WHY HIGH DIVIDEND STOCKS SHOULD CONTINUE TO OUTPERFORM
By Walter Kurtz, Sober Look
At times when faced with stressed financial conditions, it is helpful to look through history for periods that bear similarities to the current environment. Obviously no two periods are ever the same, but the period of mid 40s to early 50s in some ways resembles markets of today.
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| US 10-year treasury yield |
Throughout WW-II and for some time after, the Fed conducted what could amount to QE by capping treasury yields. It allowed the US Treasury to finance the war effort at historically low rates by continually purchasing treasury securities. As an example, below is an excerpt from the FOMC minutes of February 29, 1944.
In the mid 40s the stock market had a fairly sharp correction after a strong rally, as the war-based industries had to shift focus toward the private sector (the familiar shift from government stimulus toward reliance on the private sector). From that point on the market did not materially appreciate until the early 50s.
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| The DJIA |
As expected it was the high dividend stocks that outperformed during that period. The chart below from Barclays Capital shows the relative performance of high to low dividend stocks.
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| Source: Barclays Capital |
The outperformance lasted for some five years through the stress period. In 1951 the Treasury-Fed Accord eliminated the Fed’s obligation to the US Treasury to purchase its securities at a fixed rate (which was forcing the Fed to grow balance sheet indefinitely.) This event began the normalization of the Fed’s monetary policy and ended the outperformance of high dividend stocks.
The chart below compares the Vanguard High Dividend ETF (VYM) with the overall market (SPY). Over the past year, VYM has outperformed SPY by close to 7%.
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| VYM vs. SPY (Bloomberg) |
Based on the similarities between the post WW-II period and now, this high dividend stock outperformance should continue until the Fed ends the period of easy monetary policy. And from all the indications we have, the Fed’s extraordinary accommodation should be in place for some time to come.
Why is “”Sober Look”" looking at the 1940s and 1950s ? That’s – IMO – comparing apples to oranges. I look at what happened to dividends and stocks in the late 1920s and early 1930s. And then I see something different. Then a lot of companies did cut or even eliminated their dividends. I equate high yields/dividends with high risk in the CURRENT situation. I know a company which announced late last year that they would lower their dividends and stop the share-buy-back program. And this was a company that had a high dividend yield in the last say 10 years.
In the late 1940s and 1950s dividends were high in order to attrack investors because stocks were considered to be dangerous. Source: A. Gary Shilling (“”the age of deleveraging”", 2010).
Walter Kurtz is correct; however, I would position the thesis a little different in order to broaden the strategy.
http://www.imf.org/external/np/seminars/eng/2011/res2/pdf/crbs.pdf
Has anyone noticed that Wall Street is completely oblivious to news and events around the world, or just doesn’t care? Must have hit the saturation point, and isolationism is setting in. It will take something really really big in the Middle East or Europe to turn heads.
I am not sure it is being oblivious. Institutional money knows it has become the dumb money. They know the music has stopped, they just are not allowed to stop dancing…… The big money has nowhere to go……. hence to LTRO.
http://www.ecb.int/events/pdf/conferences/cbc4/Caballero_paper.pdf
My personal indicator shows that there’s a divergence between e.g. the Dow Jones, the S&P 500 and Nasdaq on the one hand and financial health of the financial system on the other hand.
This was what I noticed in mid 2011 as well. That was for me the sign to go short a number of things.
Investors typically over-pay for risk. High quality dividend stocks being defined as companies that consistently pay and increase their dividends, have low debt ratios and show consistent earnings are high quality and lower risk. So I guess the question is not whether they will continue to out-perform, but that they always have.
Anyone in the stock market today in any segment is over paying for risk. Thank the Fed.
I am looking forward to invest in an sector that also will increase their dividends (dramatically) in the upcoming years while other sectors are going to decrease their dividends. But now is NOT the time to do so.
“”Should”" ? This is a “buy and hope” strategy and therefore doomed to fail.
I don’t know If dividend stocks will continue to outperform but it there is anything to the theory of efficient markets, with EVERYONE but the cat recommending high dividend stocks I am doubtful, since this observation should already be priced in.
may be because dividend stocks create real revenue from their business.
but i don’t know….
I would quote mr. Bob Hoye: “”As long as markets go up the gullable public will believe any preposterous story”". And that – IMO – applies to high dividend stocks as well.
I think dividend stocks will outperform for now because they are becoming the “talk of town” and everyone has suddenly become a “dividend guru”. Back in the 80′s nobody could care less about dividends, now of course they do since capital gains are going nowhere.
And yet, people forget that there is nothing “fundamental” in the dividend policy except for signaling effects.
It is also easy to forget that all this increase in dividends helps mask the fact that companies have nowhere to invest their accumulated cash, which cannot be good in the long run.
Dividend paying stocks are just another ‘fad’. I do not mean to be a contrarian at all costs, but conventional wisdom has done very poorly lately.