Long-Term Strategy Advice: Stick With Dividend-Paying Stocks

Tune out the bond market noise

   
Long-Term Strategy Advice: Stick With Dividend-Paying Stocks

In pondering possible topics for this week, I ran into an interesting chart from FactSet showing how dividend stocks have performed in the past 20 years relative to the shares of companies offering smaller dividends.

In the September 16, 2013 issue of Dividends Quarterly, FactSet divided S&P 500 dividend-paying companies into quartiles (ignoring all non-dividend-paying companies). Quartile 1 includes the group of S&P companies with the highest yields. This chart caught my eye, since dividend-paying stocks have been underperforming those that do not pay dividends since June 2012.

This chart helps put dividends in longer perspective by showing how much dividend-paying stocks have been outperforming since 2000. Going back 20 years, there were several periods of dividend-stock under-performance, the longest of which was the 3-year run-up to the March 2000 peak in NASDAQ.

The moral here is that “pigs can fly” for extended periods of time but, sooner or later, companies with stable and growing businesses—many of which pay dividends—will likely win over the long term.

All this data led me to ask this key question: What happened in June 2012 that caused dividend-paying companies to underperform non-dividend stocks since then?

Why did Dividend-Paying Stocks Underperform after Mid-2012?

On June 4, 2012, the S&P 500 made a low of 1266.74 at the end of a sharp bull market correction that started in May of that year. Despite some sharp but shallow corrections since then, the S&P 500 has been rallying for over 17 months, recently making new all-time highs.

Here’s another clue: The 10-year Treasury note yield hit what was at the time an all-time low of 1.44% on June 1, 2012. It then made another low in July 2012 at 1.39%. At last look, the 10-year note yield is 2.75% (on news of a much-stronger-than-expected October employment report). Naturally, as the 10-year Treasury yield has practically doubled since 2012, dividend stocks have been somewhat pressured.

I am writing this not to predict an end to dividend stock under-performance at this precise moment, but to stress that such periods have come and gone over the past 20 years. Over that long stretch, dividend-paying stocks have clearly been “the place to be.” There has always been an “interest-rate sensitivity” issue, in which spiking interest rates pressure higher-yielding stocks while falling rates help them. But as the 10-year Treasury note stops coming under pressure from QE tapering expectations—exacerbated by a stronger-than-expected October jobs report—an end to dividend stock underperformance should ensue.

What’s Next for Treasury Bonds – and Dividends?

Theoretically, the 10-year note yield can rise substantially at some point in the future, but few have contemplated publicly that the 10-year note yield could fall and still make a fresh low below the 1.39% mark from 2012. I am not a technician, but I know an up-trend is defined by higher lows and higher highs and a down-trend is defined by lower lows and lower highs.

As things stand now, the 10-year Treasury note yield is still very much in a downtrend in a bull market for bond prices that began in 1981.

Inflation is low and falling, while the U.S. economy has again begun to de-leverage. Debt levels relative to GDP are declining again, which is historically consistent with subdued inflation or deflation.

I am convinced QE was an attempt to re-leverage the U.S. economy—to get everyone to borrow more money and spend it. So far, it has not succeeded in that goal. This means QE may continue under the new Fed Chairwoman, who is due to take office in February. In my opinion, without QE, deleveraging could bring deflation and Japanese-style interest rates. (For more on Bernanke’s inability to re-leverage the economy, see my MarketWatch article, “How to know if Bernanke failed.”)

I am not yet calling for a repetition of Japan, where 10-year yields still made a fresh all-time low in 2013 after everyone called the low in 2003, but I am simply noting that in a situation of ongoing deleveraging, interest rates and inflation can remain subdued for a long time. Looking for a bear market in bonds is something of a “lost cause,” despite sharp selloffs of the type we experienced last summer.

Even if bonds stage a rally from here—on renewed QE commitment from Yellen or further falling inflation or both—they have become a trading vehicle for fund managers. I believe buy-and-hold individual investors are still better off with dividend-paying stocks than timing low-yielding Treasury bonds.

Written by Ivan Martchev


Article printed from InvestorPlace Media, http://investorplace.com/2013/11/dividend-stocks-dividends/.

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