About the Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.

Josh manages DividendInvestor's model dividend portfolio, the Dividend Select Portfolio. Josh joined Morningstar in 2000 as an automotive and industrial stock analyst. After leaving in 2003 to join UBS Investment Bank as an equity research associate, he returned to Morningstar in 2004 to develop DividendInvestor.

Peters holds a BA in economics and history from the University of Minnesota Duluth and is a CFA charterholder. He is also the author of a book, The Ultimate Dividend Playbook, which was released by John Wiley & Sons in January 2008.

Investment Strategy

Dividends are for everyone regardless of age. The outcome of owning dividend-yielding stocks is the key variable-higher-yielding stocks with safe payouts being less risky while affording investors who don't need current income the ability to reinvest/reallocate the capital.

The goal of the Dividend Select Portfolio is to earn annual returns of 9% - 11% over any three-to-five year rolling time horizon. We further seek to minimize risk, as defined by the probability of a permanent loss of capital. For our portfolio as a whole, this goal is composed of:

3% - 5% current yield
5% - 7% annual income growth

May 25, 2016
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About Josh Joshs Photo
Josh Peters, CFA
Equities Strategist and Editor
Equities strategist Josh Peters is the editor of Morningstar DividendInvestor, a monthly newsletter that provides quality recommendations for current income and income growth from stocks.Josh manages DividendInvestor's model dividend portfolio, the Dividend Select Portfolio.
Featured Posts
Rate Rise Possible in June -- The Week in Dividends, 2016-05-20
With no earnings reports, dividend changes or research updates specific to our portfolio holdings, this has been a very quiet stretch in terms of company-specific news. But while the S&P 500 posted a small weekly gain after three weeks of modest losses, higher-yielding stocks took a hit. As discussed in the analyst note below, the latest commentary out of the Federal Reserve suggests that short-term interest rates may be lifted as soon as June.

There's no getting around the inverse relationship between interest rates and high-quality, high-dividend paying stocks in the short run, but the correlation grows weaker over time. Over many years, dividend income and dividend growth become the dominant factors in equity total returns. That's why I'm more concerned with the reliability of our current dividends and their long-term growth potential than with fluctuations in interest rates. The next few months may be rocky in terms of our portfolio's market value--indeed, heightened volatility and short-term losses are ever-present possibilities even for a conservative strategy like ours. But that's no reason to alter our approach, let alone dart off into other kinds of securities. Instead, if the markets throws a rate-induced tantrum, we may finally see some worthwhile opportunities to take some new positions (or add to existing ones) at more attractive prices.

Best regards,

Josh Peters, CFA
Director of Equity-Income Strategy
Editor, Morningstar DividendInvestor

Disclosure: I own all of the holdings of the Dividend Select portfolio in my personal accounts.

News and Research for Dividend Select Portfolio Holdings

Minutes From Fed's April Meeting Reinforce Our View That the Market Is Underestimating Coming Hikes
Market Note 05/19/2016 | Kristoffer Inton  

On May 18, the Federal Open Market Committee (FOMC) released its April meeting minutes. After the March meeting, the market viewed the Fed’s decision to maintain the federal-funds rate and reduce the number of anticipated 2016 rate hikes to two from four, as extending accommodative monetary policy. However, as revealed in the April minutes, this was not the intent. “…Communications after the March FOMC meeting led financial market participants to shift down their expectations concerning the likely path of the Committee’s target for the federal-funds rate.”
In response, the FOMC is taking a more aggressive stance in managing expectations. “…Market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly.” In line with this, Atlanta Fed President Lockhart and Dallas Fed President Kaplan have publicly stated a June increase is a possibility in recent weeks.
Barring a surprise in economic data, we continue to believe that a rate hike will come in June based on FOMC commentary. “…If incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal-funds rate in June.”
Market expectations for a June hike are rising. As of this writing, the implied probability of a hike based on 30-day Fed Fund futures prices has risen to 34%, compared with 15% yesterday and 1% a month ago.
Rising interest rates threaten gold prices. The release of the April minutes alone led gold prices to drop nearly 2%, and gold miner share prices to drop in high-single to low-double-digits. The 2016 gold price rally has led to inflated miners’ share prices, and we expect rising rates to force a correction toward our fair value estimates.
The Fed’s dual mandate is maximum employment and stable prices. However, with unemployment in line with the Fed’s long-term natural rate of 4.8%, we believe inflation remains the concern. However, FOMC members appear confident that inflation will improve. “…With labor markets continuing to strengthen, the dollar no longer appreciating, and energy prices apparently having bottomed out, inflation would move up to the Committee’s 2 percent objective in the medium run.” In fact, 5-year forward inflation expected rates have ticked up to about 1.7%, compared with 1.5% earlier this year. If inflation continues to strengthen, we don’t expect it to remain a barrier to a rate increase.
Earlier this year, the FOMC had also included global economic risks in its statement, uncommon for the central bank. However, the Fed’s concerns for global economic risk impacting the U.S. seem to have fallen, as discussed in the April minutes. “Participants generally saw the risks stemming from global economic and financial developments as having diminished over the intermeeting period but as continuing to warrant close monitoring.” While potential events like the Brexit or major changes in China's economy could force a change in policy, the Fed concern over global economic events has lowered and is unlikely to be a major factor in a June rate decision.

Potential Bank Energy Losses Look Manageable, but Canadian and European Banks Remain Under-Reserved
Industry Note 05/19/2016 | Erin Davis

After rounding up first-quarter updates, we remain convinced that exposures to energy remain manageable for most U.S., Canadian, and European banks. We see positive indicators for investors on four fronts. First is the strength of underlying markets--the price of Brent crude has risen to nearly $50 per barrel from below $30 in early January, alleviating pressure on oil companies and reducing likelihood of default. The second indicator, that market expectations of losses have lessened significantly, is related. In our note of Feb. 11, we noted that the S&P 500 Energy Corporate Bond Index (essentially all investment-grade) was projecting losses of about 15%, while the Bloomberg USD High Yield Corporate Bond Energy Index (junk) was projecting losses around 30%. These indexes are now projecting losses of 5% and 20%, respectively. Third, enhanced disclosures show that banks’ energy exposures tend to be high-quality. Among the U.S., Canadian, and European banks that we cover, around 59% of credits are high-quality (investment-grade or similar at the 58% of covered banks that provide quality metrics). Finally, and perhaps most importantly, at an absolute level, energy exposures remain low and manageable relative to banks' common tangible equity. We estimate that 15% energy losses would consume an average of 3.1% of common Tier 1 equity. For a bank earning a 10% return on equity, that’s one quarter’s worth of earnings--clearly not a material threat to capital strength or bank moat ratings. Current market projections (losses of 4% on energy exposure) make potential additional write-downs look even less threatening, averaging near zero for U.S. banks and just 1% of common equity Tier 1 capital for Canadian and European banks. We still think investors should take advantage of market worries to invest in Citigroup and TD Bank, which are among our top investment ideas; both are significantly undervalued and face no significant threat from a renewed fall in energy prices.

Taking a more granular look at the updated first-quarter data, we see two interesting results.

First, U.S. banks, which report under U.S. GAAP, tend to be much better reserved for energy losses than Canadian and European banks, most of which report under IFRS. At U.S. banks we cover, we calculate that reserves are sufficient to cover 44% of potential losses in a 15% loss scenario, with coverage ratios ranging from more than 60% at Wells Fargo and Huntington to a still-reasonable 30% at Citigroup and Bank of America. In contrast, at the Canadian banks we cover, reserves are sufficient to cover just 5% of losses in a 15% loss scenario, with coverage ranging from a high of 12% at Royal Bank of Canada to a low of 3% at Bank of Montreal. Disclosed energy-specific provisions at the European banks we cover are essentially nonexistent, leaving these banks still fully exposed to potential losses. To be fair, we should note that this gap in provisioning springs from differences in how the two accounting standards require banks to recognize losses. U.S. GAAP recognizes expected losses, while IFRS recognizes only incurred losses. These standards are expected to largely converge in 2018, when IFRS rules will change to require banks to recognize lifetime expected losses.

Second, while average exposure to energy is manageable, some banks have significantly more exposure than others. None of the banks that we cover would face losses equivalent to 10% of common equity Tier 1 capital, or a full year’s earnings for a bank earning a 10% return on equity, in a 15% energy loss scenario, but a few are close. We’re particularly concerned about Standard Chartered, where a 15% loss on energy loans could consume 9.3% of common equity Tier 1 capital, and Cullen-Frost, where this loss could be 8.1% of common equity Tier 1 capital. In the case of Standard Chartered and many European banks, there may not be much in the way of near-term earnings to offset these losses, and capital raises or other long-term setbacks could result. We also call out National Bank of Canada, BNP Paribas, Bank of Nova Scotia, and CIBC as more exposed, with potential 15% losses consuming 5%-7% of common equity Tier 1 capital. We think all of these banks will be able to muddle through if today’s improved conditions persist, but could face devastating losses of 10%-20% of common equity Tier 1 capital if losses were to rise to a 30% worst-case level.
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