A 'buy-the-dip' strategy

"Buy the dip," and take a close look at the shares of companies with attractive yields, said David Bianco, chief U.S. equity strategist for Merrill Lynch & Co. Inc.

He expects only a modest stock market correction at a time when "the relative attractiveness of stocks versus bonds is close to a 50-plus-year high despite the 55 to 60 per cent rally from the bottom."

Five-per-cent pullbacks are not uncommon and should not be taken as signs of an impending stock market correction, he said.

The current dividend yield of 2.1 per cent on the S&P 500 compares favourably with the negligible yield on bank deposits and the implied 1.5 per cent yield on 10-year Treasury inflation-protected securities or TIPS. The yields on common shares and TIPS should both grow in line with inflation.

The dividends being paid on the S&P 500 are also currently at a depressed level because of the severe contraction in payouts by the major U.S. banks. The dividend yields on Bank of America, JPMorgan Chase, Wells Fargo & Co. and Goldman Sachs Group Inc. range from 0.28 to 0.84 per cent. (By way of comparison, the shares of the major Canadian banks yield between 3.7 and 5.6 per cent.)

There are 20 S&P 500 companies cited by Merrill Lynch as being stocks with attractive yields. The yield on those equities range from 2.3 per cent (insurance company XL Capital Inc.) to 4.85 per cent (Merck & Co.).

Some of the household names fitting the bill in Merrill's screen are McDonald's Corp. (3.7 per cent), Coca-Cola Co. (3 per cent), Kraft Foods Inc. (4.2 per cent), Philip Morris International Inc. (4.7 per cent), Boeing Inc. (3.4 per cent) and Intel Corp. (2.9 per cent).

Companies with good yields are a low-risk way of participating in what should be healthy broad market gains into the year-end, while utilities can serve as a bond substitute play, Mr. Bianco said. He views consumer staples as the best way of playing companies with strong earnings and dividend growth potential.

Meanwhile, stocks continue to trade at attractive prices. The price-to-earnings multiples are attractive, especially given the likelihood that inflation will remain in check as a result of the high unemployment rate and unused manufacturing capacity, according to the report. The yield on the 10-year U.S. Treasury is also likely to remain relatively low as U.S. households sock money away into bonds, keeping prices up and yields down.

The S&P 500 is currently trading at about 16-times the forecast 2010 earnings, which can be easily justified with 10-year U.S. Treasuries yielding 4 to 5 per cent, Mr. Bianco said. Currently, the yield is only 3.4 per cent, which would allow a moderate rise in long-term interest rates as the economic recovery continues.

Corporate profits could also exceed expectations as a result of lower-than-expected energy prices and foreign exchange gains, he said. "We feel increasingly confident in the sustainability of the U.S. and global economic recovery."