The "secret" to success on wall street is no secret at all.
The best investors in history have been preaching the gospel of buying quality companies at reasonable or attractive valuations and then holding for the long--term, for decades.
Of course, it's one thing to know how to make money on Wall Street, and another to actually do it.
(Source: Guggenheim Partners, Ned Davis Research)
Pullbacks, corrections, and bear markets are a healthy part of the market cycle, and without them, stocks wouldn't be the best performing asset class in history.
But of course, market downturns never arrive on a neat and tidy schedule. Rather they look like this.
(Source: Jill Mislinski)
In 2009 the market ripped higher, yet suffered four pullbacks. From November 2016 through January 2018 the market's largest decline was just 2.7%.
(Source: Jill Mislinski)
Historical market valuations can tell us whether or not correction risk is elevated, but can't be used to predict when downturns begin.
We also have to remember that using too long of a time frame, such as average valuations since 1871 can provide a false sense of panic.
In 1871 the US was an emerging market economy whose annual economic growth rates would regularly rise and fall by double-digits.
There was no SEC, no GAAP, no global access to portfolios, no pension funds, no retirement accounts, and almost no one on earth had access to the stock market.
The fundamentals have changed in recent decades, which is why I use 20 to 25 year periods for historical market valuation purposes.
Long enough to be statistically significant (91%) but not so old as to miss out on important fundamental changes in the global economy and capital markets.
Fortunately, timing the market really isn't important or even that beneficial.
Here is how much better perfect market timing would have done for investors from 1970 to 2019.
Assuming you only ever bought at the exact bottom you would have earned 22% higher total returns after 39 years which is just 0.5% better-annualized returns. And that's assuming you could predict every market bottom.
Now consider the power of simply buying and holding.
A Vanguard study looking at 160 years of market data in the US, UK, and Australia found that 68% to 70% of the time being fully invested all the time was the optimal strategy resulting in 1.5% to 2.4% CAGR better returns.
But it's one thing to know these facts, and another to be able to sleep well at night during an actual market decline. After all, every downturn is caused by something new, and each time fears that "this time is different" make scary predictions of 20%, 40%, or even 80% crashes sound plausible.
The Dangers Of Market Timing
Market timing is one of those ideas that's great in theory, and dangerous in practice.
In theory, avoiding the market's worst days can greatly increase your returns.
In reality, missing the market's best days will turn a decent buy-and-hold strategy into a catastrophic retirement dream-killing inferno.
This article was inspired by a recent warning from Deutsche Bank.
(Source: Business Insider)
Deutsche Bank's chief equity strategist is expecting a "significant pullback" of up to 10% in the S&P 500 over the next three months...
A team of strategists led by Binky Chadha said they expect stocks to grind higher in the "very near term," supported by earnings upgrades and a growth acceleration...
But Chadha sees economic growth peaking soon, and historically that peak has correlated with stock declines. The strategist expects a significant stock consolidation between 6%-10% as economic growth peaks over the next quarter." - Business Insider
This kind of prediction is not actually bold, scary, or significant to any students of market history.
An 8% decline is basically the average historical pullback since 1945. The exact kind that we've seen, on average, every six months. Thus Deutsche's forecast of a likely pullback within three months is historically normal. Today's elevated valuations increase the risk of a sudden and sharp, though relatively short decline.
The purpose of this article isn't to scare anyone out of stocks. I'm 100% invested, as my risk profile says I should be. I never attempt to time the market to avoid inevitable downturns because I practice disciplined financial science.
That means always following the best available facts and reasoning to make the highest probability/lowest risk decisions.
Fortunes are made by buying right and holding on." - Tom Phelps
Rather the goal today is to prepare as many readers as possible, for that inevitable, if unpredictable, next market downturn.
The last thing I want is retirees becoming forced sellers for emotional or financial reasons when there is absolutely no cause for alarm.
This is where the power of prudent asset allocation and risk management comes in.
These are the risk-management guidelines that
- I've been perfecting over seven years
- with input from colleagues with over 100 years of asset management experience
- that have been stress-tested about 300 times
- using historical market data
- and JPMorgan's future risk assessment scenarios
- and 30 and 75 year Monte Carlo simulations
- all Dividend Kings portfolios use these risk-management guidelines
- 100% of my life savings is entrusted to these guidelines
- whatever risk-management rules are best for your specific needs stick with them
Today's article is about low volatility blue-chips.
Volatility is not actually something to be feared, though most people do.
Volatility caused by money managers who speculate irrationality with huge sums will offer the true investor more chance to make intelligent investment moves.
He can be hurt by such volatility only if he is forced, by either financial or psychological pressures, to sell at untoward times." Warren Buffett (emphasis added)
If your asset allocation and risk management are sound, then volatility is always your ally, never your enemy.
But it requires iron discipline in the face of falling stock prices. This is where owning high-quality, low volatility blue-chips can help you remain calm, disciplined, and rational in the face of market fear.
Low volatility is also an alpha factor. That's because companies that tend to fall less during declines, can rise less during recoveries and still deliver superior long-term returns.
Of course, as with anything in finance, there is a right and wrong way to approach low volatility blue-chip investing.
Dividend Kings Master List Sorted By Lowest Volatility
(Source: DK Research Terminal)
- green = potentially good buy or better
- blue = potential reasonable buy
- yellow = hold
- red = potential trim/sell
The DK 500 Master List includes the world's best companies.
- every dividend aristocrat
- every dividend champion
- every dividend king
- every 12/12 Ultra SWAN quality company (as close to perfect quality companies as exist on Wall Street, think wide moat aristocrats)
The average 15-year annual volatility of all of these companies ranges from 14.6% to 71%. The average annual volatility is 28%. For dividend aristocrats, it's 23%.
The S&P 500's historical volatility is 15.7% because any diversified portfolio will naturally be less volatile than almost any standalone company.
The undisciplined investor seeking to minimize volatility from the stock portion of their portfolio might just take the 10 least volatile companies on this list and assume that it's safe to buy them ahead of the next market downturn.
(Source: Portfolio Visualizer)
These 10 utilities and consumer staples blue-chips managed to outperform the S&P 500 by 2% annually, with 2% lower average annual volatility, for almost 35 years.
- 45% better excess total returns/negative volatility (Sortino ratio)
- and 2X the inflation-adjusted wealth
What's more, these 10 low volatility blue-chips managed to help investors sleep well at night during even the market's scariest downturns.
(Source: Portfolio Visualizer)
During the most severe market crashes, these 10 companies fell about half as much as the broader market. The longest period to recover record highs was 32 months, compared to 75 months for the S&P 500.
Ok, so that proves it! Low volatility rocks! So buy these 10 blue chips and then no correction can touch me right?
Wrong.
Fundamentals determine 91% of long-term returns. Specifically, just three factors directly determine how much money you make or lose on Wall Street.
Yield, growth, and value are the holy trinity of total returns. Respect and harness those metrics, and over time you will mint money.
(Source: FAST Graphs, FactSet Research)
Consider Xcel Energy (XEL), a blue-chip utility that is the least volatile company on the entire Master List. 14.6% average annual volatility is less than the S&P 500, from a single company rather than 500.
Yet note how from October 2020 through February 2021, XEL plunged 16% in a matter of weeks. That's a -40% annualized return from one of the least volatile companies on earth.
Can you guess why? Because XEL was about 45% overvalued and still is today.
No disciplined long-term investor would ever pay a 45% premium for any company, regardless of quality, dividend safety, historically low volatility, or any other factor.
Fortunately, it's a market of stocks, not a stock market. Something wonderful is always reasonably or attractively priced, whatever your goal, need, or risk profile.
The 4 Best Low Volatility Dividend Blue-Chips To Buy Ahead Of The Next Market Correction
Here is what grossly overpaying for blue-chips gets you.
(Source: FAST Graphs, FactSet Research)
XEL is expected to grow at an above-average rate for utilities. Yet through 2023, the consensus return potential is zero.
S&P 500 36% Overvalued = Negative 1% Annual Total Return Potential Through 2023
(Source: FAST Graphs, FactSet Research)
But now that we understand the dangers of paying very high valuations for companies, let's consider reasonably valued low volatility blue-chips.
The Best 4 Low Volatility Blue-Chips You Can Buy Today
Name Yield LT Growth Consensus Discount To Fair Value Quality LT Analyst Total Return Consensus Potential Average Volatility Kimberly-Clark (KMB) 3.3% 5.2% 4% 12/12 Ultra SWAN- Dividend Aristocrat 8.5% 15.7% General Mills (GIS) 3.3% 4.5% 1% 9/12 Blue-Chip 7.8% 16.0% Consolidated Edison (ED) 4.1% 3.8% 4% 11/12 Super SWAN- Dividend King 7.9% 16.2% Becton, Dickinson and Company (BDX) 1.4% 7.7% 2% 9/12 Blue-Chip Dividend Aristocrat 9.1% 18.5% Average 3.0% 5.3% 2.8% 10.3/12 SWAN 8.3% 16.6%
None of these low volatility blue-chips are good buys, but they are reasonable buys, basically trading at fair value.
Fair value is the price at which you fully participate in a company's future growth.
That growth is not expected to be very fast, a mere 5.3% compared to the S&P 500's 6.4%.
However, the 36% overvalued S&P 500, which yields a pathetic 1.5%, is likely to deliver 7.9% long-term returns while these four are likely to slightly outperform it if they grow as expected.
Purely due to superior fundamentals, meaning yield, growth, and value.
All while delivering a lot less downside volatility during inevitable market downturns.
Their average annual volatility is just 16.6%, far below that of the dividend aristocrats 23% and average standalone company's 28%.
To see just how low volatility KMB, GIS, ED, and BDX can be, let's look at their historical returns, as well as peak declines during the worst corrections of the last 34 years.
(Source: Portfolio Visualizer)
Just like the first 10 low volatility blue-chips we saw, these four managed to outperform the market by about 2% annually, and with 2% lower volatility.
(Source: Portfolio Visualizer)
And just like the first 10 companies, these four managed to fall significantly less during periods of strong market fear.
In fact, the 21% peak decline during the Great Recession, the 2nd worst stock market crash in US history, was barely a bear market at all. From which these four blue-chips recovered record highs in just 13 months.
But unlike the first 10 companies we looked at, with dangerously high valuations, these four are trading at reasonable prices.
Future Volatility Risk Scenarios
(Source: JPMorgan Asset Management)
JPMorgan's blue-chip economists are among the 16 most accurate teams in the world. They estimate that these four blue-chips will fall about 50% as much as the S&P 500 in most realistic risk scenarios in the short to medium-term.
Or to put it another way, if the S&P 500 falls 6% to 8%, a historically normal pullback, owning these four companies in equal amounts should result in a peak decline of slightly less than 5%.
The goal with these companies isn't maximum absolute returns, but superior volatility-adjusted returns.
Since 1986 these four companies have delivered 45% superior excess total returns (relative to 10-year Treasury yields) divided by negative volatility, the only kind anyone cares about.
Who Should Considering Buying These 4 Low Volatility Blue-Chips
- anyone looking for a very safe 3.0% yield and modest growth that's likely to significantly outpace inflation
- anyone looking for supreme quality and dependability who wants minimal volatility during inevitable market downturns
- highly conservative income investors with large portfolios primarily concerned with preserving wealth and income rather than growing it
Who Should Not Considering Buying These 4 Low Volatility Blue-Chips
- anyone for who 3.0% yield isn't sufficient to meet their financial needs
- anyone who requires more than 8.3% long-term total return potential to reach their financial goals
- anyone for whom a 5% decline is still frightening and could get you to sell in a historically normal and inevitable future downturn
- NO DIVIDEND STOCK IS A BOND ALTERNATIVE
Bottom Line: Low Volatility Blue-Chips Are Always Available, You Just Need To Know Where To Look
Market downturns are healthy, normal, inevitable and the cost of participating in the single greatest wealth and income compounding engine ever designed by man.
However, if short-term volatility is a major concern for you, then it's reasonable and prudent to consider buying high-quality, low volatility blue-chips.
Not as "bond alternatives" which no stocks are. Increased allocation to lower volatility companies, combined with the right mix of cash and bonds for your needs, is the best way to minimize the fear that can lead to disastrous retirement dream killing panic selling.
Kimberly-Clark, General Mills, Con Ed, and Becton, Dickinson are not exciting stocks, nor will they single-handedly make you rich. But they do offer an attractive proposition for certain investors with lower volatility tolerance.
- a very safe 3.0% yield that's 2X that of the S&P 500
- reasonable valuations, basically Buffett "wonderful companies at fair prices"
- modest long-term growth potential that should nearly triple the rate of inflation
- long-term consensus total return potential slightly better than the 36% overvalued and just 1.5% yielding S&P 500
Within a diversified and prudently risk-managed portfolio, buying these four low volatility blue-chips could be the kind of reasonable and prudent decision that helps you remain calm, rational, and disciplined when the market next falls out of bed.
And as Warren Buffett famously said
We don't have to be smarter than the rest. We have to be more disciplined than the rest."
Anything that allows you to practice disciplined financial science during periods of market fear is a tool you should consider using. Because ultimately only gamblers pray for luck on Wall Street, disciplined long-term investors make their own.
Wall Street is designed to transfer money from the active to the patient." - Warren Buffett
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