Just a handful of “stay-at-home winners” now comprise nearly 25% of the S&P 500 Index. What does this situation mean for dividend investors, given that none of these price leaders are reliable sources of high current income?
Michael Roomberg: Hello. I’m Michael Roomberg, a portfolio manager with Miller/Howard Investments.
2020 has been a year of many extremes. One that you’re probably familiar with by now is the degree of concentration within major stock indices, such as the S&P 500 Index. Due to dramatic price appreciation, just a handful of “stay-at-home winners”, including Microsoft, Apple, Amazon, Facebook, and Google, now comprise nearly 25% of the S&P 500. And these stocks are up an average of over 60% over just the past 12 months, leaving much of the rest of the stock market behind.
What does this situation mean for dividend investors, given that none of these price leaders are reliable sources of high current income?
Let’s say for a moment that investors (and let’s be honest, many of them are really short-term traders who have propelled Big Tech to lofty, historically expensive prices) decide to take a little profit off of the table, and diversify into other parts of the equity market.
What if this money was then reallocated into other stocks, in other sectors, on a dollar-for-dollar basis?
Suppose, for example, investors reallocated proceeds entirely to banks—as in every bank in the S&P 500. A dollar-for-dollar reallocation of this magnitude would cause banks stocks to more than double—as in go up 130% from current levels. Said differently, the 18 largest United States banks have just 1/5th the combined value of five Big Tech companies today.
The effect of a similar market rotation into other dividend-rich sectors would be even more pronounced. Just 20% of the collective market value of the top five tech names, reallocated, would allow investors to buy 100% of every S&P 500 listed electric, gas, and water utility, or every energy company or the nearly entire real estate sector—each of them twice over.
Make no mistake—the big tech stocks are outstanding companies, in our view. But there is no debating that this handful of tech giants—which now trade at more than 1.5x the median P/E multiple of the market—reflect an enormous bet on uninterrupted future good news, with no room for error, whether it be new competition or increased future government regulation, or some other factor that we can’t predict.
Given the historically discounted valuations of dividend stocks relative to zero- and low-dividend-paying companies, the favorable impact of even a minor market rotation into dividend-rich sectors such as utilities, health care, financials, real estate, and other high-yielding sectors would, no doubt, be substantial. These sectors have been rich sources of equity income for decades, and we believe should remain so for many many years ahead.
On the other hand, the almost daily jumps of 2%-3% among a handful of big tech stocks certainly smells a bit funny at the moment. As economist Herbert Stein famously said, “Something that can’t go on forever, won’t.” While we aren’t calling for a repeat of 2000 just yet, the eventual failure to find new buyers willing to pay nose-bleed valuations is precisely what ended the tech rally 20 years ago. It was a moment that paved the way for the best relative decade for dividend investors since at least the 1960s.
So while we can’t predict precisely when the market will once again determine that a bird in the hand is worth two in the bush, and that dividends matter, you can be sure that we will continue to offer diversified equity portfolios, managed with the unchanged guiding objectives of high current income, growth of income, and financial strength, on behalf of you—our clients.
Note: As of 9/15/2020, Microsoft, Apple, Amazon, Facebook, and Google were not held in Miller/Howard portfolios.