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Today’s Opportunities: Dividend Growers, Foreign Stocks

by Community Manager

‎02-07-2014 11:36 AM

Market commentary

By Matt Freund,
Chief Investment Officer, USAA Mutual Funds

 

Recently I was asked to discuss the state of the market so far in 2014 and to offer some thoughts on where we see opportunity.

 

It is certainly a challenging market with complications provided by the Fed’s necessary but disruptive move to taper its monetary stimulus and the extremely cold weather across the United States. Issues in developing economies — such as a growth slowdown in China, a weakening currency in Turkey and political turmoil in Thailand — are other complicating factors.

 

Despite this year’s rocky start, investors are still overwhelmingly bullish even as fundamental valuations are getting stretched ever tighter. Since the market bottom in March 2009, the S&P 500 climbed with scant interruption through the end of 2013. The only correction (a decline of 10% or more) came during the summer of 2011, and while it was fairly steep, it was short.

 

Since the late 1950s, a market correction has occurred, on average, every 18 months. So by the numbers, we are overdue. It’s not clear, however, that we’re experiencing a correction now. The Standard and Poor’s 500 index was down about 6% for the year as of Wednesday, but that decline had been pared back to about 3.5% by late Friday morning. Investors have been trained to buy when the market dips, in the same way that bargain shoppers wait for desirable merchandise to go on sale.

 

I would like to elaborate on where we’re finding opportunity in the market.

 

We think companies with growing dividends are more attractive than companies that are already paying a high dividend.

 

In response to the Fed’s policy decision to keep interest rates at very low levels for a very long time, income-focused investors have been on a relentless hunt for yield. Among the places where they have found yield has been in equities paying high dividends, and the tremendous demand for those equities has driven up their prices. We think investors are overpaying for current yield.

 

At the same time, we think equities paying lower but growing dividends are underpriced based on fundamentals. Companies increasing their dividend payments are making a commitment to the market. They are telling investors that their business is strong enough to generate the free cash needed to pay higher dividends in the future. Dividends contribute to total return, so rising dividends are attractive to long-term investors.

 

We like non-U.S. stocks compared to U.S. stocks.

 

Again, this comes down to fundamental valuation. Over the past few years, strong earnings growth in the U.S. has sparked a buying spree by investors that has driven the S&P 500’s price-to-earnings ratio well above its long-term average. Other key price ratios — among them, price to book and price to sales — are also suggesting rich valuations. Earnings growth has far exceeded revenue growth, which calls into question the sustainability of current multiples.

 

Overseas, particularly in Europe, earnings remain significantly below their prior peak levels. Economic growth is looking up in the eurozone, and its sovereign debt troubles appear to be stabilizing. European stocks also have a longer “QE runway.” The European Central Bank is showing no signs of following the Fed into a trend of monetary tightening, so reduced liquidity is not a pressing concern.

 

And as my colleague Wasif Latif wrote last week, we continue to see long-term opportunity in emerging markets despite the tumultuous start to 2014. We expect them to continue to see faster GDP growth than the countries of the developed world, and China and other large emerging economies are early in their transition from being low-cost producers for export to providing more goods and services for domestic consumption.

 

 

 

 

For more on how we see this year shaping up for investors, we invite you to read our 2014 investment outlook.

 

USAA Investments Managed Portfolio Outlook

 

Our view of caution toward U.S. equities remains unchanged. We remain slightly overweight cash in our diversified managed portfolios. For investors interested in income-oriented bond investments, the USAA Intermediate-Term Bond Fund, the USAA High Income Fund and the USAA Income Fund are examples. For investors interested in tax-free income, the USAA Tax Exempt Long-Term Fund, the USAA Tax Exempt Intermediate-Term Fund and the USAA Tax Exempt Short-Term Fund are examples.

 

We also are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund also provides potential protection against the risks of long-term inflation.

 

Emerging markets represent another opportunity. Though they were hit especially hard recently, we believe that emerging markets remain attractive. They offer both an interesting long-term prospect for growth and compelling valuations. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.

 

As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for their individual goals, objectives, risk tolerance and time horizon.

 

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This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.

 

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Investing in securities products involves risk, including possible loss of principal.

 

Past performance is no guarantee of future results.

 

As interest rates rise, existing bond prices fall.

 

Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities.

 

Some income may be subject to state or local taxes or the federal alternative minimum tax.

 

Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.

 

Precious metals and minerals is a volatile asset class and is subject to additional risks, such as currency fluctuation, market liquidity, political instability and increased price volatility. It may be more volatile than other asset classes that diversify across many industries and companies.

 

The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.

 

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High double digit returns are attributable, in part, to unusually favorable market conditions and may not be repeated or consistently achieved in the future.

 

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Diversification does not guarantee a profit or prevent a loss.