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Stock dividends on the rise

Picking up: after lagging the overall market, the tide appears to be turning for dividend-paying stocks

After a long hiatus, stock dividends may finally be having their day in the sun.

Last year, dividend-focused strategies lagged the overall market averages by a wide margin. In the year of the pandemic, investors flocked to growth stocks leaving more mature and economically sensitive dividend payers in the dust. As the S&P 500 rose 16.26 per cent last year, the US Dow Jones Dividend Select stock index (a representative basket of high payers) fell 4.56 per cent, underperforming by over twenty per cent.

Last year’s pivot away from dividend payers caps a much longer period during which these stocks had been largely overlooked. Over the past seven years through last year-end, the S&P 500 – largely driven by a handful of mega cap technology growth stocks – more the doubled the total investment return provided by the high paying dividend stock index.

The trend away from high payers was even more pronounced in the international markets. The Dow Jones Global Dividend Select index, eked out a mere 2.53 per cent average annual return over the past seven calendar years. Besides the investment style shift, we saw a preponderance of dividend cuts in 2020 as harsh government responses to the pandemic adversely impacted the most economically sensitive parts of the economy.

But in recent months, the tide appears to be turning. For the first quarter of this year, the Dividend Select index is up 19.70 per cent, compared to a 6.17 per cent increase in the broader S&P 500 stock index. The Global Dividend Select index has risen by 14.59 per cent for the period.

Going forward, market analysts are optimistic about dividend reinstatements and raises for 2021 and beyond. According to a recent report from IHS Market, “Dividends declared by firms in 2021 are predicted to approach $1.78 trillion, up 6.5 per cent from the $1.67 trillion paid by the same firms in 2020. The market survey company reported, “Our positive outlook reflects increasing business visibility, wider availability of a Covid-19 vaccine, and the strength of the Asia Pacific and emerging markets.”

While the healthy rebound in payouts is welcome, further ground remains to be covered from last year’s dividend decline – a 12 per cent drop from 2019 levels. That’s on a global basis, though. In the US, total dividend payments actually rose 2.4 per cent to just over $500 billion, including special one-time dividends paid late in the year as the economy began to recover.

Clearly, the pandemic has been causing unprecedented volatility in payouts which ultimately led to suspensions from some of the largest payers, particularly in Europe and the UK. However, with the Brexit deal completed and the increasing availability of vaccines, uncertainty is expected to gradually dissipate and encourage more companies to resume payments or grow dividends this year.

A common presumption about high-dividend paying companies is that they will not act well during a period of rising interest rates. The theory is these stocks act like bond substitutes and therefore as yields grind higher, these companies will be less attractive to investors who might buy bonds instead.

Indeed, since the beginning on this year longer term interest rates, as measured by the ten-year US Treasury bond have markedly climbed from 0.91 per cent to 1.74 per cent at the end of the latest quarter. However, the positive price action in many dividend paying sectors demonstrates this theory is not always accurate. In fact, our view is that we are seeing more of a normalisation of interest rates at still low levels rather than extended period of rising yields.

On this point, Federal Reserve chairman Jerome Powell recently indicated the US central bank’s intention to maintain the current quantitative easing programme. On multiple occasions, Powell has reiterated the Fed’s commitment to a dovish monetary policy until reaching the dual goal of full employment and two per cent inflation on a sustainable basis.

Powell has downplayed the risk of inflation overheating, citing any inflation surge this year will likely be transitory. Based on the latest FOMC dot plot, majority of the policymakers forecast that the first rate hike will not happen until 2024.

Dividend payers could therefore continue to shine over the next few years as we experience an ongoing era of low interest rates suppressed by massive government debt issuances, ageing populations, ubiquitous technological adoption and other deflationary forces.

Adding to their attractiveness, many of the highest paying equities are more closely tied to economic growth prospects which continue to look encouraging as the world gradually reopens. The Dividend Select index, for example, maintains large positions in banks, diversified financial companies and energy holdings which are all closely tied to economic growth.

Electric utilities, one of the largest sectors in the high dividend paying universe, is not only leveraged to macroeconomic growth but also has covert exposure to the burgeoning field of green energy.

According to a recent Barron’s article: “As electric vehicles gain market share, power for them will shift from petroleum to the utilities. A massive increased power demand should significantly boost utilities’ revenue and earnings annually for the next two decades.”

“What’s more, the current power grid can’t handle that increased demand. Utility infrastructure spending, in addition to outlays for renewable power sources and batteries, will be immense. That will benefit power-infrastructure construction companies.”

As equity markets touch new highs, investors searching for attractive long-term income and growth opportunities should consider carefully selected dividend payers as part of a balanced portfolio.

Bryan Dooley, CFA is Head of Portfolio Management at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.

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Published April 13, 2021 at 8:00 am (Updated April 08, 2021 at 5:13 pm)

Stock dividends on the rise

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