Low-Volatility And High-Dividend Stocks Are In A Bubble That Might Pop Soon by Jared Dillian, Mauldin Economics

Every once in a while, investors go through these convulsions where people think they can get a free lunch. Remember, there ain’t no such thing as a free lunch. There is even an acronym for it: TANSTAAFL. Yet people try.

The latest attempt to do so is buying “low-volatility” stocks.

Everyone knows that some stocks are more volatile than others. It’s not uncommon for some biotech stocks or gold miners to move 10% in a day. McDonald’s will move a half-percent a day—if that.

Where people get confused is that they think they can get even more reward for the same amount of risk. We could follow up here with a diagram and a chart of the efficient frontier, but I don’t feel like getting all academic on you today.

Let’s just say there is a positive relationship between risk and reward, which should be obvious to everyone here.

And yet, an ETF of low-volatility stocks has actually outperformed the S&P 500—over quite a long period of time.

Low-Volatility, High-Dividend Stocks

Not just by a little. By a lot.

That shouldn’t happen in theory. But it is happening. An ETF that is full of things like…

AT&T

Verizon

Johnson & Johnson

Procter & Gamble

General Mills

PepsiCo

Paychex

McDonald’s

Con Edison

Automatic Data Processing

Etc.

…is vastly outperforming the S&P 500… and has been for a while. People have become enamored of low-volatility strategies, and so they pile into them, forming yet another bubble.

It isn’t strictly low-volatility stocks that people buy, though. It’s also high-dividend payers (which are essentially the same thing).

Here’s a chart of the iShares Select Dividend ETF (DVY). It looks the same as the iShares Edge MSCI Min Vol USA ETF (USMV).

Low-Volatility, High-Dividend Stocks

Some people call it a “consumer staples bubble.” A lot of these stocks fit that description.

Low-Volatility, High-Dividend Stocks

I guess the 10th Man conclusion that you can draw from this is that… if people can pile into these names, people can pile out of them.

What would the catalyst be?

Never ask me what the catalyst would be. I never know. My job is to point out a market distortion and figure out what to do about it. The thing about market distortions is that they can persist for a really long time.

We could be talking about low-volatility stocks three years from now.

But I will speculate. Since these are all high-yielders, my guess is that people have been piling into dividend-paying stocks for the same reason they piled into high-yield bonds: fed funds at zero, can’t get anything in a savings account, need to live off some income.

All Baby Boomers are in the same boat. That’s at least part of it.

It could take a small crisis or correction to turn low-volatility stocks into high-volatility stocks. There is some hidden gamma/convexity in these names that nobody is really aware of.

Up on an escalator, down on an elevator.

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