After a strong first quarter, what happens in Q2?
I wanted to look at what happens with second quarter performance after a strong, three month start to a year. As we wrap up the first quarter, the S&P 500 has rallied more than 10 percent. There have been no less than 20 new all-time highs, something we’ve only seen matched five other times in a first quarter, going all the way back to World War II. Of course, the TSX is off to a solid start as well. So – what happens in the second quarter after a big surge in the first quarter?
If history is any guide, don’t expect the same kind of returns and in addition, be prepared for a pullback. Using data from CFRA, we looked at the fifteen best first quarter returns since World War II.
On average, the return during those quarters was 12.5%. In those years, the second quarter return averaged out to be 3.7%. But it’s also worth highlighting that four of those 15 years had negative performance in the second quarter. That would suggest this year’s strong start makes the market vulnerable in the coming months.
Meanwhile, in those 15 years of standout first quarter performance, there were 13 instances when the market then declined at least 5 percent or more. And the average drop during those selloffs was substantial – it nets out to around 11%. Also worth noting – in those 13 instances where we did see a market decline, there were 8 times when the market then fell again later in the year. So, a second significant selloff.
That’s the scary part, I suppose. But here’s the encouraging news. When all is said and done, going back to those 15 years of top first quarter performance for the S&P 500 since World War II – when the year is complete, 14 out of the 15 years ended with double digit market returns, with the average annual gain clocking in at 23%. 1987 would be the lone exception where a strong start was matched with a miserable finish.
SO — in conclusion, you might need to close your eyes for a bit, but history would suggest things will look pretty good by the end of the year.
Slow and steady rate cuts wins the stock market race.
Over the course of the year, the conversation around when the Fed will ultimately cut rates has changed. Earlier in the year, many economy watchers thought we could be in for more than 5 cuts in the U.S. this year. Easing inflation pressures and a resilient economy -- not to mention messaging from the Fed itself – has shifted the market’s thinking on that number, which is now down to around 2 or 3 cuts. Well, what’s important to note from history is that a development like this – what you might call a slow rate cutting cycle – tends to be bullish for stocks.
Ned Davis Research has looked back at rate cut cycles since the 1950’s and it has found that on average, the S&P 500 tends to rally more than 24 percent in the first year after easing begins – when that easing cycle tends to be a slower one. By comparison, when the cycle is fast – in other words, the rate cuts are faster and more furious – the performance one year out is generally smaller, averaging around 5 percent.
And if you think about it, this does make some sense. While investors have been hungry for rate cuts, a fast cycle tends to suggest urgency is needed to catch up to the issue. In this case, an extremely aggressive fed would likely signal that the economy is losing momentum fast. By comparison, if this easing cycle ends up looking like, say, 1984 or 2019 – it would indicate that the Fed is moving slowly because it can. That’s a more controlled environment and one that might feel less uncertain for investors.
Now – the wild card for investors is a third scenario. This is what you might call the non-cycle. In that example, the S&P 500 return in the year after the cutting begins is much more muted. And that is the kind of development investors might want to watch most closely going forward. This is the idea that after, say, one rate cut – that the Fed is still dealing with inflation and it needs to hold the line on rates. In other words, the easing cycle never really gets going.
If that situation materializes, investors may need to re-assess.
Some of the Dow’s Dividend Kings
The pros talk about dividend yields, which measures how much a company pays out each year, relative to its stock price. But, of course, with dividend yields, those percentages can climb when a stock is down. And your total return is going to be based on both your dividend payments and the stock’s actual performance. So you don’t always want to be reliant on a high dividend yield on its own. Instead, we wanted to look at the 30 stocks within the Dow Jones Industrial Average to see which names in that index pay the highest per share dividend each quarter.
The company that currently has the highest per share quarterly dividend among Dow stocks is Goldman Sachs. Its quarterly payout is $2.75. Home Depot and Amgen tie for the next spots down.
Amgen shares are down this year, but Goldman and Home Depot are up, so that’s a nice combo of stock performance and dividend payouts.
Now, let’s assume you own $10,000 worth of each stock, which will give you a different amount of shares in each case since all these stocks have different prices. Based on an overall investment worth $10,000, you would be getting roughly $324 a year in dividends for owning Amgen, $275 for owning Goldman Sachs, and $234 for owning Home Depot. There are some Dow stocks that would ultimately pay out more in dividends over the course of the year based on a $10,000 investments – such as 3M, IBM, Chevron or Verizon. But that’s because they have lower per share prices right now, so your $10,000 affords you more stock.
Anyway, back to Goldman, Home Depot and Amgen — Bloomberg’s dividend forecasting tool suggests all three will see their dividend payments grow over the next three years.
Goldman is expected to see the most dividend growth of the group, with an expected increase of 9 percent, followed by Home Depot at 8%, and Amgen at 6%.
Free Cash Flow Growth Machines
They say cash is king. And free cash flow gives you a good sense of how much money companies are sitting with after they’ve paid for all the costs associated with running the business. And sure, free cash flow today is something helpful to analyze. But knowing what free cash flow will look like down the road is even more helpful.
Bloomberg surveys analysts on where they see a company’s financials being in the year’s ahead. So we decided to look at Wall Street’s expected levels of free cash flow for big tech companies – looking out five years.
It is likely no surprise that since these companies are expected to keep growing, their free cash flow in many cases is expected to skyrocket. Here are some examples…
Expected free cash flow growth in next 5 years:
AMD: +1,179%
Shopify: +538%
Spotify: +353%
Tesla: +352%
Amazon: +337%
Uber: +272%
Nvidia: +191%
ServiceNow: +185%
Microsoft: +150%
Airbnb: +94%
Salesforce: +89%
Broadcom: +85%
Netflix: +79%
Adobe: +59%
Alphabet: +56%
Apple: +55%
Meta: +20%
Investing in Asset-Light Businesses
I had a great conversation this week with Ian de Verteuil, head of portfolio strategy, CIBC Capital Markets. One of the topics we discussed was the compounding advantage that asset-light businesses can have. But what came to light was how these kinds of business can exist in all sorts of sectors.
It came up because Ian likes to track great compounders and companies that operate in this fashion can be solid returners for investors overtime.
“A lot of it is examining the capital expenditure vis a vis the actual enforced business,” he said.
“In the case of Tim Horton’s parent Restaurant Brands, they are using other people’s money to grow the business through franchising. In life insurance, you wouldn’t think of Great West Life as an asset light business, but a large proportion of their business is in their participating block, where they don’t take a lot of the investment risk. Dollarama is another great example. It actually frees up capital when it opens a store. The same thing is true with Sleep Country. You might ask how is that possible? The reality is that they get such good great credit terms from their suppliers that they are selling inventory before they’ve paid for it.”
That’s not to say he doesn’t like capital intensive businesses, such as railroads and banks.
But some food for thought.
By the way, 10 TSX stocks (not necessarily asset light per se) he had flagged in a note earlier this year as quality names are: Constellation Software, Dollarama, Gibson Energy, Russell Metals, BRP, CGI, Labrador Iron Ore Royalty, Sleep Country, Parkland and Loblaw.
Stock picks of the week
Kim Forrest, Bokeh Capital Partners: Intel, AMD, Synopsys
Neela White, Blue Wing Advisory Group: Alimentation Couche-Tard, Dollarama, Fortis
Stan Wong, Scotia Wealth Management: Dollarama, Novo Nordisk, Palo Alto Networks
Andrew Moffs, Vision Capital: Dream Industrial, First Industrial Realty, Chartwell Retirement
Bob Iaccino, Path Trading Partners: Hillenbrand, Arm Holdings, Sprouts Farmers Market
Mike Archibal,, AGF Investments: Raymond James Financial, First Service
Diana Avigdor, Barometer Capital Management: Citigroup, Agnico Eagle Mines
David Nelson,Belpointe Asset Management: Invesco S&P 500 Eql Wght Energy ETF