One of the upsides of a weak economy is that companies need to find productive uses for the growing piles of cash on their balance sheets.
That should be good news for dividend investors.
In fact, it is one of the silver linings of this earnings season, according to Terry Sandven, chief equity strategist at U.S. Bank Wealth Management.
“In general, the U.S. lacks attractive growth drivers because taxes are going up, interest rates are near record lows and there's not--- a lot of pressure on companies to raise wages,” he said. “The environment is favorable for companies to provide a consistent pattern of dividend growth.”
Mr. Sandven pointed out that companies are retaining an average of about 68% of their net income, which has pushed cash levels to a 50-year high of nearly 5%.
Meanwhile, dividend payout ratios, averaging about 33%, are at 75-year lows.
“As cash levels rise, companies can make acquisitions, buy back shares or raise their dividends,” Mr. Sandven said.
LOOKING FOR INCOME
In the context of the earnings season, it all adds up to more strength for equities because investors are still looking for income, he said.
“I think the path of least resistance for equities is going to be up through the first-quarter earnings and the rest of the year,” Mr. Sandven said. “You could even make the case that, considering everything, equities are modestly undervalued.”
Most market watchers and analysts are downplaying first-quarter reports because expectations already have been reduced dramatically.
Those lowered expectations make it easier for companies to beat estimates, and that in turn adds new fuel to the equity markets.
But what the lowered expectations don't do is change the dynamics of a sluggish recovery and lower levels of revenue growth.
“Right now, this is a market that is seeing the glass as half full, which is good if you're in the market and long equities,” said Uri Landesman, president of Platinum Partners LP. “The question is, what is going to upset the apple cart?”
With a price-earnings ratio of about 15, the S&P 500 isn't considered “wildly expensive,” Mr. Landesman said.
“But this is an important point in the market because it seems to be stalling out a bit, and I think this earnings season will contribute to its giving some ground back,” he said.
PSYCHOLOGICAL IMPACT
Chris Wallis, chief executive and chief investment officer at Vaughan & Nelson Investment Management, also stressed the psychological impact of watching companies report earnings that are beating lowered expectations.
“The guidance and expectations have been brought down enough that companies should be in pretty good shape to meet expectations,” he said. “But on a year-over-year basis, the numbers are going to be very, very muted.”
The stock market continues to bank on a strong U.S. economy in the second half, even if that isn't what has been driving stocks lately, Mr. Wallis said.
“The stock market has not been reflective of an improving economy, it has been reflective of the fact that people are more comfortable with the tail risk from Europe and Japan,” he said. “The market is counting on an acceleration of the economy in the second half, and corporate management teams are also counting on second-half earnings being better than the first half.”
