Long on Europe

By Gerelyn Terzo - August 28, 2012 | Tickers: LLY, TOT, VZ, VOD | 0 Comments

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Market contrarians are always fascinating to listen to if for the simple reason that they are not part of a herd mentality. Independent thinking has long been the breeding ground for investment ideas, from the likes of John D. Rockefeller to Warren Buffett to John Paulson.  Nonetheless, I can't help but experience some whiplash when I hear someone touting European equities.

Jim O'Shaughnessy of the investment house that bears his name with some $4.7 billion in AUM is in fact hunting for opportunities across the pond. If he were looking for distressed assets I might just place him in the Indiana Jones risk-taker category and call it a day. The truth is, however, that O'Shaughnessy believes we're in a 'bond bubble,' according to a segment on CNBC. Investors who are fleeing stocks for debt are 'locking in a loss,' he said. For instance, with a 10-year note yielding 1.8% and inflation running at 3%, pointing investors to bonds is 'irrational.'

And unlike Bill Gross, this asset manager does not believe that the cult of equities is dead. Indeed, he is doing something even more breathtaking - buying European stocks. In fact, nearly half - 45% - of O'Shaughnessy's assets are in Europe, with the remaining exposures across North America and Asia.

Here's the rub.  Like a fixed income investor, O'Shaughnessy's strategy is tied to income. He is buying high-yielding, dividend paying stocks across telecommunication and energy. The strategy is working, as the enhanced dividend portfolio is offering a dividend yield of 5.3%. Companies in the dividend portfolio include:

• French energy company Total (NYSE: TOT), which currently has a dividend yield  about of 5.37%
• Vodafone (NASDAQ: VOD), a British telecom play with a dividend yield of about 5.7%

Other more recognizable names include Verizon (NYSE: VZ), which has a dividend yield of about 5.4% and Eli Lilly (NYSE: LLY), which has a dividend yield of about 5.49%. One thing all of these names have in common is that they are all "very secure companies," he said, adding that in Europe, it's very important to separate the Sovereign problems from companies with financial strength. "There are a lot of tremendous bargains now in Europe paying high dividends," he said.

Investors may not want to design a portfolio devoted solely to dividend income, and understandably so for those seeking alpha. But if dividend yield is any indication of future stock performance, there are indeed some stocks on sale. Dividend income is nothing to sneeze at either, especially in waters of market uncertainty where we continue to tread.

Based on a study performed by O'Shaughnessy, dividend investors came out on top even in one of the worst decades in market history. If investors were to focus solely on the income portion of their portfolios as opposed to the market value for the period 2000-2009, they would have increased their income by over 12% annually. Included in this calculation was 2008, when corporate values were slashed nearly in half. "When stock prices go down, dividend yields go up. We saw an increase in income in [2008]," said O'Shaughnessy.

The moral is that when investors are focused on dividend income, whether in Europe or in the US, they are likely to maintain some income stream each year. A dividend strategy is reassuring in a world with competing regional unemployment rates and a 'new normal' penetrating the financial markets.

Incidentally, this morning in the media circuit, PIMCO's Mohamed El Erian brought some clarity to recent comments made by his boss Bill Gross. By suggesting that the cult of equities are dead, Mr. Gross meant two things:  1.) Returns will be lower - expect average market returns of 4-6% for equities and 3% for fixed income; 2.) asset class correlations will change so investors must be more agile in the way they invest. With this backdrop, dividend income is looking more appealing than ever.

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