Whether a stock market crash is coming or not, you need to protect your money.
Our Dividend Stock Portfolio is still making market-busting gains and the stock market is taking out fresh highs, so why am I selling stocks?
The economy isn't doing too bad and stocks aren't quite as expensive as they've been during other bull markets.
I’ve uncovered two warning signs, two reasons to sell stocks right now, and you cannot miss these if you want to protect your money. In this video, I'll update our dividend portfolio and show you why you should sell stocks now.
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Beating the Market with Dividend Stocks
We are four months into our 2019 Stock Market Challenge and the portfolio is still beating the market. As of last week, our portfolio of dividend stocks was up 23.6% against 15.8% for the stock market and just 14% for the Vanguard Dividend Appreciation fund.
But the stock market rally has been insane, up 18% since the bottom on Christmas Eve and that 85-day advance puts it within the top 2% of strongest rallies since 1928. I’ve found some market signals that are flashing bright red and we’re moving into what has historically been the worst time of the year for investors.
The message is YOU HAVE TO BE READY for what’s coming. In this video, I’m going to first update you on our 2019 dividend portfolio, show you some of the changes I’ve made to protect our profits. Then I’ll reveal those market signals and why I’m selling stocks. I’m not saying there will be a stock market crash in 2019 but there doesn’t have to be. The data I’m looking at is proof enough that you need to be protected.
I’m also going to talk about how you can be investing if you’re just joining us. Maybe you missed out on some of those portfolio gains but want to get started, so I’ll reveal what to buy now for protection and returns.
I’m putting this video into our 2019 Stock Market Challenge playlist so if you haven’t seen the other updates, check those out. Along with some of the biggest investing channels here on YouTube, I created a $1,000 portfolio in January and will be tracking it all year.
To track my portfolio of dividend stocks, I’m investing $1000 on M1 Finance, a no-fee platform that lets you pick your stocks and automatically invests any new deposits across your group.
Are Stocks Ready for a Crash?
Here’s our portfolio on M1 Finance and it’s tough to be anything but happy with almost a 24% gain in the first four months, especially compared to what the market is doing. The stocks pay an average 4.2% dividend yield which is about double the market rate and have provided that double-digit upside.
Scrolling down we see some of the real out-performers in the group. Hanesbrands continues to run with a 67% return. ConAgra which we just put on in March is our second-best return and we have five stocks, almost half the portfolio with returns of 35% or higher.
Some of the laggards here are the funds like the Vanguard Real Estate ETF, the iShares China Fund and the iShares European Financials. It’s intuitive that these aren’t going to have those 30% plus returns because they’re more diversified across hundreds of companies but they give us some great exposure to larger themes without the risk in a specific company.
I still like that China play, especially as we see more from recent stimulus measures by the government. Economic growth recently surprised to the upside with 6.4% growth in the quarter and I think these financial companies will benefit. The European financials have lagged but there’s still a lot of value there as well.
Our investment in PPL Corporation has taken a hit on those Brexit uncertainties but I think it can rebound again. Like I covered in last month’s update, that Alerian MLP fund is probably my favorite investment right now and I think could be the surprise for the rest of the year. Oil prices are still fairly solid and the yield difference between these MLPs and the US Treasury yield is pointing to strong gains ahead.
What Stocks to Buy for Safety
I took profits in some of the high-flying stocks this month to buy into these last two funds here and we’ll get into why I sold and why I picked these two funds.
The first is this Vanguard Long-Term Bond Fund, ticker BLV. The fund invests in corporate bonds and US Treasuries and pays a strong 3.74% dividend. Just over 42% of the fund is in super-safe government debt with the rest right around that A and triple-B credit rating so companies with strong financials.
I also added a position in the Utilities Select Sector SPDR, ticker XLU. An ETF of 28 companies in the public utilities space with a 3.1% dividend yield.
These are two safety plays. Not only are the funds, so they will tend to be less risky than individual stocks, but they’re in ideas that will tend to zig when the rest of the market zags.
The bond fund is the ultimate in anti-stock safety because these corporate debts are due whether the market rises or falls. The utility fund still invests in stocks so there’s that upside on growth but the sector is typically more stable than others.
And just look at what these two funds did late last year. From October through December when the stock market tanked, falling 18.5% over the three months, the bond fund beat stocks by 21% and even the utilities fund eked out a positive gain. That’s not even including those dividends on the funds which are both over 3% annually.
Reasons to Sell Stocks
So what I’m doing here, selling down some of our most profitable stocks and buying into these two funds, is I’m buying protection. I’ve still got exposure to those stocks but if the market tanks again, no matter how great the company is, the market is going to drag it down with it.
So I’m rebalancing into safer sectors like bonds and utilities. And we’re going to spend the rest of the video explaining why, why I think the market could be in trouble and the warning signs I’m looking at.
So honestly, most of the economic data isn’t bad. Unemployment is still low and consumer spending is strong. We saw a manufacturing report last week that said growth in US factories was the slowest it’s been since 2016 but it was still in growth territory. The Chinese economy looks to be getting its footing back and even global trade doesn’t look horrible.
In fact, we see here in this table by the US Bureau of Economic Analysis that even though this period of expansion, that 9.8 years of economic growth, is the tied for the second longest going back to 1950, it still might have room to run.
The thing we see here is that because the economy has been growing so slowly, just 2.3% a year, then the total economic growth over the period, just 25% hasn’t been like some of these other wild runs we’ve seen. We’re not worried that the economy has gotten too overheated that we should be worried about a crash.
But the economy isn’t great, right? We’re expecting just about 2% or less for growth this year in the United States. And those warning signs I talked about are really coming from two sides, a forward outlook on where returns come from and by far the most accurate trading signal we have.
Will Earnings Cause a Stock Market Crash?
First let’s look at a really simple explanation of stock returns and I think you’ll see where we run into trouble. Then I’m going to reveal that trading signal we just hit.
Over the last decade, the S&P 500 has returned 13.9% on an annual basis after inflation and including dividends. If we look into this, we had corporate profits growing at 5.5% and the dividend yield averaged 2.1% over the period. That’s a 7.6% return.
Top it off with the fact that the price-to-earnings ratio increased from 10.5-times to 18.5-times, so people were willing to pay a higher price for those earnings that increased. This change in the PE ratio accounts for that other 6.3% in real return after you adjust for inflation.
These three factors; corporate earnings, dividends and the price-to-earnings ratio, that’s all you need to know to see where stocks are going. Stocks are an ownership of those earnings and dividends and the PE ratio is how much investors are willing to pay.
So looking forward on these three factors and you quickly run into a dead end.
Real corporate earnings growth have been on a tear lately but won’t last. Earnings averaged just 1.9% over the last 150 years and is expected just 1.4% this year. Earnings are actually lower so negative 2.3% in the first quarter versus last year. Wage inflation is starting to eat into profits and that’s going to be a headwind.
Here we see the expected earnings growth for the year with energy and materials companies expected to see huge decreases in their profits. Among the winners look to be financials, consumer discretionary and utility companies.
Understand this is with inflation so not that real earnings growth. If we take this 3.6% estimate for earnings growth at S&P 500 companies and take out the expected 2.2% inflation for this year, we get to just 1.4% real earnings growth.
The dividend yield is fairly constant but even that is down to 1.85% on the S&P 500. So if we get even a 1.4% real earnings growth and 1.85% dividends, that brings expected returns to just 3.25% and leaves everything else up to the price-to-earnings ratio… and unfortunately, we’re not starting from a good place there either.
At 18.5-times earnings, investors are already paying a lot for earnings and this number rarely goes above 20 for long. In fact, the longer-term average is closer to 15 or 16-times earnings which would mean a contraction in that 3.25% return we get from earnings and dividends. Even if investors keep feeling good about stocks and we make it to that 20-times price to earnings ratio, that still only gets us to a 5% return on stocks.
That’s pretty close to a lot of the estimates. BlackRock and BNY Mellon are both estimating stocks will return about 6% annually over the next ten years. JP Morgan is estimating a little lower, closer to a 5% annual return and again, these are returns including inflation so that would be around 3% to 4% after inflation.
So the message here isn’t necessarily that I think stocks are heading for a crash but the upside doesn’t look that rosy. The market is holding out it’s fists saying pick one. In one hand, I’ve got a weak five or six percent return if everything goes well. In the other hand, I have a repeat of last year and an 18% drop like we saw in December.
Does Sell in May Mean a Stock Crash is Coming?
So we’re starting off from a disadvantage. Top this off by the trading signal we just ran into. Those of you in the community know, I don’t usually follow trading signals or short-term stock signals, but this one is eerily strong.
I’m talking about the Sell in May phenomenon, also called the best six months strategy. This strategy says to invest in stocks from November through April then shift to a bond-heavy protected portfolio from May through October.
Like I said, I generally hate these simple trading strategies. Everyone knows about these so they shouldn’t work, but Sell in May continues to confound investors and really is one you want to pay attention to.
It’s been a little off over the last few years, stocks have been up five in the last six years during that May through October period, but it remains one of the best strategies ever.
An investor putting $10,000 in a portfolio of S&P 500 stocks between May and October from 1950 to 2018 would have lost more than half his money. As crazy as that sounds, the portfolio would have lost $5,862 of that initial portfolio invested during the six month period for the last 68 years.
Conversely, an investor putting that $10,000 in the same S&P 500 portfolio over those same 68 years but during the November through April period would have grown it to over $2,836,000! That’s no typo, there is a $2.8 million difference investing during the best six months versus the worst.
As simple as it may sound, the Sell in May strategy does work to protect your money.
And it’s not all chance, there is some intuitive reasoning why it happens. Investors and traders would rather be on the golf course or at the beach during those summer months and trading volume plunges. This can amplify those large swings, especially to the downside. September and October are often down because of profit-taking by portfolio managers and mutual funds.
When you get into the last two months of the year, a lot of those year-end trading strategies tend to boost stocks with institutional investors jumping back into the market and bidding up stocks. You get year-end bonuses coming into the market and consumer spending can put a positive spin on the economy. Finally you get January and the new year positivity that hits investors.
So combining that headwind from those three factors; corporate earnings, dividends and the PE ratio with this Sell in May phenomenon and I’m pulling back a little on the 2019 Dividend portfolio. I took profits in a few of the high-flyers and put it in that utility fund and the bond fund.
How to Protect Your Money with a Long-Term Investing Goal
Now most of you have a long-term focus on your investments and anyone with more than 15 years left to their goals, you really don’t have to worry too much about a stock market crash or recession. You’ll be investing through lots of these market hiccups and will have lots of time to see your stocks rebound.
But even if you’ve got that long-term investing strategy and you don’t want to sell stocks, you still need to protect the money you’ve made. Maybe Sell in May isn’t quite the words I want to use but definitely reposition in May. Checking back on your investments in stocks, bonds and real estate through those real estate investment trusts and making sure you have enough in each.
For a lot of people, their stock gains have zoomed ahead of these other assets so it’s time to sell stocks, take some of those profits, and put money back in bonds and real estate. You should be doing the same thing for the sectors within your stock portfolio. Over the past five years, we see that while the stock market has done well with a 55% total return, sectors like consumer discretionary and technology have boomed with an 85% and a 115% gain over that period while sectors like energy, materials and communications have lagged.
So you don’t even need to sell out of stocks to do this repositioning out of expensive sectors and into value. You can take profits in some of your tech stocks or consumer discretionary and maybe look for those value names in the lagging sectors.
I’m not talking about trying to time the market here or even saying that you can totally avoid a stock market crash. What I’m saying, and this is important for those of you just joining us that maybe missed out when we started the dividend challenge in January, you can still do really well this year if you reposition for safety and value.
Look to some of those bond and real estate investments like the Vanguard real estate fund, ticker VNQ or the bond fund we added to the portfolio. Look to some of the stocks in the portfolio that have lagged a little but still have lots of value like the Alerian MLP fund and some of the other funds.
Our 2019 Stock Market Challenge portfolio has done really well so far but that doesn't mean we can ignore the market signals pointing to tough times ahead. I'm not sure we're heading for a full-blown stock market crash but it doesn't have to be to really hit your portfolio. Just a repeat of last year could destroy almost 20% of your wealth. Take the opportunity to rebalance and reposition your portfolio into asset classes and stock sectors for safety.