Riding out the Volatility with Dividends

The old saying of “it’s not a profit until you book it” rings true during this earnings season when stock gains are fleeting amid bullish earnings headlines.

One leading company after another within the S&P 500 that is beating first-quarter estimates on the top and bottom line, while also raising guidance, is getting met with selling pressure on the news. And it’s not just reserved for any particular sector, since professional and retail investors alike are booking gains on any short-term spike in share prices.

Investor sentiment is clearly having a confidence problem, confounded by Caterpillar (NYSE:CAT) management stating that its first-quarter performance is as good as it likely will get this year. Plus, the 10-year Treasury Note briefly breached 3.0%. Other concerns include how the economy will respond if the Fed does, in fact, hike rates four times by the year’s end. Another risk involves a possible trade war with China.

These are all legitimate outliers that collectively have had a negative impact on the broader market. But underlying economic fundamentals and earnings growth are rock solid and should at some point restore bullish sentiment.

As a group, the FANG stocks — Facebook (NASDAQ:FB), Amazon.com (NASDAQ:AMZN), Netflix (NASDAQ:NFLX) and Alphabet/Google (NASDAQ:GOOG) — led the tech sector lower heading into this week. Now that all four companies have posted stellar earnings, there has been some stability returning to the tech sector. Further earnings support from Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC) and Texas Instruments (NYSE:TXN) has helped investors navigate through this very choppy and volatile period that is showing few, if any, signs of abating. The “sell the rallies” mentality has yet to give way to a buy-the-dips mentality.

The market is in a fairly well-defined trading range, with the support for the S&P 500 sitting down at 2,600 and overhead resistance at 2,700. Given that most of the high-profile companies have reported their Q1 numbers as of last Friday, the market will be hard pressed to find a series of catalysts sufficient to break the S&P out of its trading range. As such, it is prudent to take profits when possible and not reach too much. The tape is fickle and leaves little room for disappointment without hurting share prices.

For some investors, the current high level of volatility is just too stressful to sleep well at night. Yet, they need something better than 1.0% money market rates or 2.2% returns for one-year CDs to satisfy the need for income. What seems to be luring some of this nervous money this past week are utility stocks that have, for lack of better terminology, been crushed with the recent spike in short-term interest rates.

It is a counter-intuitive move, considering the Fed is very likely to raise interest rates on June 13, then again in September and possibly again by the end of the year. But in the one-year chart of the Utilities Select SPDR ETF (NYSE:XLU) below, the rally off the low of $47.37 to its current price of $51.66 represents a gain of 9.05%. Consider that shares of XLU fell from $57.23 to $47.37, or a dip of 17.22%. A 9% recovery only gets XLU back to the flatline year to date. Still, it’s an impressive bounce and is getting a lot of chatter from those who monitor sector rotation.

I personally am not ready to jump into the pool of utility stocks just yet, as the motto “don’t fight the Fed” comes to mind. I’m fairly certain the Fed is going to hike rates at least two more times this year, with the objective to raise them further in 2019. In my view, the path of least resistance for interest rates is up. Until the economy puts up data showing deterioration, I’m a spectator.

With that said, if I were to buy any utility stocks, my favorites are Dominion Energy (NYSE:D) with a current dividend yield of 5.03%, Duke Energy (NYSE:DUK) with a 4.42% dividend yield and Southern Co. (NYSE:SO) with a 5.17% dividend yield. At least with these three stocks, investors are getting 1.5 times the 10-year Treasury yield in companies that are seeing net migration of new households and businesses that drive higher demand for power.

Some stock sectors will buck the trend for reasons that aren’t fundamentally clear. In this case, I chalk up the recent bump in utility stocks to market volatility. When the Fed does get closer to its dot-plot tightening cycle for short-term interest rates, I’ll be there backing up the truck. But as for right now, I think it’s still early and a retest of the lower prices seen in early February is highly probable.