The last few years have been a confusing time in the stock market. 2020 was chock-full of discussions on meme stocks, cryptocurrency, and other high-risk assets. 2021 was a rip-roaring rally for growth stocks of all sizes.
2022 has been a complete reversal from the last two years. This year's winners have been oil and gas companies, stodgy dividend-paying companies, value stocks, utilities, consumer staples giants, and really any company where investors feel safe.
Here's why everyone is talking about dividend stocks, why quality high-yield dividend stocks are rare, and why integrating dividend stocks into a diversified portfolio is a good idea regardless of the market cycle.
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The rise of quality
A phrase you may have heard lately is "quality stocks." A quality stock, or a blue-chip stock, is an established, recognizable, often industry-leading company. These companies tend to have strong balance sheets. And many pay dividends.
Plenty of exchange-traded funds focus on blue-chip stocks. But one of the easiest ways of gauging the market's appetite for quality compared to growth is to simply compare the performance of the Nasdaq Composite versus the Dow Jones Industrial Average.
At the time of this writing, the Dow is down a little less than 8% year to date (YTD), while the Nasdaq Composite is down a little less than 29% YTD. That is the widest outperformance for the Dow relative to the Nasdaq Composite since the year 2000.
One of the reasons why so many people are talking about dividend stocks is simply that growth investing isn't working in the short term, while dividend investing is flourishing. This doesn't mean that you should change your investment strategy by jumping into what's working now. But it's important to recognize that we are witnessing a very favorable period for boring dividend-paying companies.
Why quality wins in a bear market
2022 has been a golden year for dividend stocks. Companies that pay stable and growing dividends whatever the market cycle tend to be quality, reputable names with strong balance sheets. Having a strong balance sheet means a company isn't as reliant on debt, which is a big advantage in a rising interest rate environment.
When the cost of capital is cheap (low interest rates) and investor optimism is high (expensive valuations), then quality companies don't look as attractive. But when times get tough, it's natural for investors to flock toward lower-risk, lower-reward investments that have a low chance of blowing up. Bear markets bring out the survival mentality in us all. But the best investors don't simply jump in and out of quality when it's convenient to do so. In fact, there's a far simpler way to navigate volatility and even beat the market.
Using quality to beat the market
One of the reasons why so many investors underperform the S&P 500 is that they don't earn the consistent returns needed to take advantage of a bull market while also outlasting a bear market by avoiding catastrophic losses. The S&P 500 is far from perfect. You can even make the argument that it's full of mediocre companies. But one thing the S&P 500 does really well is avoiding that irrecoverable blow. And it does that by balancing growth, blue-chip dividend stocks, and value from every sector of the economy.
If the last three years have taught us anything, it's that different types of stocks can fall in and out of favor on Wall Street in a flash. Everyone's talking about dividend stocks because there is a lot of fear in the market. But eventually, the cycle will turn. We'll hear less about dividend stocks and more about growth stocks. And then it will shift again.
The important lesson is to understand what's hot in the market and how that affects short-term price action. If your investment portfolio is down big -- more than the Dow, the S&P 500, or even the Nasdaq Composite -- there's a good chance you own companies that are simply out of favor right now. That doesn't mean these companies are bad. It just means they may have the characteristics that Wall Street doesn't like right now.
By operating a diversified portfolio that focuses on quality companies from different sectors and then holding those companies over the long term, an investor stands a better chance at outlasting gyrations in sentiment. With time, you can find yourself beating the market too.
