividends from the assets themselves. The current annual dividend yield is 4.80%. Shares of SPHD traded as high as $44.42 prior to the March sell-off. Today, they trade at $37.50. Finding a blue-chip, investment-grade asset trading at an 18% discount to its prior high and paying out nearly a 5% yield on a monthly basis is a fortunate situation for income investors seeking to add capital to an elevated market.

This is just one example of how to deploy capital dedicated to income moving out of bonds and into more economically sensitive assets. In such cases, capital usually ends up flowing to blue-chip equities, most of which have qualified dividends. When comparing HYG and other conventional income vehicles, the case for blue-chip dividend stocks with investment grade balance sheets is pretty solid.

Highest Published Fixed Rates Table

The SPDR S&P 500 ETF (SPY) sports a current 1.57% yield, which has come down as the SPY has risen, but it still exceeds that of the benchmark 10-year Treasury. As long as this 60-basis point premium continues, so will the rally in dividend and dividend growth stocks. The best days for bonds are probably over until the next Great Recession, but some of the best days for dividend stocks are likely just ahead.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

Also In This Issue

Global Mail by Ivan Martchev
Industrial Metals Predict a Stronger Global Economy

Sector Spotlight by Jason Bodner
Solving the Rubik’s Cube of Stock Market Logic

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About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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