Overview: Why investors should watch for asset class deception (Part 4 of 5)
Although attractive in a “lower for longer” rate environment, these cross-dressing asset classes are also relatively expensive. And if interest rates eventually do resume their move higher, as I expect, I would be leery of segments of the market that require low yields to justify their valuations.
Here are five investing ideas I would focus on instead:
Pursue international and global dividend opportunities. While I’d be wary of seeking income at all costs (i.e. don’t be agnostic to valuations), that’s not to say there aren’t certain market segments that are worth pursuing, especially given that equities continue to look cheaper than bonds.
One segment I believe investors should consider is international and global dividend funds, rather than funds focused exclusively on U.S. dividends. The reason: U.S. dividend funds look the most expensive, and dividend yields in the United States are low compared to those in the rest of the world (stay tuned for more on this potential opportunity in an upcoming post). In addition, I also like the global financials and technology sectors for their cyclical exposure and relatively inexpensive valuations, and dividends have grown especially fast in these sectors as well in recent years.
Market Realist – Technology (QQQ) and financial (XLF) firms have been yielding high dividends in the past five years. According to research by WisdomTree and Bloomberg, the greatest contribution to dividend growth has been made by technology (XLK) companies in the past five years. In fact 54% of the increase in dividend from November 30, 2007, to June 30, 2012, can be accounted for by technology firms. According to NASDAQ OMX, at an average of 24.27%, the technology sector yielded the fastest annualized rate of dividend growth in the decade ending December, 2012. The previous graph shows the returns of dividend growth exchange-traded funds (or ETFs) from technology and finance and compares the performance with the iShares Core S&P 500 ETF (IVV). The technology dividend growth fund has outperformed the U.S. markets (SPY) over the past year as is evident in the graph.
Harvest capital gains: If it’s income you’re after, what better way to generate income than to harvest long-term capital gains in high yield bonds (HYG)? The resulting potential “income” stream would accrue more favorable tax treatment than interest and would lock in gains at expensive levels. The alternative – letting your winners ride at a below 6% yield – seems like a risky proposition.
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