Dividends, dividends, dividends, with the exception of the election, it seems that was one of the big investment themes of 2016. But what about now with a Fed interest rate increase(s) more than likely in the coming months.
Here is why dividend investing has been the way to go. Just look at this chart.
What this says is that if you invested solely in the S&P 500 over a recent 10-year period, your total return, which includes dividends, would have been nearly four times greater than from capital appreciation alone.
If that doesn’t make your eyes light up, consider that this is just an average. If you happen to be a particularly good stock picker, wham! I grant that any data pool can be manipulated to demonstrate just about any point so you may not want to put full faith in the data on dividend stocks. But results on the S&P 500 offer strong proof, at least about history. But, is there still a case for dividend investing today?
Excess financial returns can be lasting so long as there is an abundance of supply and a shortage of smart investors. To appreciate why it appears that dividend investing has taken on mania proportions while still offering perfectly logical economic reasoning requires an understanding of the deeply rooted forces.
The stock market correction in 2000 ushered the current over performance of dividend stocks. Global deflation produced ever-lower interest rates. The US Treasury 10 Year Note for example yielded 2.43% in January 2003 and 2.38% four years later in 2007. At it’s 2016 low, the yield was a meager 1.42%.
As recently as 2004 dividend yields on S&P 500 companies offered a comparatively less miniscule 1.60% yield compared with the US Treasure 10 Year Note at 4.18%. This all changed in 2008 when the financial crisis drove investors to the 10 Year Note driving yields to new lows. The two rates intersected about that time igniting the most resent over performance of dividend based stock investing.
But history notes that no financial trend can provide superior performance forever. Even Bernie Midoff’s unique methods finally came to an end. So let’s take a few things into account.
Dividends are paid to shareholders for one simple reason. Corporate management can’t find a better place to put the money. Apple may be able to keep shareholders content with a bazillion dollars in the bank but most other company owners want to grab some of the loot. So putting money away for a rainy day is not an option.
Since the 2008 financial crisis, investing capital on plant and equipment has gone nowhere. Companies have been buying up their own stock and paying out dividends using very low cost borrowed money. It is a common sense approach to financial management and it is one of the bigger factors in helping the stock markets recovery going for nearly a decade now.
Outsourcing of manufacturing is one important explanation for reduced US capital investing. High taxes and excessive regulation are another. Changing this is the mantra of POTUS 45.
If you are betting on Mr. T making US manufacturing great again, that is going to take a heap of capital and that means the habit of buying in stock and boosting the dividend will be affected. How much? It’s too early to speculate, but it will happen.
Total return investors will shrug their shoulders and point out that any reduction in dividends or dividend growth will be offset by gains through capital appreciation. That is entirely true. But income investors banking on year after year of superior dividend growth will want to adjust their budgets.
The one question that remains a true mystery is this. If the Fed increases interest rates multiple times this year will dividend-yielding stocks over or under perform? Since the market has reached record levels during the December rate increase and multiple rate increases have about a 40% chance in 2017, it is hard to know the answer. In this case, there is a risk to equities in general and when the when the market corrects, it tends to take everything with it. Stay tuned.
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