CONTRIBUTORS
John Baldi
Portfolio Manager, ClearBridge Investments
Michael Clarfeld, CFA
Portfolio Manager
ClearBridge Investments
Key takeaways
- Fear of missing out (FOMO) is driving up the prices of a narrow group of recent winners, skewing market indexes toward low-yield stocks and creating good opportunities for active investors scouring for quality at a reasonable price.
- Consumer staples—a resilient sector with substantial dividends, high margins and returns, and which usually trades at a premium to the market—is currently priced at a discount to the market.
- Over the last year, dividend growers have trailed the broader market to a degree rarely seen over the past three decades; past instances of similar underperformance have been followed by a strong bounce-back for dividend growers.
Relative opportunity in high-quality names
Much ink has been spilt in the last year about market concentration, with the Magnificent Seven stocks recently making up roughly one-third of the S&P 500 Index weight.1 While there are excellent businesses in this group, such extreme market concentration underscores the need for diversification to manage risk. Further, as these stocks have soared, their valuations have become stretched, increasing their risk and creating a relative opportunity in the names that have not participated in this AI-driven rally.
In particular, the recent underperformance of high-quality dividend payers offers investors an attractive opportunity. Companies that pay no or low dividends outperformed meaningfully in 2023, skewing overall index performance. Indeed, this group2 made up just over a quarter of the index yet contributed 52% of total return (Exhibit 1).
This phenomenon has not only continued in 2024 — it has accelerated. Stocks yielding less than 50 bps now represent 37.5% of the index and have driven 55% of YTD total return (Exhibit 2). Again, while many of these companies are excellent businesses, this skew suggests animal spirits are causing market participants to pay high prices for a small group of stocks as they chase recent winners.
Exhibit 1: Low Yielders Skewed Index Performance in 2023
As of Jan. 2, 2024. Source: ClearBridge Investments. S&P 500 Index holdings from January 3, 2023, through Jan. 2, 2024.
Exhibit 2: Market Skew Continues in 2024
As of May 31, 2024. Source: ClearBridge Investments. S&P 500 Index holdings from January 2, 2024, through May 31, 2024.
Against this backdrop, the current market offers good opportunities for risk-averse investors seeking quality businesses at a reasonable price. While less glitzy than AI, sectors like utilities, real estate, and consumer staples — all of which lagged in 2023 as the Fed lifted interest rates — offer the potential for attractive total return while embedding a margin of safety. Within utilities, we are finding companies that have sold off with the sector but that offer desirable regional exposures, high-single-digit growth rates and healthy up-front coupons and yet trade at meaningful discounts to the market. In real estate, we are seeing apartment and storage REITs with strong balance sheets, reasonable valuations, nice up-front yields and best-in-class assets. Despite challenges in some parts of the real estate market, rental rates are increasing, as high interest rates impede renters from buying homes.
High-quality consumer staples typically trade at a premium to the market given their stability, pricing power and attractive returns on investment. Yet we are finding fundamentally sound dividend growers with phenomenal balance sheets, terrific brands and portfolios that are well-diversified by product line and geography trading at discounted relative valuations. Within consumer staples, there are opportunities in the consumer health industry, which specializes in everyday consumer health products that are non-discretionary and are immune to GLP-1 concerns that have weighed on packaged good companies. We are seeing companies with attractive upfront yields and that generate solid free cash flow, and we expect their relative valuations will ultimately improve compared to the rest of the market.
Over the past year, dividend growers have trailed the broader market to a degree rarely seen over the past three decades (Exhibit 3). Past instances of similar underperformance have been followed by a strong bounce-back for dividend growers.
Exhibit 3: Dividend Growers Overdue
As of March 31, 2024. Source: S&P, NBER, Bloomberg. *Dividend Growers are S&P 500 stocks with three consecutive trailing years of positive dividend growth (inclusive of special dividends) on a rolling basis (quarterly), evaluated monthly, equal weighted. The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the United States.
If history is any guide and a rebound for dividend stocks is due, it stands to reason that the group would benefit from stocks from some sectors that AI fervor has left behind, especially those offering quality at a reasonable price.
Endnotes
- As of March 31, 2024.
- Defined as those with no dividend or with a yield less than 0.5%.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance is no guarantee of future results.
Equity securities are subject to price fluctuation and possible loss of principal.
Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Diversification does not guarantee a profit or protect against a loss.
US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.
