There has been plenty of ink spilt lamenting how Central Banker’s policy have distorted bonds.

In the U.S., one can still find Treasury bonds with a positive yield but globally over $13 trillion of sovereign bonds have negative yields.

The poster child for this insanity is a 50-year Swiss sovereign bond which yields negative .023%. Try to make sense of intentionally investing your money for 50 years with the guarantee of losing money. 

This has driven investors, institutional and individuals alike, into dividend yielding stocks. With “risk free” U.S. Treasury bonds and other relatively safe investment-grade bonds offering yields in the low single digits, “conservative” investors are struggling to find investments providing decent credit quality and respectable returns. The result of this quest for yield has been a mad rush by investors into dividend yielding stocks.

The following two graphs highlight how those stocks with the highest dividend yields are clearly most in demand this year. The first graph below plots the average, non-weighted, year-to-date returns for the stock of each S&P 500 company, categorized by their respective dividend yield ranges.

These stocks, such as Proctor & Gamble (PG) and Con-Edison (ED) now trade at historically high P/E multiples, despite low growth rates. But no-one perceives a problem, or at least they seem to be willing to ignore it, as long as interest rates stay anchored near zero.

Value Trap

The flip side of the bloated P/E’s for the utility and consumer staple stocks are the seemingly low values placed on sectors and companies that still have true potential earnings growth.

Michael Santoli, who has broad experience in market commentary, recently became a Senior Markets Commentator at CBNC. He recently presented on the theme of this blog post Is 2016 the Year of the Value Trap.

He accurately observed cyclical stocks trade at low P/E’s at times of economic tops and high P/E’s when the market is low. This widely-known observation (Peter Lynch from 30 years ago, for example) is certainly accurate. Santoli listed several current value trap stocks. He informed us that the market was suggesting the top of the economic cycle.

Since I have a value approach, driven by a sophisticated analysis of economics, I looked at his list with interest. Several of my holdings were on his list Ford (F), Gilead (GILD), Gamestop (GME) and a variety of airlines.

The problem is, he is attempting to explain what already happened. He does this very authoritatively. His real message is that traders have a fixation on yesterday’s news. Here are the problems:

• If the market has all of the answers, investors, traders, and CNBC watchers cannot gain any edge. Warren Buffett says he would be on a street corner selling pencils if markets were efficient. Does Santoli really believe he or his viewers can make money from an authoritative explanation of yesterday’s news?
• He is ignoring the important investing concept of being contrarian. That is where you can make real gains.
• He is ignoring the strong mean-reversion tendencies of relationships – like that between growth and value stocks.

I have seen this argument many times before. Past “value trap” candidates were MSFT, INTC, and CSCO, to pick a few prominent examples in which you got paid a healthy dividend while waiting for the stocks to recover.

They have recovered quite well, each gaining over 50% in the past two years alone, but putting a label on something is not analysis.

In sharp contrast, my approach is that 2016 is the year of the value stock. It is better to profit from finding market errors than a slavish devotion to what worked last month or last year. The current market is punishing cyclical stocks with recession valuations, with no recession in sight. We have two great ways to play this theme:

1. If there is a near-term catalyst, we just buy the stock in our long-only program.
2. If we expect time before the catalyst, we sell near-term calls with a target of 9% return. If the stocks are safe, the return is safe.

This is not an imminent warning to sell but an alert to monitor stock market valuations and not just dividend yields. The hunt for yield could easily persist driving prices even higher, but do not lose sight of underlying valuations.

At some point, as is true throughout the history of financial markets, regression to the mean will occur. Where others see a value trap, I see an income opportunity. Take what the market is giving you!