Just like what we saw in August, the S&P 500* fell quickly in the first week or so of September, but it managed to climb back steadily. As of this writing, the index is up 1.5% for the month.
This performance flies in the face of August and September’s typical seasonal weakness. Thus, we at Cornerstone think it’s a sign of a strong market.
This impressive comeback also bucks the trend of history: since 1928, when indices drop 1.5% or more in the first week of September, there has never been a single prior instance where equities were then positive for the month.
That said, it's important for us to be cognizant that there are still uncertain weeks ahead leading up to Election Day, which matters more considering this race is currently tighter than both 2016 and 2020. Theoretically, that could lead to increased uncertainty comparable to previous election cycles. And we all know the one thing markets despise the most is uncertainty.
But the bigger overall picture remains positive for three main reasons.
First, the Federal Reserve is dovish, and we know historically stocks are higher three months later, seven of seven times after the first cut:
Next, since 1928, after a 10% gain in the first half of the year, equity markets are higher in the second half of the year, averaging a 9.8% gain in 83% of instances:
Lastly, margin debt fell $14 billion in August to $797 billion. That indicates there is significant firepower yet to be unleashed.
Understanding those three positive catalysts, today we want dig deeper into another potentially important positive catalyst that would support additional tailwinds in the market.
The Power of Supply and Demand
“Cash is king” has been the mantra for years now. Households have poured cash into money market accounts at stunning levels. But we are now already witnessing the buildup beginning to unfold.
As interest rates decline, the reality of high-yielding cash will once again become a dream. It’s true, the fact that you could earn a risk-free 5% or more return not only made sense, but also good fortune.
Those days are dwindling. Investors face a looming dilemma of where to redirect this cash hoard in the face of sinking risk-free yields.
But if Economics 101 taught us anything, it was the power of supply and demand. When income- starved investors are greeted with a newfound cash stream, they will pounce, like they did with money markets from 2022-24:
Zooming in, we can understand how the rise in interest rates correlated with increased demand in money market assets:
Digging even further, our friends at MAPsignals did some interesting research where they determined who was mostly responsible for the influx of capital into money markets. Perhaps it shouldn’t surprise that wealthy investors were responsible for most of the money market asset growth.
As of the second quarter, the top 1% of households controlled 35.3% of money market assets. And the second tier, the 90 to 99th percentile, made up an additional 41% of the total:
It's also interesting to note that the top 10% of households were responsible for 80% of the money market asset growth during this time.
Perhaps most importantly for those keeping score at home – 76% of household money market assets almost assuredly will need to find a new home in short order.
We know that when one asset class thrives, typically another suffers. Well, from January 2022 through June 2024, popular income equities significantly underperformed. For example, the S&P 500 gained 18.8%. But under the surface, real estate stocks fell 19.2%, utilities gained only 3.3%, and staples rose just 5.3%:
From roughly June 2024 (when we said a reversion trade was underway) until now, there’s been a monumental money shift under the surface into those unloved dividend-oriented equities.
Looking at sector performance since July below, high-yielding utilities have gained 19.2%, real estate is up 18.2%, and staples are up 9.3%. In that time the S&P 500 rose 2.7%.
Clearly, money market assets are already searching for new homes as rates fall. This trend will only continue as the odds are now calling for the federal funds rate to reach a 3% handle in about a year or so:
What does this mean from an asset allocation standpoint?
In our opinion, a big prize will result from owning shares of amazing companies that have great businesses, high profit margins, and consistent dividend growth.
And don’t focus on the highest-yielding stocks. Those yields never keep up. Instead, focus on compounders.
This chart shows the power of compounding dividends and reinvestments over time. Reinvesting growing dividend payouts significantly contributes to equity returns. Even in the S&P 500, 37% of the long-term returns come from dividends.
The annual growth of your reinvested payouts supercharges long-term compounding. For example, since 2000, S&P 500 dividends have more than quadrupled from $139 billion to $588 billion. That alone equates to 6.8% annual income growth.
Obviously, big yields are tempting for dividend investors, but oftentimes a high dividend yield signals distress. For instance, the payout might be high because the company's shares have either fallen due to poor fundamentals or it’s the only way to entice investors to buy the stock. This has happened to some household names in the recent past. Think CVS, Walgreens and AT&T.
Either way, it's almost assuredly a head fake, and soon that juicy yield is often wiped out by capital losses. So, it's no surprise that dividend growth strategies consistently outperform their high dividend yield counterparts:
The bottom line is that quality matters. Dividend growth stocks have returns on equity of 27% versus only 17% for high dividend stocks.
All in all, there's a cash bubble that appears to already have been pricked and those assets are searching for a new home. The data is telling us that chase is leading investors to elite dividend growth stocks with strong balance sheets and low payout ratios. These should be the prime beneficiaries of inflows going into 2025.
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*Past performance does not guarantee future results.
* The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
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