Thanks, Yellen… Here’s What to Do After Yesterday’s Rate Hike

This post Thanks, Yellen… Here’s What to Do After Yesterday’s Rate Hike appeared first on Daily Reckoning.

Yesterday’s announcement from the Federal Reserve was certainly no surprise…

Just as expected, the FOMC decided to raise interest rates 0.25%, bringing the Federal Fund rate to a meager 0.75%.

Following Yellen’s announcement, the markets rallied half a percent. Gold was the bigger star, rising 1.5% over the course of an hour.

Now that the drama of the meeting is over, the headlines will have to find something else to fret over…

For us, it’s time to focus on where the markets are headed.

While investors cheer as the market climbs to new highs, the elephant in the room remains…

By almost every metric, the market is over-valued.

Listen, I am all for buying and holding on for the long term. But these days, it’s almost impossible to find a fairly priced company that offers a decent yield.

It’s an uncertain time for investors. But you CAN find decent yield at a fair price— you just need to know where to look.

Below, Jody Chudley reveals a hidden gem in the world of income.

Here we are… eight years into the bull market that started in March 2009.

To appreciate how rare a bull market of this length is, we need to realize that this is the second longest bull run in the history of the S&P 500.

Let’s not beat around the bush. There is going to be a bump in the road at some point, and perhaps soon. Bull markets end when a bear market arrives.

They always do.

As usually happens when stocks go up for eight straight years, valuations end up looking pretty expensive. Remember, the S&P 500 hasn’t just gone up for the past eight years — it has soared. From the 666 low in March 2009, the S&P is now bumping up against 2,300.

I stumbled onto the chart below from Goldman Sachs, which compares the market today on seven valuation metrics against historical averages. I thought it was well worth sharing.

Source: Goldman Sachs

What this shows us is that the S&P 500 today is more expensive than it has been at almost any time historically. We need to have our eyes open to this fact.

Now, I’m not suggesting that there is going to be any immediate market crash. What I am willing to say is that we need to be prepared for an S&P 500 that has much tougher sledding over the next few years.

Which is why dividend-paying stocks are going to be so important.

First, dividend income is going to provide a solid amount of investment returns on its own.

Second, if the market does decline at any point, dividend-paying stocks are going to hold up a whole lot better than the overall market. The dividends that these companies pay provide a floor for their stock prices that growth stocks with frothy valuations do not have.

And third, that dividend income provides us with ammunition to take advantage of any stock bargains that a bear market serves up.

The past eight years have been the age of the index fund investor. The next eight may just be the age of the dividend investor.

Better Valuations and Huge Dividends… From Across the Pond!

While the overall U.S. market is expensive, there are still bargains to be found.

I’ve noted in recent months that I’m are bullish on select financial stocks and have also zeroed in on the fact that defensive sectors such as health care have also underperformed and offer value.

There is another place where bargains are much easier to find today…

This isn’t a sector, it is a continent. In this case, Europe.

We already tapped a European stock once when we profiled Shell and its 7.5% yield.

The appeal of European stocks today is twofold.

European stocks currently offer much lower valuations than their American counterparts. Last year, the S&P 500 rose by 10%, while the big European index (Stoxx 600), which was challenged by Brexit and never-ending European financial woes, declined by 1%. The lower valuations that European stocks trade at provide a much better chance of significant capital appreciation going forward.

Even better, the yields that you can lock in on European stocks today are also higher.

That makes them hard not to like. Not only do they trade at a discount, but they provide more dividend income.

The nice part is that to get better value in European stocks, we don’t have to compromise on quality. Even the biggest blue chip European stocks are more attractively valued.

I think a great way to play this is through an ETF called the First Trust Dow Jones Stoxx European Select Dividend Index Fund (FDD). The name of the ETF is a mouthful, but is has some appealing qualities today. This fund holds exclusively strong European companies that have sustainable dividends.

How do I know the dividends are sustainable? In order to become a position in the fund, the company must have a dividend payout ratio less than 60%. That means that these companies are paying out less than 60% of their earnings as dividends.

Also required from every company that makes it into the fund is positive five-year dividend growth on a per share basis. That means these dividends are both sustainable and growing.

The yield on the ETF is currently 4.87%. That is a lot of income from a diversified bundle of 31 stocks. Companies from 18 different European countries are represented in the ETF, with the U.K. (28%), Switzerland (23%) and France (16%) having the largest weightings.

The key vital statistics of the ETF are below. The median market cap of the companies included is $21.66 billion, so these are big, solid companies.

Source: First Trust

The valuation metrics point to much better value than what the S&P 500 currently offers. While the S&P 500 trades near 25 times earnings, the Stoxx European Select is just over 14 times. To trade at a multiple similar to the S&P 500, the companies in the ETF would have to experience nearly a 70% rise in price.

With U.S. valuations heading higher, there’s no time like the present to start looking for better trades!

Keep looking through the windshield,

Jody Chudley

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