The past few months have felt uncomfortable.
Markets are plagued by uncertainty, creating an incredibly challenging environment for investors. The conflict in Ukraine continues to escalate, putting the world on edge. All the while, the timing and direction of Fed action and inflation seems ever changing. This uncertainty is reflected in the price movement of the S&P 500: The index moved up or down by 1% or more in 50% of trading days this year. Volatility like that can be hard to digest, but it’s normal for markets to get shaken up every now and then. It’s even healthy for future returns. Still, near-term volatility can make it tough to pull the trigger on investing.
Volatility is likely to persist, but opportunities can be found in environments like this. I’ll dig into two areas of the market that have held up better in uncertain times, and one that may present value given its price action.
Cash is king among big cap technology.
The Nasdaq 100 had a rough start to 2022. With rising rates and high valuations, many tech stocks have been hit hard. You’re not alone if you feel a bit anxious about investing in tech. Yet, it wasn’t that long ago that this group was considered a defensive investment.
The Nasdaq 100 has fallen nearly 15% from its November peak. A swift decline after a stellar run should not be shocking to investors. Valuations have come in for tech. The sector’s forward P/E ratio has drifted under 23x after flirting with 30x in January. When it comes to investing in tech, you could consider companies whose valuations have been reduced in the latest pullback, or you can look for quality.
Given the amount of uncertainty that looms, I’m leaning toward the quality camp when it comes to tech. Quality has held up well over the past several months. That might not be surprising, considering stocks like Apple, Microsoft and Alphabet (a.k.a. Google) have lots of cash on their balance sheets. Those three S&P 500 stalwarts together held more than $325 billion of cash and short-term reserves as of the end of 2021.
All three companies have experienced about a 60% increase in their free cash flow from the end of 2019 to the end of 2021. While M&A could always be a use of that cash, another possible allocation might be to reward shareholders through higher dividends and share repurchases. Apple alone spent $85 billion on share repurchases last year. Some Wall Street analysts expect Apple to announce another $90 billion share repurchases during its earnings results and conference call next month, along with a 10% hike to its dividend.
Tech has consistently led the way in share buybacks over the past several years, and the recent pullback gives reason for the trend to continue. Consistent capital allocation in the form of dividends and buybacks from some of these companies is a signal of confidence in their future operating prospects. The return can help buffer the volatile times we are currently experiencing.
Once Favored, Now Neglected: U.S. Small Cap Stocks
Small caps were supposed to be the place to be in 2021. It made sense since these firms tend to have more domestic operations, making them the ideal “re-opening” play. But that didn’t pan out. It was one variant of coronavirus after another that dented the world’s reopening plans. Small- and mid-sized firms came under selling pressure and remain well off their 2021 peaks.
The Russell 2000 is near a 20% pullback — known as “bear market territory.” After that type of move, it might be time to give small caps another look.
A rising interest rate environment should be a boon for small caps, if history is a good guide. In the nine rising rate regimes since 1983, the Russell 2000 featured multiple expansions along with an average price increase of 25%, according to Bank of America. With the Federal Reserve set to hike its short-term policy rate by a quarter-point in less than two weeks, small caps might benefit.
Finding Value and Stability in Dividend Paying Companies
If you’re looking for less volatility these days, shares of dividend paying companies can often offer some stability when the Volatility Index (VIX) spikes. Perhaps now more than ever, prioritizing profitability and steady operations might be a safe move for your portfolio. As inflation fears persist, owning shares in firms that generate strong cash flows today could help buffer your risk of higher consumer prices over the next year. But there are diverse ways you can play it.
The Vanguard High Dividend Yield ETF (VYM) has a 13% weight in the Consumer Staples sector and features a beta of 0.89. A beta lower than one means the fund is less volatile than the broader market. VYM, which tends to invest in companies with secure but not stretched dividends, is about 4% off its highs from just two months ago. The Staples sector does not come cheap, though. Valuations are elevated with a forward operating P/E ratio above 20x, near the upper end of the range since 2014.
Another way to invest in dividend stocks is to focus on firms that have a track record of increasing payouts to stockholders. You can do that via the S&P 500 Dividend Aristocrats ETF (NOBL). Shares are almost 6% off their December peak even as U.S. companies paid out a record amount in dividends in 2021. Looking ahead, another new high in payouts is expected to be reached this year. S&P 500 dividends sport a track record of steady increases.
Amid geopolitical uncertainty and a “sell first, ask questions later” mindset, sifting through the rubble after a significant pullback to start the year could be worthwhile, especially if you are sitting on some cash. Big tech, small caps and dividend stocks could be three spots to find stability and value.
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Lindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.