By Daniel McGarvey, Portfolio Analyst
After many years of market performance driven by high beta growth stocks, last year demonstrated that the speculative exuberance could not last forever. As we continue moving past the era of quantitative easing and “free money,” we favor fundamentally sound companies that are returning capital to shareholders regularly in the form of dividends.
Historically, dividends have accounted for close to 60% of total returns for the S&P 500, but in the 2010s, that figure was only 26.1% (see chart below). Going forward, we believe dividends will play a greater role in total return. The S&P 500’s current dividend payout ratio of 33.4% is also historically low compared to the long-term average of 48.1%, indicating that companies have room to increase their dividend payouts. We especially prefer companies with a history of consistently growing their dividend and the ability to continue doing so into the future, given that such companies have historically dominated during and after prior rate hiking cycles.
Chart provided by Strategas Research Partners LLC.
Another argument for overweighting dividend growers and value stocks is that they are rather underrepresented in passive index investing. With the top five stocks making up roughly 20% of the S&P 500, most market-cap weighted strategies are quite top-heavy and growth-tilted. This level of concentration can lead to diversification risk and an overreliance on companies whose terminal values are based mostly on uncertain future earnings instead of near-term cash flows.
The S&P 500 had a positive start to the year, ending January up 6.3%. Many speculative stocks bounced even more, but that could prove to be temporary. Fourth quarter earnings announced in January were generally underwhelming, with fewer companies beating estimates than is typical. The Bloomberg US Aggregate Index returned 3.1% as the 10-Year Treasury rate dropped to 3.5%. The yield curve inverted further, with the 3-Month yield exceeding the 10-Year by 118 bps, while high-yield credit spreads narrowed to 4.3%.
Charts provided by YCharts, Inc.
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Daniel is a Portfolio Analyst at Stonebridge Financial Group and works on portfolio analysis and other related tasks. When away from the office, Daniel spends his time playing guitar, reading, and exploring the outdoors.