Tailwinds or headwinds? Which are you going to choose for your long-term investments?
Check out this dreary chart. This shows demand for products of three large income sectors indexed back to 1990. You've probably already guessed that the bottom line on the graph shows cigarette volumes. Looking back at history tobacco stocks have had some great years due primarily to price hikes and cost control. But the industry continues to shrink relentlessly, creating a headwind that becomes more severe with every year.
The orange line represents US soft drink consumption. This was once a great category—growing demand, good pricing and management teams that were willing to share profits with investors. But tastes have changed and demand for soft drinks has come down consistently over the past decade. The companies have scrambled to develop new products for health-oriented consumers, but these products aren't as profitable, and meanwhile, the once-upon-a-time tailwind from rising thirst for Coke and Pepsi has long since turned into a headwind.
The top line on the graph may surprise you‐it shows total US electricity demand indexed back to 1990. Despite the mounting number of gadgets and a still rising population, electricity consumption has plateaued. Think about LED lights, more efficient household appliances and the construction of green commercial buildings. This wave of efficiency has disconnected electricity demand from economic growth.
Now one might argue that stock prices in these sectors reflect these headwinds. That's a tough sell because valuations in the consumer staples and utility sectors are actually high relative to history. This chart shows the price to earnings multiple for the consumer staples and utility sectors over time. These sectors have both headwinds and rather full valuations.
In our Income-Equity Strategies our bias in the current market is towards technology and financials, two sectors that we believe have clear tailwinds. The technology sector has morphed from cyclical, nice-to-have products to mainstays in our personal and business lives. The industry is booming in a way that electricity demand did in decades past.
We feel that the growth case for financials is just as strong as for technology. Financial products—loans, insurance and investments are much more pervasive in our economy than they were years ago. As just one example, this graph shows total US bank loans adjusted for inflation compared to electricity consumption. As you can see, the growth in bank loans has easily outpaced the growth in electricity consumption. The increasing demand for bank loans combined with rising interest rates give banks a tailwind going forward.
One indication that we're on the right track is that recent research shows that over 50% of the S&Ps dividend growth is projected to come from just two sectors—technology and financials.
Investing in dividend-producing equities requires looking at a raft of factors, including valuation, balance sheet strength, industry dynamics and management strategies. But a good starting point for long-term investors is to focus on industries with strong demand tailwinds.
