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Monday, 3 October 2011

Is Cash Currently The Best Market Strategy?

William Scott O'Neil

Most investors are very concerned about their retirement savings right now. It’s understandable. Chances are their portfolios got crushed from March 2000 to October 2002, then again from November 2007 to March 2009, and now the current market is starting to feel eerily familiar.

The stock market is a cunning animal that moves to disappoint the masses, and it’s doing a great job now. Investors cannot fall back on thoughts like “I’m all right, I’m still getting my dividends” or “I’ll ride it out, I’m a long-term investor.” This kind of thinking destroyed portfolios in those previous downturns.

With the risk in the stock market running so high right now, my basic question is this: Does it make sense to be in the market at all—even in dividend-paying stocks? Individual investors can go to cash any time they wish. It is one huge advantage individuals have over institutions.

The portfolio managers of the institutions are required to stay anywhere from 85% to 100% invested at all times. So an institution’s best strategy in a bad market is to own stocks that will go down the least. Why would an individual willingly follow that strategy?

The universal advice swirling around now is that investors should “take shelter” in high-yielding dividend stocks. In a poor market environment like we are experiencing right now, the price depreciation of dividend-paying stocks can completely displace the gains made from the dividends.

In other words, if a stock is down 20%, what does a 4% yield matter? Our firm ran a screen looking for all dividend-paying stocks in the S&P 500 and their performance year-to-date to illustrate this point. The results as of this writing: Of the 342 S&P 500 stocks that have a yield of 1% or higher, one-third are up an average of 10% year-to-date, and two-thirds are down an average of 20% year-to-date.

Not good odds.

I maintain that sitting in the sidelines is the safest strategy for now.

But you still want to own dividend-paying stocks, consider only those with a record of stable earnings and a high Relative Strength ranking, because those stocks are holding up best in the current market.

Here are some examples: McDonald’s (MCD), Wisconsin Energy (WEC), The Coca-Cola Company (KO), International Business Machines (IBM), and Southern Company (SO).

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