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Market View

In a low-rate world, dividend-paying equities can offer a compelling solution for investors seeking yield and growth.

Investors continue to be flummoxed by the continued decline in fixed-income yields around the globe. In prior weeks, we have identified several attractive sources of income in a negative-rate world, such as short-duration high-yield municipal bonds and short credit. High-yield bonds, bank loans, and emerging-market debt also have provided yield advantages over government securities. One area that may be overlooked by income-seeking investors, however, is the U.S. equity market.

Investors Can Find Attractive Yield in Equities
Income-oriented investors can be forgiven for not thinking of the equity market as a source of reliable income, as historically they have been able to find higher yields in fixed-income securities. As Chart 1 shows, for the majority of the past few decades, government bonds provided a significant yield advantage over stocks. However, with 10-year Treasury yields at 1.58%, and the yield on the S&P 500® Index at 2.11%, the spread between stock yields and bond yields is near an all-time record. Furthermore, Bloomberg recently noted that the yield on the S&P 500 was higher than the 30-year Treasury. As Bloomberg succinctly summarizes, “We’re witnessing something happening with U.S. Treasury yields that has never been since outside of one of the greatest financial crises of all time.”1

 

Chart 1. The Spread between Stock Yields and Bond Yields Nears a Record
June 30, 1990–June 30, 2016

Source: Bloomberg. Past performance is no guarantee of future results. 

 

Dividends Often Increased Over Time
One attractive feature of investing in equities for income is that, historically, companies consistently have increased their dividends. In fact, since 1946, the S&P 500 has seen its annual dividend per share increase 88% of the time (see Chart 2). Over this time period, the average annual increase has been 6.4%, well above the rate of inflation.

 

Chart 2. Dividend Growth Over Time

Source: Strategas Research Partners LLC

 

Dividend Stocks May Provide Principal Growth and Risk Mitigation
On top of an income stream that is currently higher than what can be found in many fixed-income markets, and the potential for a growing income stream, dividend-paying stocks also have provided principal growth potential. Certainly, this growth potential comes with an elevated level of volatility compared to bonds. However, as seen in Chart 3, dividend-paying stocks historically have provided higher returns with less risk than stocks that do not pay a dividend. If one of the major forces driving global bond yields lower is increased uncertainty and volatility in the markets, dividend-paying stocks may be an attractive way to reduce the volatility of investors’ equity allocations, in addition to the attractive income and appreciation potential.

 

Chart 3.  Dividend Payers Have Provided Higher Returns with Less Risk than Non-Payers



Source: Lord Abbett. The chart is based upon an equal-weighted geometric average of the historical total return and standard deviation of dividend-paying and non-dividend paying stocks in the S&P 500® Index for the period 12/31/1989–06/30/2016. The dividend policy for each stock in the S&P 500 Index is determined monthly, based on dividends paid over the trailing 12 months. Components are reconstituted and rebalanced monthly. The periods shown do not represent the full history of the S&P 500 Index.
Past performance is no guarantee of future results. For illustrative purposes only and does not reflect any specific portfolio managed by Lord Abbett or any particular investment. Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

 

Finding Sustainable Dividends and Value Can Be Key for Long-Term Performance
Though the performance of dividend-paying stocks has been impressive, assembling equity portfolios designed for performance and yield can be challenging. For example, while the characteristic of being a dividend-payer has been a positive attribute for stock performance, more is not necessarily better. A portfolio of the highest dividend-payers historically has led to negative outcomes, as shown in Chart 4.

 

Chart 4. Stocks with the Highest Yields Tend to Underperform
Growth of $10,000

Source: Lord Abbett. The chart is based upon an equal-weighted geometric average of the historical total return of dividend-paying and a subset of the top 20% of stocks ranked by dividend yield in the S&P 500® Index for the period 12/31/1989–06/30/2016. The dividend policy for each stock in the S&P 500 Index is determined monthly, based on dividends paid over the trailing 12 months. Components are reconstituted and rebalanced monthly. Dividend-paying stocks are ranked by dividend yield each month to form the top 20% grouping. The periods shown do not represent the full history of the S&P 500 Index.
Past performance is no guarantee of future results. For illustrative purposes only and does not reflect any specific portfolio managed by Lord Abbett or any particular investment. Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

 

The problem with the highest dividend-paying stocks is that often the high stated yield is due to a recent impairment of the stock price. Many times, the dividend is not sustainable as a result of changes in a company’s business prospects. This scenario highlights the benefits that a skilled active manager can provide. By conducting in-depth fundamental analysis on dividend-paying companies, an active manager can determine whether a company’s dividend policies are sustainable and whether future dividends might be higher, lower, or the same as they were in the past.

The price paid for an investment is always important. Dividend stocks are increasingly coveted pieces of investors’ portfolios, and prices for these stocks have escalated. Further, studies have shown that much of the outperformance by dividend-paying stocks is actually due to the tendency of these stocks to also be value stocks.2 A value-conscious manager in the equity-income space, then, can be in position to capture the benefits of current and future income as well as the full-cycle outperformance historically associated with value stocks. We believe active managers focused on identifying undervalued dividend-paying stocks with sound and sustainable dividend policies should be able to provide investors with attractive prospects for both growth and income.

 

1 Jay Wiesenthal, “The 30-Year U.S. Treasury Hit a Milestone It Hasn't Seen Since the Financial Crisis,” Bloomberg, July 6, 2016.
2 Gregg S. Fischer, CFA, CFP, “Dividend Investing: A Value Tilt in Disguise?” Journal of Financial Planning (April 2013).

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.

Dividend policy: A stock is classified as a dividend payer if it paid a cash dividend any time during the previous 12 months, a dividend grower if it initiated or raised its cash dividend at any time during the previous 12 months, and non-dividend payer if it did not pay a cash dividend at any time during the previous 12 months.

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.

Risks to consider: The value of investments in debt securities will fluctuate in response to market movements. When interest rates rise, the prices of debt securities are likely to decline, and when interest rates fall, the prices of debt securities tend to rise. High-yield securities carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal.  High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. High-yield municipal bonds with shorter maturities and durations carry heightened credit risk, liquidity risk and potential for default.  A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Puerto Rico and other U.S. territories, commonwealths, and possessions, may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems. No investing strategy can overcome all market volatility or guarantee future results.

This material is provided for general and educational purposes only and is not intended to provide legal or tax advice.

There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

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. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements.

A basis point is a financial unit of measurement that is 1/100 of 1%.

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

Yield is the annual interest received from a bond and is typically expressed as a percentage of the bond's market price.

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

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.

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