4 Reasons To Consider Dividend Growth Stocks Today (20/07/2019)
Four macro factors supporting dividend growth investing:
- Macro factor 1: Lower expected equity market capital returns.
- Macro factor 2: Stable-to-falling interest rate environment.
- Macro Factor 3: Inflation uncertainty.
- Macro Factor 4: Aging demographics.
In the decade following the Global Financial Crisis, global fixed income yields have remained low by historical standards - and many investors have turned to dividend growth stocks for their combination of yield and capital appreciation potential. At Invesco Unit Trusts, we don’t see this trend abating anytime soon. In fact, we believe the current environment may be especially well-suited to investing in dividend growth strategies, due to four macro factors described below.
A history of higher returns and lower volatility
Before we discuss today’s environment, what’s the appeal of dividend growth stocks in general? Companies that are growing their dividends tend to be associated with advantageous business models, strong fundamentals, and good stewardship of shareholder capital. While these stocks can be eclipsed by non-dividend-paying momentum stocks in the short term, they have proven to be an effective strategy to generate attractive returns with lower volatility in the long term (Figures 1 and 2).
Figure 1: Dividend growth stocks have a history of higher returns
Growth of $100 invested in the S&P 500 Index and the S&P 500 Dividend Aristocrats Index, with and without reinvesting dividends, over the past 10 years (6/30/2009 - 6/30/2019).
Source: Bloomberg, L.P. A total return index assumes that dividends are reinvested back into the index. Past performance does not guarantee future results. An investment cannot be made directly into an index.
Figure 2: Dividend growth stocks have a history of lower volatility
Historical 260-day annualized volatility of the S&P 500 Index and the S&P 500 Dividend Aristocrats Index, over the past five years (6/30/2014 - 6/30/2019).
Source: Bloomberg, L.P. The 260-day price volatility equals the annualized standard deviation of the relative price change for the 260 most recent trading days closing price, expressed as a percentage. Past performance does not guarantee future results. An investment cannot be made directly into an index.
Four macro factors supporting dividend growth investing
Macro factor 1: Lower expected equity market capital returns. From the market low on March 6, 2009, through June 30, 2019, the S&P 500 Index has returned over 17% annually, inclusive of dividend reinvestment.1 While bull markets don’t die of old age, we believe that historical market returns and current market valuations suggest that it’s unlikely the S&P 500 Index will repeat its stellar performance over the next decade.
Why does this matter to dividend growth investors? In a world of lower expected equity market capital returns, the importance of reliable and growing dividends increases. By way of hypothetical example, a 2% to 3% dividend yield has a much bigger impact on total return when performance is 7% versus 17%. Moreover, under a scenario of limited capital appreciation, dividend growth may help bolster long-term total return by potentially driving higher future dividend yields.
Macro factor 2: Stable-to-falling interest rate environment. From its recent November 2018 high through June 30, 2019, the 10-year US Treasury yield has fallen 122 basis points to 2.01%.2 In March, the Federal Reserve (Fed) paused its rate hikes. Then in June, the Fed removed the word “patient” from its market commentary, cementing its dovish pivot and signaling the potential for future rate cuts.
Why does this matter to dividend growth investors? In a falling interest rate environment, bond yields fall and the relative attractiveness of dividend growth equities increases. Most bonds typically only provide fixed nominal income, which doesn’t grow and gets eroded by rising inflation. Lower bond yields also theoretically limit potential future bond capital appreciation. Growing dividend payments provide an alternative to stagnant fixed income coupons while retaining the potential for higher capital appreciation. Versus the broader equity market, dividend growth equities have also historically performed well during falling interest rate regimes (Figure 3).
Figure 3: Dividend growth equities have outperformed the broader equity market when interest rates have fallen
Monthly change in the 10-year US Treasury Yield, plotted against the monthly excess return of the S&P 500 Dividend Aristocrats Index versus the S&P 500 Index, over the past 10 years (6/30/2009 - 6/30/2019)
Source: Bloomberg, L.P. Past performance does not guarantee future results. An investment cannot be made directly into an index.
Macro Factor 3: Inflation uncertainty. While US inflation has been benign in recent years, that doesn’t mean that inflation will remain permanently subdued. Additionally, certain expenses, such as health care, have historically risen significantly faster than overall inflation.
Why does this matter to dividend growth investors? Dividend growth equities may provide a natural hedge against the potential impact of rising inflation. In the case of retirees relying on dividends for income, growing dividend payments may help keep pace with monthly expenses, which tend to rise at least in-line with inflation. And with rising life expectancies, retirement can last decades, so keeping up with inflation is essential to preserving one’s current lifestyle. Even at just 3% inflation, the purchasing power of $1 falls to $0.48 over 25 years.
Macro Factor 4: Aging demographics. Globally, the massive baby boomer generation is retiring and entering the de-accumulation phase of their lives. In the US alone, 10,000 people turn 65 each day.3
Why does this matter to dividend growth investors? Since dividend growth equities have historically provided an attractive mix of income growth, capital appreciation, and downside volatility mitigation, they are a popular investment choice with retirees. With stock prices partially influenced by supply and demand dynamics, the swelling population of retirees could provide a demographic tailwind to the demand for dividend growth equities.