What catalysts or potential tailwinds do you think might spark a broadening out in this market?
In the short term, we don’t know what might lead to a broadening out in the equity market. It could already be underway following the recent Federal Reserve interest rate cut. We’ve recently seen improvement in some areas of the market, like small cap stocks, along with some dividend stocks moving higher. The equal-weighted S&P 500 is also hitting new all-time highs.
Over the long term, we expect the valuation gap between expensive technology stocks, which have been trading near record highs after years of strong performance, and cheaper dividend stocks to narrow.
Our preferred valuation metric compares the relative dividend yield of stocks to the S&P 500. The relative dividend yield of the Madison Dividend Income strategy is 2.2x the S&P 500 dividend yield, which is at the very high end of its historical range. In our view, this indicates that dividend stocks remain on sale relative to the broader market, presenting an attractive opportunity.
We’ve seen massive investments in building out the AI infrastructure. What do you make of the investments here, and what are some of the things you’re watching?
There have been several large infrastructure announcements over the past few months. Perhaps the most notable one was a recent agreement between OpenAI and Oracle worth hundreds of billions of dollars over five years, which sent Oracle stock soaring. We believe there are some dividend stocks that have solid current fundamentals that will also benefit from AI-related tailwinds. NextEra Energy, for example, a leader in renewable energy, should participate in the AI buildout, as data centers require significant electricity and power capacity, generated across power sources.
NextEra Energy has solid growth prospects, an absolute dividend yield of 3.2%, and an all-time high relative yield of 2.6x the S&P 500. Looking at another valuation metric, its relative forward price-to-earnings ratio is 0.9x the S&P 500, near an all-time low. What we like about NextEra is that the company has increased its dividend by 10% annually over the last five years, and we expect continued dividend increases well above inflation rates going forward.
The Fed appears to be on a path of lowering short-term interest rates. How does that impact your outlook for dividend-paying stocks?
We think the Fed’s lowering of interest rates is a positive for dividend stocks, all else equal. Lower interest rates can increase the attractiveness of dividend stocks compared to fixed income investments. It also lowers borrowing costs for companies, including those in high-yield sectors such as Utilities, Real Estate, and Telecommunications, which can really benefit from lower debt servicing costs.
Where are you looking for opportunities?
We believe that the best opportunities lie in areas of the market that investors have largely overlooked in recent years. Two sectors that jump out are Healthcare and Energy. Healthcare is down about 10% over the past year, while the S&P 500 Index is up nearly 20%, and Healthcare valuations are very attractive. We’re finding companies with good growth, strong balance sheets, and that are raising guidance. They have above-average dividend yields and, more importantly, significantly lower valuations than the broader market. We’re finding similar setups in the Energy sector, even with oil prices relatively low. These companies have strong balance sheets, they’ve increased their dividends, and there is good industry discipline—they are not overspending on capex.