Dividend Stocks: Less Of The Upside And More Of The Downside
While bubble-spotting among equity investing tilts is often futile, the ever-increasing call for investors to buy high-quality dividend-paying stocks has become as over-used a term as 'long-term investor', and 'buy-the-dips'. It seems the general belief is that a 3-5% dividend yield will provide 'protection' to cushion volatility as it offers income above Treasuries. Back in September we highlighted both the apples-to-unicorns comparison that is dividend yields to TSY yields and moreover, how risk (and ultimately capital loss) should play a critical part in the decision of asset allocation. Today we take a quick look at dividend stock performance over the last few years and find something intriguing - and not often mentioned - that dividend stock portfolios appear to significantly underperform in sell-offs and marginally underperform in rallies. So if you want a high beta crowded trade, admittedly with some carry, buy high quality dividend-paying stocks.
Eviudently, based on Goldman's high quality dividend-paying stock focused portfolio, when markets significantly sell-off, dividend-paying stocks will tend to notably underperform (up to 5% over the last 4 years). Unfortunately, the upside beta is not as tilted in your favor with underperformance in extended rallies and furthermore only around 1% outperformance in modest sell-offs. Of course, during these moves, the dividend will indeed cushion the moves - well shift it up - but the point is that the performance of the portfolio itself is adjusting for the dividend relative to the market and so there really is no free lunch.
One more item of interest is the growing belief that corporations will borrow to fund buybacks or increased dividends. The latter is a little less financially flexible for the corporation, however, the market seems to believe this will happen as forward option implied dividend expectations (basically a way to look through forward option prices to infer expectations of dividends) are set to grow significantly over the next two years with the dividend yield looking to reach 2.5% in the next 2 years (for SPY this is). It certainly seems like markets are 'decided' that this is the way it will be and crowded trades such as this never end well.
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