By Lucas Downey, Contributing Editor, TradeSmith Daily
The most popular safety trade right now is the "scramble for yield."
It's no secret: record-breaking capital is flowing into money market funds. And I don't blame folks… we've had ultra-low interest rates for decades. Money market funds paying 5%-plus sounds like a free lunch.
And while this risk-free income is uber attractive right now… I've got news for you.
Don't count on 5%-plus income checks forever.
The Fed will eventually cut interest rates, driving down yields and making this asset class less appealing. But don't fret! There's a tremendous opportunity coming.
Income seekers resting blissfully in money markets today will eventually shift their dollars toward another out-of-favor income class.
Once the tidal wave starts, you'll want to be on board for what I believe will be the biggest income shift we've seen in decades. Today, we'll review the interest rate landscape. Then we'll take stock on red-hot money markets. And lastly, we'll uncover three dividend stocks set to explode once the Fed reduces interest rates.
The Fed just began the rollout of a new technology that'll "shake the US financial system." It'll likely go down in history as the biggest change to money since Western Union launched its "lightning lines" in the early days of the telegraph.
The thirst for yield is real. After the Federal Reserve went on one of the fastest hiking sprees in decades, the Federal Funds effective rate has reached an enticing 5.33%… a level last seen in early 2001:
With multi-decade-high yields, it's no surprise that income-starved investors are plowing cash into money markets at a breakneck pace.
The popular money market mantra to "collect and chill" is gathering steam.
The latest FRED data pegs money market assets at nearly $6 trillion:
But this income-chasing trend is set to decline. As a reminder, last week I detailed how myself and many professionals believe the Fed is done hiking rates.
More importantly, the Fed is set to start cutting rates in 2024. That means two things are likely to happen once interest rates fall back to earth:
Money market yields will decline, making the asset class less attractive to yield-hungry investors.
Dividend stocks, shunned at the expense of rising yields, will prove to be a very strong alternative for the income crowd.
But as you know at TradeSmith, we use data and history to back up our ideas.
And history shines a bright green light on elite dividend stocks when interest rates fall.
3 Best Dividend Stocks to Buy Before the Fed Cuts Rates
I'm reusing this chart for illustration. Going back to the early '80s, there've been seven distinct periods when the 3-month T-bill yield declined:
Source: FactSet
As a reminder, this 40-year lookback includes a handful of unsettling events:
COVID pandemic of 2020
Global financial crisis of 2008
Early 2000s Tech bubble
The 1987 Crash
Those were scary moments indeed. But if you're inclined to avoid stocks altogether during times like these, think again.
Dividend-rich companies have demonstrated outstanding gains during these rate plunges. Let me show you three of them that should be great buys for what's to come…
The first example is a company I've owned for many years, discount retailer Walmart Inc. (WMT). When you think of stable dividend growth, this one is the poster child.
Walmart has paid dividends going all the way back to 1974. Continual increasing cashflows have made this stock a top choice for dividend junkies like myself.
But here's what makes it so impressive in the coming lower-rate environment…
When you review WMT's performance during each of the seven rate declines isolated above, it's awe-inspiring.
Since 1981, when T-bill yields fall, WMT stock has gained a whopping 63% on average:
Once rates fall, I could easily see WMT as a nice home for all of the money market outflows.
Microsoft's CEO says AI is a "tidal wave" with more potential than the internet. That's why Microsoft has spent $13 billion on AI investments - they're desperate to claim their own stake. And you should be too.
But before you buy MSFT (or any other FAANG stock), you'll want to watch this interview. In it, 50-year Wall Street veteran names his #1 AI stock to buy (it's not what you'd expect).
The No. 2 dividend stalwart to consider is one of Warren Buffett's war chests, Coca-Cola (KO).
Founded in 1886, the iconic beverage maker has put the sparkling touch in many dividend growth portfolios.
Like Walmart, when 3-month T-bill yields decline, dividend-rich Coca-Cola shares have sweet returns. Looking back since 1981, KO has been a knockout performer when rates fall — with an average gain of 47%:
Use these stocks to hedge falling rates or Ozempic worries — the odds favor a Coca-Cola resurgence!
The third dividend grower to own when rates decline is biopharma powerhouse Johnson & Johnson (JNJ). The health care space is one of the most defensive areas out there, no matter what the economy faces.
Humans have a rich history of prioritizing their health — in times of both abundance and scarcity.
Founded in 1886, Johnson & Johnson has a rich history of growth and dividend raises back to 1972.
But here's why falling rates have been no match for this dividend heavyweight…
Back to 1981, during falling 3-month T-bill regimes, JNJ has returned an average of 35%:
Next year, when the media is fearmongering about falling yields, you'll be equipped with a storied dividend playbook.
Write down these tickers — WMT, KO, and JNJ — and put them on your watch list. These stalwarts will be a great way to juice your portfolio no matter what kind of market is coming our way.
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TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
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