November 18, 2010

Outlook 2011, Investing: Big Payoff From High-Dividend Stocks, MFS Says

'Paradigm shift' shows stocks delinking from weak GDP

Chart shows S&P 500 dividend payers outperforming overall S&P 500. Chart shows S&P 500 dividend payers outperforming overall S&P 500.

As the nation’s economy continues to see a sluggish recovery, U.S. stocks will rally in 2011, with an especially strong performance among high dividend payers, a group of MFS Investment Management strategists said in November.

The U.S. economy is grinding along slowly in preparation for a “paradigm shift,” the Boston-based investment firm’s strategists said in a presentation at the New York Palace Hotel, and while the form of that shift is still unknown, it will likely continue the current delinking of stock market performance from gross domestic product (GDP) growth.

Since at least 1975, said MFS investment officer and portfolio manager Erik Weisman, GDP has typically seen a V-shaped recovery that brings the economy bouncing back at a rate of anywhere from 6% to almost 14% growth. This time around, though, the U.S. economy is treading water and looks likely to keep barely afloat at a rate of 3% GDP growth in 2011.

‘There Is No V-Shaped Economy’

“There is no V-shaped economy, and the absence of a V will dictate economic policy,” Weisman said, adding that stagnant unemployment will keep the labor market in a long-term funk. “The ramifications of the financial recovery will extend over several years—if we’re lucky.”

Weisman’s conclusion? Historically, the nation has moved from an agrarian way of life to a manufacturing-based economy to a service-oriented society. The paradigm shift that comes next will likely involve big swings of inflation followed by deflation, and the U.S. dollar’s dominance could give way to a return to the gold standard. Weisman also suggested that green industries may fuel the nation’s economic engine in the future.

“The probability today that we’ll be seeing shifts is high,” Weisman said. “All this sounds bearish, and it is bearish, but meanwhile we can expect to see GDP growth of 3% to 3.5%.”

For investors, the lesson to take away from the current recovery is that globally, stocks are no longer growing in line with GDP, said MFS chief investment strategist and fixed-income portfolio manager James Swanson. In the United States, slow growth no longer means weak S&P 500 earnings, he noted, saying that the growth of stock to GDP “has completely broken down.”

With increasingly cash-rich companies continuing to build earnings, dividend-paying firms merit attention as both cash flows and inflation risks rise in 2012, Swanson added. Between now and 2012, he said, both U.S. and European non-financial company margins are forecast to exceed their 2007 peak.

Market watchers can expect to see companies spending all that pent-up cash on

share buybacks, increased dividend payouts, new growth through mergers and acquisitions,  capital expenditures and—last but not least—new jobs.

“If this persists, we’ll see an exceptionally strong quarter in the fourth quarter,” Swanson predicted, saying the technology and utilities sectors are good places for investor dollars. “That’s astonishing work given a market that nearly experienced an ATM failure in 2008.”

Expect High Dividend-Paying Stocks to Surge in 2011

Right now, companies with the highest-paying dividends in the S&P 500 equal weighted index offer superior returns. While many market players are running for the exits and putting their money into precious metals such as gold, which carries the added cost of insurance, investors may do better to keep their money in high dividend-paying stocks, “which compound while you sleep,” Swanson said.

Looking at asset allocation strategies, MFS quantitative research director Joseph Flaherty stressed the importance of diversification as investors adjust their portfolios during this period of uncertainty.

That said, Flaherty noted that 50% of 401(k) investors have never adjusted their portfolios, and those who do, often buy and sell at inopportune times. “Investors lose about 150 basis points a year due to poor timing decisions,” he said.

Using the example of four different types of investors—performance chasers, market contrarians, buy-and-holders and diversified rebalancers—Flaherty said that investors who frequently rebalance their assets see the least volatility along with the greatest return. These investors rebalance their portfolios each quarter so that they stay equally distributed among as many as eight asset classes.

“The only free lunch out there is market diversification,” Flaherty said.

See AdvisorOne's Outlook 2011 calendar to find the publishing dates for, and links to, other categories in the Outlook series.

Read about MFS’s midyear outlook in June at AdvisorOne.com.

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