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After an 18-month run of nearly uninterrupted outperformance for tech stocks, conditions changed rapidly in July. The markets had been generally satisfied that economic growth had remained resilient enough and that inflation was moderating steadily. Investors grew confident that the Fed might actually achieve the soft landing and that made them more than comfortable enough to keep loading up on growth equities.

That changed in July. A much lower than expected inflation reading and another tick up in unemployment raised concerns that maybe the pendulum was swinging too far in the other direction and the economy was slowing too quickly. Investors didn’t abandon equities altogether, but they made a massive rotation into defensive and undervalued. That resulted in one of the best stretches ever for small-caps relative to large-caps and one of best rallies for value, low volatility and dividend stocks in about two years.

July and August produced a much better environment for non-tech stocks. Cyclicals (save for energy) did very well as steady GDP growth numbers convinced a lot of folks that recession was far from imminent. Yet defensive sectors, including utilities and consumer staples, rebounded as some folks decided to take some risk off the table. For the first time since 2022, the U.S. stock market was broadening out and the magnificent 7 was no longer the “set it and forget it” option to generate 20%+ gains.

What Worked & Didn’t Work in August

Overall, dividend stocks outperformed the broader market, but it was those with a specific tilt that did comparatively better.

The WisdomTree U.S. Total Dividend ETF (DTD) beat the S&P 500 by a narrow margin, but factor-tilted dividend ETFs did much better.

High yielders, represented by the SPDR S&P 500 High Dividend ETF (SPYD), outperformed the index by more than 2%. This fund is heavily weighted in real estate, utilities and financials, three of the best-performing sectors in August. Real estate benefited from falling interest rates, utilities benefited from the defensive shift and financials did well due both interest rates and the rise of cyclicals.

Dividend growth, represented by the ProShares S&P 500 Dividend Aristocrats ETF (NOBL), was next up beating the S&P 500 by about 1.3%. This portfolio leans heavily towards more established, durable companies, which means higher allocations to defensives and cyclicals.

The quality factor, represented here by the Global X S&P 500 Quality Dividend ETF (QDIV), has been tilted towards tech and growth in recent quarters, but not in this fund. Its heavy focus on consumer staples and industrials with strong balance sheets fell right into the market’s sweet spot. It also has almost no exposure to tech, which helped it avoid a primary source of underperformance.

I see economic conditions continuing to deteriorate throughout the remainder of this year. The labor market is clearly slowing and it may actually be in worse shape than we realize. This is the one thing that’s reflective of everything else going on. If the unemployment rate keeps trending higher, it’s a strong sign that the corporate landscape is weakening and it will soon spill over to consumers and their ability to keep spending.

3 Dividend ETF Picks For The Rest Of 2024

For these selections, I'm going to start with the universe of dividend ETFs according to the ETF Action database, which currently includes more than 160 ETFs.

Sometimes, I start by narrowing down the universe to just U.S. dividend ETFs, but I'm going to consider international and emerging markets ETFs as well. We've seen international stocks start to pick up some momentum here. The falling dollar along with the preference for more value-oriented stocks could play well for foreign dividend ETFs.

To start out with, I’m going to eliminate from consideration ETFs with high value or growth tilts. Some of these turn out to be outliers and can actually demonstrate above average volatility. Plus, I’m more concerned with managing risk here than anything. That narrows down our universe to 125 funds.

Next, I want to consider funds with at least an average quality factor. With anything below the midpoint you risk including portfolios with below average fundamentals. I want something more durable and proven to help protect against major downside risks. That takes us to 87 funds.

I also want funds with at least some positive momentum. The momentum factor has obviously been filled with growth and tech stocks in recent months, but a positive momentum score indicates areas of the market that are more in favor and could have some more run in them. I don’t think this should be the be all and end all selection criteria, but it should be at least helpful. We’re at 71 ETFs now.

I also want to include a risk-adjusted performance criteria. Solid performance is fine, but taking excessive risks to achieve that performance isn’t a good idea. I’m going to add a screen to include only ETFs with a positive alpha over the past three years. I know that will eliminate newer funds from consideration, but I really want ETFs that have a demonstrated history of risk-managed outperformance. Now we’re down to 35 funds.

That should provide a good group to make my dividend ETF selections from. We’ve narrowed the larger universe down to about three dozen funds that look well-positioned for where the economic trends are heading and have demonstrated a history of producing above average risk-adjusted returns.

After looking through this list of funds and making some of my own qualitative assessments, here are the three dividend ETFs that I’m particularly positive on for the final four months of 2024!

FlexShares Quality Dividend Defensive Index ETF (QDEF)

I talk often about my fondness for the FlexShares U.S. Quality Dividend Index ETF (QDF). It focuses on companies with strong profitability, high management efficiency and healthy cash flows. The qualifying components get optimized to control risk and maximize yield. QDEF follows the same portfolio construction methodology, but its portfolio gets optimized to produce a beta of between 0.5 and 1.0.

The fund’s current top 3 holdings consist of Microsoft, Apple and NVIDIA, while Facebook lurks lower in the top 10. I’m not necessarily a big fan of that much magnificent 7 exposure at the top of the portfolio, but the overall fund composition is consistent with what it sets out to do. Balance sheet health is strong and the fund’s beta over the past year is a very reasonable 0.81. I think this combination of growth potential and high quality could do well regardless of the market environment.

ALPS O’Shares U.S. Small Cap Quality Dividend ETF (OUSM)

OUSM hits on three themes that I believe could all outperform in latter part of this year - quality, low volatility and dividend yield. Its overweights in cyclicals and discretionary stocks could mean it’s going to be more heavily reliant on economic growth rates holding up, but these are companies with high margins and strong returns of equity. Therefore, they should hold up much better should conditions turn south.

OUSM’s real value (pun intended) could be its focus on small-caps. I’m a believer in the value factor’s potential for outperformance later this year and few groups have as much value built in as small-caps. We saw this play out in July when the great rotation occurred and small-caps really soared. I’m not sure we’ll see outperformance to that degree again, but I do think this portfolio is set up well.

Schwab International Dividend Equity ETF (SCHY)

If you’re a fan of the Schwab U.S. Dividend Equity ETF (SCHD), you’re probably going to be a fan of SCHY as well. That’s because it’s essentially the international version of it. They are both among the few funds that utilize elements of dividend growth, dividend quality and high yield in their selection process. The processes ultimately narrow down the equity universe to a narrow group of stocks that possess all of the best qualities of dividend payers. SCHY simply looks overseas instead of within the United States.

This kind of multi-factor strategy is really ideal for any environment, but it could prove especially useful in this one. SCHD, in particular, really struggled when growth was dominating, but did very well under almost every other set of conditions. As tech continues to lose its stranglehold on the markets, SCHD and SCHY could be elite performers.