PM Images
In a world where technology cannibalizes the headlines, many investors got caught offsides to start off September as the Dow Jones declined by -626.15, the S&P 500 fell -119.47, and the Nasdaq retraced by -577.33. Tom Lee, who is a Managing Partner and the Head of Research at Fundstrat Global Advisors, who continued to be correct when others were calling for a selloff, cautions investors that we could see a 7-10% pullback before the markets head higher. While NVIDIA Corporation (NVDA) fell -9.53% in one trading day and the Invesco QQQ Trust ETF declined by more than -3%, income investors who are invested in the Vanguard High Dividend Yield Index Fund ETF Shares (NYSEARCA:VYM) weren’t nearly impacted. VYM fell -1.21% and is now yielding 2.83%. The upcoming Fed meeting is less than 2 weeks away, and everyone is anticipating at least a 25 bps reduction to the Fed Funds Rate.
VYM has been a standout in the traditional high dividend yield ETF space for investors who aren’t interested in ETFs that implement an option overlay strategy to generate larger yields. With yields falling in the bond market and the Fed about to adjust monetary policy, I believe VYM will be a magnet for investors looking to reallocate capital into income-producing assets. VYM is one of the largest dividend-focused ETFs with $70 billion in assets under management (AUM), and I believe it will continue to outperform similar ETFs such as the Schwab U.S. Dividend Equity ETF (SCHD) and the iShares Core High Dividend ETF (HDV) throughout the rest of the year.
Following up on my previous article about VYM
In April, I wrote an article on VYM discussing why I felt it would continue to outperform similar ETFs as 2024 progressed. Not only did VYM outperform SCHD and HDV, but it’s increased by 7.25% since the article was published, while the S&P 500 increased by 6.91% over the same period. When VYM’s dividend was accounted for, its total return since 4/11 has been 8.18%. A lot has changed since April, we have a clear Fed policy, inflation continues to fall, and oil has retraced to the lowest levels of the year. I am following up with a new article on VYM because I think it’s positioned well to continue rallying into the end of 2024 and could be attractive for many income investors looking to reallocate capital from the sidelines.
Risks to my investment thesis pertaining to VYM
Nobody has a crystal ball, and the current selloff is either going to be a buying opportunity or the first leg downward into a correction. At this point, the biggest risk to VYM is that investors take rate cuts as bad news and decide that the election cycle is creating too much uncertainty and hedge their downside by selling a portion of their holdings. The election cycle is heating up, and political talking points are becoming headlines that will form a future narrative about the economy. Investors may take this opportunity to sit on the sidelines as the market tends to dislike uncertainty. VYM doesn’t implement a hedging strategy, and if the market continues to correct itself, shares of VYM will likely follow the market lower. There is always a risk of losing money when it comes to investing, and the next 6-8 weeks could be additionally volatile. The secondary risk to VYM is that if this ends up being a buying opportunity and the market rips higher, traditional index funds such as QQQ or the SPDR® S&P 500® ETF Trust (SPY) will likely outperform VYM even after the dividends are accounted for. There is a significant opportunity cost to consider for long-term investors who don’t need to generate income at this stage in their lives. While I am bullish on VYM, there are risk factors to consider prior to allocating capital toward this investment.
VYM continues to deliver on its objectives and is outperforming its peers
VYM is a dividend index fund that invests in most companies within the FTSE Dividend Yield Index. Some investors don’t want to take on individual equity exposure, while others look toward ETFs to round out their portfolios. VYM allows investors to gain exposure to equities that have dividend yields that are above average in a single investment product. VYM replicates the low management fees that Vanguard is known for, as it has an expense ratio of 0.06%.
Over the past year, VYM has appreciated by 17.63%, and its current yield is 2.83%. VYM has provided its investors with 13 years of dividend growth at a 5.81% average growth rate over the past 5 years. For investors who are looking for a hands-off hybrid solution that can generate a combination of upside appreciation and modest dividend yield, VYM has been a strong ETF.
Over the past decade, VYM has increased by 88.15% and generated $27.69 in dividends, which is a 40.91% yield on cost, considering that shares were $67.69 on 9/1/14. VYM has solidified a history of delivering for its investors, and the 40.91% yield over the past decade doesn’t include if investors decide to reinvest the dividends.
Over the past year, VYM has continued to outperform SCHD and HDV by modest margins. VYM has a larger allocation toward financials, technology, and utilities than SCHD and a larger allocation toward technology, and financials than HDV. By looking at the holdings and the sector breakdowns, I believe that VYM is better situated to outperform if the market continues higher than SCHD and HDV due to their exposure toward technology and financials.
I believe that the AI revolution is in its early stages and that a rate-cutting environment will be bullish for financials as the lending and housing markets see increased activity. If I am correct, then there is a significant chance that VYM will continue to outpace SCHD and HDV throughout the rest of the year and into 2025. VYM has a well-balanced fund and has been able to hold its own in a market led by technology.
Why I think the market is setting up well for VYM
We’re less than 2 weeks away from the Fed meeting, and CME Group is projecting that there is a 100% chance of a rate cut. The big question is whether it will be 25 or 50 bps. Their estimates are leaning toward a 25bps cut with a 62% probability. The bond market also signals that the Fed is offside as the 2-year yield is 3.87% while the 10-year is at 3.84%. With inflation falling to under 3% in July and Fed Chair Powell signaling at Jackson Hole that the time has come for change to monetary policy, I believe we will get ongoing rate cuts throughout the year.
There is over $6.44 trillion sitting in money market accounts, according to the St. Louis Fed, and it’s likely that as rate cuts occur and the risk-free rate of return declines that investors will reallocate capital back to the equity markets. I think this is positive for VYM from a yield perspective because the 2 and 10-year have been declining, and as the Fed cuts, they are likely to decline further. VYM could become a magnet for capital as it offers investors a balanced approach to investing in equities focused on dividend growth while paying a 2.83% yield.
Crude is also on the decline, and crude is one of the most important commodities to track. Crude is a critical raw material in the manufacturing process, and derivatives of oil are used as lubricants and feedstocks. Crude is also used to produce refined products such as gas, diesel, and jet fuel. When the price of crude declines, it impacts the global economy because input costs decline. This can favorably impact many different industries and companies as the costs from production to transportation decline. When I look at the potential for a shift in Fed policy and a decline in crude prices occurring at the same time, I become bullish for many businesses. The carrying cost on current debt or tapping the debt markets to fuel future growth should become more favorable while the overall costs should decrease. This could lead to improved margins and profitability for many companies within VYM.
When I look at VYM’s holdings, it has 21.31% of its portfolio tied to financials then 12.69% to consumer defensive, 12.17% to industrials, and 7.06% to consumer cyclical. These industries should be direct beneficiaries of a lower rate and oil price environment. Companies like JPMorgan Chase (JPM) and Bank of America (BAC) should benefit from increased borrowing, increased economic activity, and larger spreads as their funding costs decline. Companies such as Johnson & Johnson (JNJ) and Procter & Gamble (PG) should benefit because their input and transportation costs should be reduced, causing their margins to expand. VYM’s top 10 holdings trade at an average 2024 P/E of 20.06 and an average 2026 P/E of 16.34. These companies have on average 22.27% of earnings growth on the horizon from the end of 2024 through 2026. Based on the macroeconomic conditions and how they should positively impact many companies in VYM’s holdings, I believe that VYM is in a strong position to continue higher.
Steven Fiorillo, Seeking Alpha
Conclusion
VYM continues to outperform its peers in 2024, and I am bullish on VYM heading into the end of the year. While technology has made many companies outperform the indexes this year, the incoming rate cuts combined with lower commodity prices should act as a catalyst for the market. I think VYM is positioned well for a broad market rally and could also become attractive for income investors looking to reallocate capital, as they will no longer be able to hide in cash and collect 5% yields. VYM provides investors with a 2.83% yield and has increased the dividend for the past 13 years. If you’re looking for a hybrid fund that can continue to appreciate, generate modest yield, and provide dividend increases on an annual basis, then VYM is a strong ETF to look into. I think VYM will finish in 2024 higher than it is today, and we could see the rally continue into 2025.