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When The Seas Get Rough, Sailors Prefer Larger (And Better Made) Boats

It’s been said that when the seas get rough, sailors prefer larger boats. They probably also opt for better-made boats. The same goes for investors. History shows that investors have gravitated toward the stability of higher quality companies during periods in which the S&P 500 has fallen by 10% or more.

One likely reason is reduced volatility. If you lose less on the way down, you have less to make up upon recovery. Indeed, in every instance but one since 1990, investors rotated toward high-quality stocks, in general, and the S&P 500 Dividend Aristocrats, in particular, whenever the S&P 500 slipped into a correction or bear market.

When something appears to perform so well for so long, the question that invariably arises is “Is it in a bubble?” And the same thinking has been applied to the S&P 500 Dividend Aristocrats, due to its superior cumulative relative return. Well, to paraphrase former NYC Mayor Fiorello LaGuardia, “Investors need to get the facts straight before they distort them.” Since the inception of the index in 1990, the S&P 500 Dividend Aristocrats have beaten the S&P 500 in 54% of calendar years, which is not an unsustainable pace.

In the past 10 years, the Dividend Aristocrats outpaced the “500” six times (60% of the time), only slightly more than its long-term average. And from a valuations perspective, the S&P 500 Dividend Aristocrats have historically traded at a 2% premium to the S&P 500. Today they trade at a 7% premium, slightly higher than its long-term average, but well below the 20% premium peak reached in December 2011.

Investors are breathing a sigh of relief now that the U.S. economy no longer appears to be slipping into recession, and the Fed seems to have backed off of its aggressive rate-tightening stance.

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 Yet S&P Capital IQ’s S&P 500 EPS growth estimates for 2016 have fallen from 7.4% to 1.2%, and the S&P 500 is trading at 17.1X projected 12 month EPS, versus its long-term average of 16.0X (and median of 15.2X).

What’s more, with the bull market now in its eighth year, versus the average duration of less than five years, seas are likely to remain rough. As a result S&P Global Market Intelligence believes investors should continue to be discriminating by favoring attractively valued stocks with proven track records of raising EPS and dividends.

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