Dividend Stocks in Bear Markets

Preferred stock shares are most often known for their bond-like tendencies since they usually feature higher yields like corporate debt, but also have the option for conversion into common stock, allowing for capital appreciation. While it is true that in bull markets preferred stock shares act more like bonds than stocks, during bear markets, even common but high yield stocks, especially in solid blue chip companies, begin to trade like bonds.

The Purpose of the Financial Markets

The financial markets serve many important purposes. Of these are correctly pricing companies, profits, and assets, as well as financing new opportunities, and most importantly, finding the optimum balance between risk and reward. When investors bring their money to the market, the goal, for most, is to find the biggest reward imaginable with the least amount of risk. During bear markets, high yield stock tends to fit this criteria quite well.

What Happens in Bear Markets

There are a number of important factors that must happen before high yield stock begins to trade like a bond. First, it is almost a necessity for a recession to occur. Second, following most economic recessions and bear markets, there is always a flight to safety, which is often accompanied by monetary easing, or increasing the money supply to push rates lower.

When rates move lower, the prices of bonds rise. Beyond central bank actions, however, investors also push their money to bonds as a “flight to safety” and accept lower yields than the historical performance of stocks in a trade for less volatility and immediately lower risk profiles. Stocks, as a result of the exodus to commercial paper, treasuries, and other debt securities, tend to fall as a result.

One asset class that almost always avoids the fall, however, is high yield stocks, those which produce dividends considerably higher than other companies. Often, these are well established firms, which despite being financially healthy, no longer have any room to grow. Instead of reinvesting in their business, these high yield stocks instead pay out profits to stockholders in the form of dividends.

Playing High Yield Stocks

High yield stocks are far less prone to capital loss because they have a financial safety net. As the price of the high yield stock declines, the dividend in terms of dollars stays the same, generating a larger percentage return. Thus, just like a bond, when the stock price increases, the yield declines, but while the high yield stock falls in value, the yield rises.

High yield stocks, thanks to this safety net, enjoy much lower lows during downcycles and highs just as high as other names during bull markets. At the start of recession and an obvious bear market, it is even likely to see the price of high yield stocks to rise quickly as bond yields plummet and investors look for better yields with the opportunity for appreciation. In the case of bonds, which are quickly snapped up, high yield stocks are practically guilty by association, avoided by investors because they share an asset class with a sinking ship, not because the stock itself is a poor investment.

If you're looking for an asset class with the opportunity for growth, income, and downside protection, look no further than assembling a portfolio of high yield stocks. Even if all the other shares plummet, at some point, the impressive yields offered by high yield stocks will shine brightly against bonds.
Tim Ord
Ord Oracle


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