VIG: A Fund For The Long Term – Vanguard Dividend Appreciation ETF (NYSEARCA:VIG)

Main Thesis

The purpose of this article is to evaluate the Vanguard Dividend Appreciation ETF (VIG) as an investment option at its current market price. While VIG is a not a “flashy” fund, it consistently performs well, as it is comprised of large, U.S. companies that annually increase their dividends – which is a recipe for long-term success. VIG’s Q1 dividend increased by a large amount on a year-over-year basis, suggesting accelerating dividend growth at a time when the Fed has halted interest rate increases in the short-term. This is a winning combination in a low-rate environment. Furthermore, VIG is heavily exposed to the U.S. consumer, and the picture there is positive as well. Consumer spending was up strongly in March, and wages continue to climb across the board. While trade-war fears are currently dominating the headlines, I believe VIG is comprised of the right types of companies that will emerge from any geopolitical risk just as strong as ever.

Background

First, a little about VIG. The fund “seeks to track the performance of the NASDAQ US Dividend Achievers Select Index,” which includes companies with a proven track of consistently raising their dividends. VIG is currently trading at $111.33/share, and based on its four most recent distributions, is yielding 1.92% annually. The last time I covered VIG was back in September, when I viewed the fund positively. Since then, quite a bit has happened, including a 20% market correction and a swift rebound. Through this all, VIG has returned about 1.5% since that time, after accounting for dividends. Given the recent volatility in the market, I felt a review of VIG was timely, and continue to view it as a fund long-term investors should hold. This is a fund to use to ignore the short-term market noise and own for the exposure to time-tested companies who increase their dividends in all economic cycles, and I will discuss the fund’s merits in more detail below.

Dividend Growth Robust in 2019 So Far

My first point on VIG is related to the fund’s dividend. As a dividend-focused fund, which only holds companies that increase their payouts consistently, I would expect marked growth in the fund’s distribution over time. Without it, I would question whether the fund’s holdings are truly raising their dividends in a meaningful way. While even small increases on a consistent basis add up, healthy growth year after year is even better. On this front, VIG is meeting the mark, with dividend growth accelerating in the short term, as illustrated in the chart below:

Source: Vanguard

As you can see, dividend growth was very robust in Q1 2019, but I would not expect this same level of growth to persist throughout the full calendar year. However, I still view this quite positively, as it showed a marked improvement over the Q4 distribution (in terms of growth), and this acceleration was not expected, in my view, as the immediate impact from corporate tax reform should have been largest last year. To see the dividend grow in an even more meaningful way to start 2019, provides me with a lot of confidence in the underlying holdings in VIG.

U.S. Consumer Is A Bright Spot

I now want to turn my attention to the health of the U.S. consumer. While the economy as a whole is heavily reliant on consumer spending, so is VIG, as almost 1/3 of the fund is exposed to consumer-oriented sectors, as illustrated in the chart below:

Source: Vanguard

With this in mind, I wanted to examine the current state of the U.S. consumer, and to see if we can rely on the sectors most reliant on the consumer to help drive VIG higher.

Fortunately, recent data shows a healthy backdrop in this regard. Based on data released by the U.S. Department of Commerce and compiled by Bloomberg, consumer purchases rose in March by .9%, in a month-over-month comparison. This was a bump from a .1% increase in February, and was actually the biggest month-over-month gain in a decade, as illustrated in the graph below:

Source: Bloomberg

Similar to the dividend growth, I see this recent acceleration as a very positive sign, as it shows continued confidence in the all-important consumer sector. Importantly, with inflation low, I would expect consumer spending to remain robust as rising prices are not currently chipping away at individual buying power.

On this point, it is also important to highlight rising wages, which has been a key factor in the consumer spending results. According to the April release from the U.S. Bureau of Labor Statistics, real average hourly earnings increased 1.3% in March on a year-over-year basis. While positive, what was most striking to me was the 1.6% rise in wages (same time period) for production and non-supervisory employees. This means lower-income employees are actually driving wage gains across the country, which is a very positive sign for a few reasons. One, it helps reinforce that the economic recovery is finally helping the workers who were initially feeling left behind. Further, this is a segment that is more likely to spend wage gains and inject that money back in to the economy, as opposed to high-income earners who would be more likely to save/invest it, as a lower percentage of their income is used on basic spending. On all accounts, this data from March should help support consumer spending in the near-term, and that is good news for VIG.

Interest Rate Outlook – Dovish

A final point on VIG, and most dividend funds for that matter, is the current dovish stance by the Federal Reserve with respect to interest rates. While the four rate increases last year created volatility among most equities, dividend payers were especially hit, as the value of their income streams decreases when the risk-free rate goes up. As investors are likely aware, VIG suffered in Q4 along with most of the market, so even dividend achievers are not immune to a correction when the interest rate forecast changes.

Fortunately, the fund can also move in positive directions when the Fed relaxes its forecast, and that is what has happened so far in 2019. While the Fed entered the year expecting to raise rates twice, their current stance is “hold”, and a “wait and see” approach, which has left many investors expecting zero increases to come this year. In fact, while the Fed has not specifically mentioned cutting rates, the market believes there is a strong possibility that will happen by year-end, according to data compiled by CME Group, which tracks the futures market for investor sentiment on interest rate movements, illustrated in the chart below:

Source: CME Group

As you can see, market participants view a rate decrease by year-end to be the more likely scenario, rather than a hike.

I do want to point out that my personal view is rates will stay at a neutral level until 2020, but it is always important to consider market sentiment. Regardless, the current outlook is that the probability of rate hikes in the short-term appears to be an unlikely scenario. This is regardless of whether or not there is a cut by December. That is a tailwind for VIG, along with most income-oriented products, and that is not a scenario I see changing over the summer months.

Furthermore, the data behind the Fed’s decision to hold off on further hikes continues to favor the dovish stance. The Fed continues to target the 2% inflation mark, and the data shows inflation is actually moving in the opposite direction, as illustrated in the graph below:

Source: Bloomberg

As you can see, the personal consumption index is actually dropping over the past few months, and, at 1.6%, is well below the 2% Fed target. Until this metric picks up, and the current downward trend suggests this is not likely in the immediate-term, the Fed should continue to hold off on rate increases. For now, dividend investors can take some comfort in this dovish stance, as the data is supporting it.

Bottom Line

VIG is I fund I regularly recommend, although it came under pressure at the end of last year just like most funds. With interest rates moving higher, dividend payers were particularly prone to a pullback, and that did indeed occur. However, much has changed since last December. The Fed has paused further rate hikes, and the economy, as well as the stock market, are on the rebound. Consumer spending remains robust, and rising wages should support that trend going forward. Furthermore, inflation remains tame, which should likewise support consumer spending as well as convince the Fed to continue to remain dovish for the year. With strong dividend growth in Q1, VIG has a noticeably higher yield than it did during my last review, which is important for investors looking for income. Therefore, I continue to like VIG, and continue to recommend investors consider the fund at this time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.