NOBL Has Been Beating The S&P 500 And Should Continue To Do So

ETFS

Main Thesis

The purpose of this article is to evaluate the S&P 500 Dividend Aristocrats ETF (NOBL) as an investment option at its current market price. After some wild rides, the broader market is back within a few percentage points of all-time highs, despite some fundamental challenges facing the global economy. While I do not believe a full-fledged sell-off is right around the corner, I continue to recommend a cautious stance on equities. In this light, I believe NOBL offers investors a reasonable risk-reward trade-off at current levels.

While not a “flashy” fund, NOBL holds “dividend aristocrats”, which are companies that have grown their dividends annually for at least 25 years (and many for more than that). Buying this fund is a play on large, established companies, that have proven they can maintain revenues and profits in all markets. While this may sound like a boring investment objective, keep in mind that NOBL has actually beaten the S&P 500 over the past six months, which was when I last recommended the fund. Furthermore, while sectors such as Consumer Staples appear expensive, I believe further upside is likely. The reasons behind the recent out-performance in bond proxies, such as Consumer Staples and Utilities, include trade-induced volatility, declining interest rates, and concerns over economic growth. All of these attributes remain in place currently, and are unlikely to dissipate by year-end. Therefore, I see dividend aristocrats as an asset class to add to going forward.

Background

First, a little about NOBL. The fund’s stated objective is “to seek investment results, before fees and expenses, that track the performance of the S&P 500 Dividend Aristocrats Index”. Therefore, the fund focuses exclusively on companies in the S&P 500 that have grown their dividends for 25 consecutive years (or more). NOBL currently trades at $71.12/share and yields 1.97% annually. I recommended NOBL when I covered it in early March, and its performance since then has been strong. In fact, it has beaten the S&P 500 since publication, as shown below:



Source: Seeking Alpha

With this performance in mind, I felt now was an opportune time to reassess NOBL and decide if it makes sense to remain bullish on the fund going forward. I believe it does, and I will explain why in detail below.

Why Aristocrats?

To begin, I want to do a brief summary on why I like dividend aristocrats in general, before detailing why NOBL specifically is a good hold. As I mentioned, I am generally cautious on equities right now, but dividend aristocrats are an area I am bullish on under most economic scenarios. While I do not expect the aristocrats index to go up always in a straight line, the fact that these established companies have such great dividend track records speaks volumes to me on their sustainability. Dividend growth is a metric I critically examine in any stock or fund I buy, and aristocrats fit that bill in a great fashion. It is quite an achievement to be included in this list (NOBL only has 57 holdings), and once this status is achieved companies will make staying on the list a priority. This tells me that these firms will want to do everything possible to remain in good standing, with respect to growing their dividends, and gives me comfort for the long-term.

Furthermore, this category of stocks is generally less volatile than the market as a whole, which could be what investors are looking for to attempt to smooth out the ride to finish the year. Consider that NOBL has a beta of .88, which makes it noticeably less volatile than the broader market, although it certainly can have large swings. Finally, the index is about to get a bit more diverse, with tech giant International Business Machines Corp. (IBM) is set to join the list in 2020. Currently, technology stocks make up only around 2% of NOBL’s holdings, so the inclusion of IBM will help diversify the fund starting next year. All these attributes help me remain bullish on NOBL.

I Like The Consumer Staples Exposure

I now want to focus on the Consumer Staples sector, which is NOBL’s top sector by weighting. In fact, it makes up almost 24% of total fund assets, which is up from 22% since March, as shown below:



Source: ProShares

Clearly, this is an important area for NOBL, but I believe it will be beneficial for the fund going forward for a few reasons. One, trade-induced volatility is sure to impact consumer-oriented sectors, but mainly the cyclical ones. Staples, on the other hand, relate to items consumers need (not merely want), such as household goods, food, and beverages, etc. These are items that consumers will need to buy regardless of the economy or market volatility, so I believe the exposure gives investor a smoother ride when things get dicey. While there has been progress on the trade front, there is still the reality that President Trump’s latest tariffs on China went in to effect at the beginning of the month. This reality is likely to cause some short-term pain once the positive news on potential negotiations set to take place in October begins to wear off.

Two, with interest rates set to decline further, investors should be looking at sectors that have negative correlations with interest rates. Fortunately, Consumer Staples has a very clear inverse relationship with declining treasury yields. This is not a new trend, but has existed for years, as shown below:



Source: TheStreet.com

As you can see, Consumer Staples have broadly rallied as treasury yields declined, and noticeably have shot higher when yields dropped aggressively. This shows a pretty clear negative correlation, that I would expect to continue it rates decline further. And this is exactly what markets are predicting, according to data compiled by CME Group. The futures market is predicting a rate cut in a few weeks at the Fed’s September 18th meeting, with a probability of over 91%. This tells me Consumer Staples should see some bullish momentum in the short-term.

Three, the sector has been less volatile post-earnings than the majority of the market. Currently, the market is punishing companies that fall short of earnings estimates, or project a lower outlook, to a larger degree than they are rewarding companies that beat earnings estimates. This imbalance has resulted in most sectors seeing negative returns during reporting periods, which happen to be larger than their average positive returns during non-reporting periods. In fact, according to data compiled by Bloomberg, only four sectors, including Consumer Staples, have seen positives returns during the 3-day period before, during, and after earnings releases, as shown below:



Source: Bloomberg

What this tells me is that companies within the Consumer Staples sector have been either meeting earnings estimates and/or offering strong enough guidance that investors are not punishing any misses or slowdowns. The same cannot be said across the market, which again makes me confident that investing heavily in Consumer Staples (or the funds that own them like NOBL) will help make the road ahead a bit smoother for investors.

Financials Sector Helps Overall Valuation

Another quick point I want to highlight on why I like NOBL has to do with its Financials exposure, which is the third largest sector by weighting in the fund. While I have been neutral on Financials as a whole in 2019, I appreciate the exposure for NOBL because it is helping keep the fund’s valuation below what it costs to own the broader market. When looking at the P/E’s of the S&P, NOBL, the Financials sector, as measured by the Financial Select Sector SPDR Fund (XLF), and individual Financial holdings, we see this exposure is bringing down the overall multiple of NOBL:

Sector/Fund/Benchmark Current P/E
S&P 22
NOBL 19
XLF 12
CINCINNATI FINANCIAL CORP (CINF) 15
PEOPLE’S UNITED FINANCIAL INC (PBCT) 11

Source: ProShares; Google Finance; Multipl.com

As you can see, while NOBL is certainly not “cheap,” it does trade at a nice discount to the broader market, which is especially attractive considering its recent out-performance. While the Financials exposure is only 12% of the total fund, its inclusion is helping to keep NOBL from getting too expensive (in terms of P/E), and that is another positive attribute in my view.

What’s The Risk?

Of course, betting on NOBL is not a “sure thing,” and investors do need to be aware of the risks of doing so at current prices. The primary risk that I see right now is the stretched valuation of defensive sectors, namely Utilities, Health Care, and Consumer Staples. As investors have dealt with an increasingly skittish market since late 2018, sectors considered “bond proxies”, such as the three listed above, have generated enormous interest. This is because investors are looking for reliable revenue streams, above-average dividends, and less volatility than the broader market. Because this theme has been playing out for so long, stocks/sectors that are heavily correlated to bonds have seen their P/E’s soar. Simultaneously, stocks with a negative correlation to bonds (more cyclical sectors) have actually seen their P/E’s decline over the last couple of years, as shown below:



Source: Bloomberg

My takeaway here is that these bond proxies are quite expensive, so investors need to be aware of that when considering new positions. While NOBL has very little exposure to the Utilities sector, Health Care and Consumer Staples make up over 1/3 of the fund, which is driving up the cost to own NOBL. Furthermore, this large run-up in price makes these defensive sectors more prone to sell-offs than they normally would be. In fact, to end last week (9/6), on the backdrop of positive trade developments, the Consumer Staples sector ETF saw net outflows of cash at a level not seen in decades, as shown below:



Source: Bloomberg

My point here is investors do need to recognize that this market is causing some imbalances within different sectors. This can make defensive-oriented sectors, such as Consumer Staples, more volatile than the historical range, in both directions. Therefore, when the “risk-on” trade re-emerges, such as last week, this is an area that could sell-off to a higher degree than investors are used to seeing.

However, my takeaway is still to stay the course with funds like NOBL. Yes, defensive sectors are seeing some volatility, but I believe the longer term trend still favors them. As we have seen over the course of the year, positive trade developments are often short-lived, so the flight back to safety could occur on a dime. Furthermore, dividend funds in general, not just NOBL, are likely to benefit from our continued low interest rate environment, especially if rates decline further as the market is forecasting. Therefore, I would not let the valuation or intra-day volatility deter me away from the fund at this time.

Bottom line

NOBL continues to be a fund I recommend, and feel investors could benefit from picking up shares heading in to 2020. I expect short-term volatility, and the focus on dividend aristocrats should help the fund weather any potential storm better than the market. With a high weighting in Consumer Staples, NOBL is made up of companies who should continue to see stable revenue and earnings, even if the trade dispute escalates further. Finally, while NOBL certainly is not trading at “value” levels, the fund is markedly cheaper than the S&P 500, which should help limit any downside from here. Therefore, I continue to view NOBL favorably, and recommend investors give the fund a serious look at this time.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NOBL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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