Investing in a Market Sell-Off
“So 2018 was a bad year for stocks, will 2019 be worse?”
That’s a question I got asked a lot during this holiday season. After witnessing the huge sell-off in the U.S. stock market—particularly in the fourth quarter—people are wondering whether this was just the start of a much bigger crash.
They have a good reason to be concerned. 2018 was the worst year for stocks in a decade. Even scarier, we just had the worst December for U.S. equities since 1931.
The scariest part is that even the dividend giants took a hit in this market downturn. The Dow Jones Industrial Average (DJIA)—a benchmark index made up of 30 large-cap stocks that all pay a dividend—dropped by 5.6% in 2018.
Now, keep in mind that to make it to the Dow, a company has to be really, really established. As a result of their entrenched market positions, components of this benchmark index tend to have the ability to pay recurring dividends.
Indeed, the Dow includes many familiar names for dividend investors, such as The Coca-Cola Co (NYSE:KO), Johnson & Johnson (NYSE:JNJ), and McDonald’s Corp (NYSE:MCD).
But the blunt reality is, even an index that consists of some of the most established dividend-payers can still fall in a market sell-off.
The broader S&P 500 Index performed even worse, slipping 6.2% in 2018.
Notably, only two of the 11 major sectors of the S&P 500 posted gains, healthcare and utilities, which were up 4.7% and 0.5% in 2018, respectively.
The outperformance of these two sectors shouldn’t come as a surprise. The demand for healthcare stays relatively consistent through economic cycles. And even in a recession, we still need to heat our homes in the winter and turn the lights on at night, providing utility companies with a stable business.
The remaining nine sectors—Energy, Financials, Industrials, Consumer Staples, Consumer Discretionary, Materials, Communication Services, Real Estate, and Information Technology—were all in the red for the year.
Now, you might have noticed something: Consumer Staples is also known for being non-cyclical, but stocks in the sector still dropped for the year.
Does that mean the sector is no longer good enough for income investors?
Not really.
You see, so far I’ve only talked about index and sector performance in terms of price change, which should not be the primary focus for income investors. Instead, we should judge stocks based on their ability to maintain and hopefully increase their dividend payments.
To illustrate this point, let’s take a look at the S&P Dividend Aristocrats Index, which measures the performance of S&P 500 companies that have increased dividends every year for at least 25 consecutive years. In 2018, the index went from 1,136.85 to 1,078.87 points, marking a decline of 5.1%.
Not very impressive, right?
However, if you had held onto a portfolio of these stocks for the year (the index has 53 components at the moment), you would have earned more dividends in 2018 than before. That’s because these companies raised their dividends during the year.
In other words, if you were to invest in companies that can keep growing their payouts, you would collect bigger dividend checks as time goes by—even in a market crash.
And that’s exactly what dividend investors want to achieve.
Therefore, the implication is quite clear. In an extreme sell-off, stocks—no matter how recession-proof they’ve been known for—will take losses. But if a company can keep paying you dividends and increasing them over time, you should be in no rush to sell.
In fact, because stocks had gotten too expensive during the rally over the last several years, the recent pullback could represent an opportunity for value-conscious investors.
And for those that don’t need to spend the dividends right away, consider signing up for a dividend reinvestment plan (DRIP). When stocks get cheaper in market sell-off, the same dollar amount of dividends will buy you more additional shares. That is, DRIP investing can help investors achieve dollar cost averaging.
Still, not everything is a “buy.” Because an economic recession could be looming in the distance, businesses that are highly cyclical might not be the best bet for 2019. At the same time, falling oil prices could keep hurting oil producers. And since the U.S. Federal Reserve remained hawkish at their latest meeting in December, I’d be worried about companies that carry a lot of floating-rate debt.
Bottom line: The sell-off in the fourth quarter of 2018 could continue in 2019, and this might trigger a downturn in the economy. For income investors, the case for owning recession-proof dividend growth stocks has never been stronger.