As I write this post, stock markets around the world are reeling.
The S&P 500 finished down more than 3.5%, most European markets closed down at least 6% (including double-digit losses in Italy, Spain, and Greece), and Japan’s Nikkei 225 dropped by approximately 8%.
We haven’t seen this type of volatility since 2008.
What drove today’s plunge in financial markets, and should dividend investors care?
In case you somehow missed the flood of headlines, Britain voted to leave the European Union (EU) late last night.
Few people expected this outcome, resulting in the knee-jerk reaction across financial markets today.
Leaving the EU introduces a number of consequences that could weigh on the United Kingdom’s economy.
Most obviously, Britain would lose its favorable trade relationships with EU member countries and be subject to tariffs.
More importantly, the event introduces meaningful uncertainty regarding the country’s future.
As a result, psychological effects could cause businesses and consumers to pause their activity, resulting in less investment, higher unemployment, and a possible recession.
While these are legitimate concerns, investors might be surprised to learn that Britain’s economy accounts for less than 4% of the world’s GDP.
Why the plunge in stock prices given Britain’s relatively small contribution to the global economy?
Investors fear potential knock-on effects rippling around the world. What if additional members of the EU such as Spain and Italy decide to leave?
How will Britain’s exit impact the rest of Europe’s economy, which accounts for close to 20% of global GDP?
Is there some sort of contagion risk given the financial services hub that Britain is for the world?
Additionally, the stock market was somewhat fragile to begin with.
The market has gone nowhere but up for seven years, and we are in the second longest bull market ever despite sluggish global growth. Central banks deserve much of the “praise.”
Regardless, adding in an event like Brexit doesn’t help the case for global growth as it introduces additional uncertainty and fear, which are the enemies of business investment and consumption.
The global consequences of Britain’s unprecedented decision are unclear and will likely take years to play out.
For one thing, Britain first needs to negotiate its withdrawal with the EU, which will take place over the next two years and impact its future relationship with the Union.
The number of future outcomes is almost limitless.
Britain could ultimately negotiate relatively favorable trade terms with the EU, cushioning its fallout. Weakness in the pound could also help the company’s exports, and you can bet that central banks around the world will do everything they can to prevent any potential crisis as well.
On the other hand, the EU could impose harsh terms to send a message to other member countries mulling the idea of also leaving the union. Central banks have already stretched their policies and are losing a bit of the world’s confidence as well.
No one knows what will happen, but the U.K’s government previously estimated that a Brexit event could make Britain’s economy smaller by 3-8% by 2030.
In my view, there is little to gain from speculating about the world’s economic future as a result of Brexit.
There are far too many known and unknown variables moving at once to gain any sort of clarity, and much will change yet again as Britain negotiates with the EU over the next two years.
As Warren Buffett once said, “We think any company that has an economist has one employee too many.”
Should Dividend Investors Care About Brexit?
Equities are risky assets, and dividend stocks are no exception. Looking across my dividend portfolios today, I was greeted with a lot of red on the screen.
During times of market stress, it’s not uncommon for correlations between different asset classes and stocks to go to 1 – everything moves together over short periods of time.
This phenomenon can be a blessing and a curse. For investors sitting on the sidelines with cash to deploy, days like today can potentially provide opportunities to pick up shares in high quality companies that have been thrown out with everything else.
One example would be Hormel (HRL).
For those who are unfamiliar with the company, Hormel has been in business for more than 125 years and sells a variety of perishable meats, poultry, and shelf-stable products.
Over 90% of the company’s sales are in the U.S., and its products are non-discretionary (Hormel’s sales fell by just 3% during the financial crisis). The company is also a member of the Dividend Aristocrats Index.
Does this sound like a business that could be materially impacted by Brexit over the coming years? Of course not.
However, Hormel’s stock was down over 2% at the open this morning. The stock rallied throughout the morning to eventually close up more than 2%, beating the S&P 500’s return by more than 5% in a single day.
No one knows if Hormel will be a successful investment over the coming years (see my full thesis here), but this is one example of a high quality dividend growth stock that dividend investors could have opportunistically targeted for days like today.
When the baby is thrown out with the bathwater, you pick up the baby.
Of course, there is no guarantee that the market’s dip won’t turn into a deeper gash, causing quality businesses like Hormel to trade at even lower prices.
However, attempting to forecast where the market might go over the next week or year is a fool’s errand. Not a single person knows (remember Buffett’s quote about economists?).
Instead, we need to focus on staying the course and embrace the mentality of a long-term investor.
Falling stock prices are no reason to sell if a company’s business quality and long-term earnings power remain unchanged.
If anything, lower stock prices reduce risk and increase the rate of future expected returns.
Instead of potentially shooting ourselves in the foot by trying to move in and out of the market, remain focused on what your companies are doing to further strengthen their competitive advantages and opportunities for earnings growth.
Price volatility is to be expected, but let it work for you and not against you. Only invest what you can financially and emotionally afford and stay focused on the long-term.
From Brexits to Black Mondays, there have been many financial and economic shocks that blue-chip dividend stocks have withstood over time.
In almost all of these cases, wonderful buying opportunities were presented to dividend investors who were able to embrace a long-term outlook and stay focused on business quality.