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Market View

Investors bracing for high volatility may want to consider high-quality, dividend-growth stocks which, like ballast in a boat, may offer the potential for portfolio stability.

Since the end of the U.S. Federal Reserve’s (Fed) quantitative easing (QE) program in October 2014, the stock market (as represented by the S&P 500® Index) has become more volatile and has had an increasingly difficult time holding onto its gains. Dividend-paying stocks, on the other hand, have been on a roll.

Dividend stocks didn’t garner much attention during the era of QE (2009–14). As stock prices moved significantly higher in a raging QE-driven bull market, dividends accounted for a relatively small portion of stock returns—just 20% of the S&P 500’s total return,1 compared with the long-term average of 45%.2

Since the end of QE, however, dividends have accounted for 70% of the S&P 500’s returns (as of May 31, 2016),3 providing a much-needed source of current income for yield-starved investors. This is a relatively rare point in history during which even moderate dividend-yielding stocks have higher yields than U.S. Treasuries and even higher yields than some investment-grade corporate bonds. Consider also the potential for growth among these dividend-yielders. Going back 70 years, for example, the S&P 500 component companies have raised their dividends by an average of 6.4% per year.4 So, in many cases, stocks have a higher-yield starting point than bonds, and offer the potential for growth in this yield. It’s not hard, then, to see why investors are so interested in this space.

In that regard, one of the traps that investors can fall into, however, is the temptation to focus only on stocks with the highest dividend yields—a strategy that has a number of drawbacks. It is often the case that these high-yielding companies cannot sustain the dividend payout through difficult periods, resulting in a forced dividend cut down the line. This typically is not a positive indicator; dividend growth companies have significantly outperformed those that cut or eliminate their dividends, and they’ve done so with much lower risk (as measured by standard deviation).  

 

Chart 1: Dividend Growers Have Outperformed Dividend Cutters, and with Lower Risk
10 years, as of 03/31/2016 

Source: FactSet.  The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results.  Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is no guarantee of future results. 
* S&P 900 10-Year Dividend Growth Index. ** Based on stocks in the S&P 500 Index that have cut their dividends at least once over the trailing 12 months.

 

Over the past six months, media headlines have focused a great deal on companies announcing dividend cuts, a cohort whose numbers have, indeed, increased—mostly in the energy and energy-related sectors.  Other sectors with more healthy fundamentals have continued to provide dividend growth. To date this year (as of May 31, 2016), 184 companies have either increased dividends or initiated dividend payouts, more than 12 times more than have cut or suspended their dividends. 

We believe investing in companies with a historical record of consistent dividend growth can be a rewarding long-term strategy. These companies typically are blue-chip names—that is, market leaders with stable business models and strong balance sheets. As such, they tend to capture most of the market’s upside over the long term, while also performing well on a relative basis as volatility increases. Nearly 75% of consistent dividend growers boast a quality ranking of ‘A-‘ or higher from Standard & Poor’s—a ranking that is based on the long-term growth and stability of a company’s earnings and dividends—compared with only 42% in the S&P 500. 

And, as shown in Chart 2, high-quality stocks historically have outperformed lower-quality stocks during periods of high market volatility—exactly what we’ve seen in the post–QE era. 

 

Chart 2: Dividend-Grower Stocks Outperformed When Volatility Increased
Data as of 04/01/1991-03/31/2016

Source: Bloomberg and Bank of America Merrill Lynch U.S. Equity and U.S. Quant Strategy. Correlation of BofAML quality indexes’ 12-month performance (relative to BofAML coverage universe) with 12-month changes in the CBOE VIX during 1991–2016. The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results.  Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is no guarantee of future results.

 

Over the long term, these stocks also tend to capture most, if not all, of the broader market’s upside with lower levels of volatility, as Chart 3 illustrates.

 

Chart 3: Dividend Growers Have Offered Attractive Risk-Adjusted Returns
10 years, as of 03/31/2016

Source: FactSet and Morningstar, Inc. The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett & Co LLC Abbett or any particular investment, and are not intended to predict or depict future results. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Past performance is no guarantee of future results. 
* S&P 900 10-year Dividend Growth Index. ** Morningstar Large Blend Category.

 

In conclusion, investors bracing for high volatility may want to consider high-quality, dividend-growth stocks. 

 

1 Morningstar, Inc.
2 Strategas Research Partners.
3 Morningstar, Inc.
4 Strategas Research Partners.

 

IMPORTANT INFORMATION

Dividend yield is equal to the dividend divided by the stock price. Dividend yield is one measure of a stock's value. A high dividend yield may indicate that a stock is relatively inexpensive.

Standard deviation is a measure of a measure of volatility. It indicates the variability of an investment's returns.

Dividend policy: Each stock’s dividend policy is determined on a rolling 12-month basis. For example, a stock is classified as dividend-paying if it paid a cash dividend at any time during the previous 12 months and non-dividend paying if it did not pay a cash dividend at any time during the previous 12 months.  Dividend Growers and initiators include stocks that raised their existing dividend or initiated a new dividend during the preceding 12 months. Dividend cutters or eliminators include stocks that lowered their existing dividend or stopped paying regular dividends during the preceding 12 months.  A stock is reclassified only if its dividend policies change.  

Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

Dividend Growers, Payers, and Non-Payers are subcomponents of the S&P 500© Index. The categories are created using actual annual dividends to identify dividend-paying stocks and are rebalanced annually. The dividend policy for each stock is determined on a rolling 12-month basis.

S&P Quality Rankings System attempts to reflect the long-term growth and stability of a company’s earnings and dividends. The rankings are generated using a computerized system based on a company’s per-share earnings and dividends record across the most recent 10 years. The system focuses on earnings and dividend performance, and does not reflect all of the factors that may bear on the quality of a company. Basic scores are computed for earnings and dividends, and then adjusted by a set of predetermined modifiers for changes in the rate of growth, stability over long periods, and cyclicality. Adjusted scores are then combined to produce a final ranking. The Quality Ranking Scale is as follows: A+ Highest, A High, A- Above Average, B+ Average, B Below Average, B- Lower, C Lowest, D In Reorganization, LIQ Liquidation. Copyright© 2016 Standard & Poor's Financial Services LLC, a part of McGraw-Hill Financial.

The CBOE (Chicago Board of Exchange) Volatility Index© (VIX©) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world’s premier barometer of investor sentiment and market volatility (www.cboe.com)

S&P 900© 10-Year Dividend Growth Index is a subset of the S&P 900 Index. The index consists of large and mid-sized companies that have a 10-year history of dividend issuance and growth, and that meet certain other criteria. The Dividend Growth Index represents a considerably narrower investable universe than the S&P 900 Index because of these stringent criteria. The Dividend Growth Index is a custom index that was developed at the request of Lord Abbett. The Dividend Growth Index is the exclusive property of Standard & Poor's Financial Services LLC. Under a contract with Lord Abbett, Standard & Poor’s administers, maintains, and calculates the Dividend Growth Index. Standard & Poor's and its affiliates shall have no liability for any errors or omissions in calculating the Index.

The S&P 500© Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.

A Note about Risk: The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall.

No investing strategy can overcome all market volatility or guarantee future results. 

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

MARKET VIEW PDFs


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