Where Do We Go Now?

Where Do We Go Now?

Sustainable dividend stocks may offer equity exposure and yield with some insulation from price fluctuations.


It’s been more than 50 days since the S&P 500 index reached its market bottom on March 23, 2020, having fallen into bear market territory in a record 16 trading days from its February peak. As of mid-May, the S&P 500 was up 31% since its trough, and in-line with September 2019 levels, while the tech-heavy NASDAQ index was up 7% for the year.*

This is all rather eye popping when one considers the current macro-economic backdrop. The unemployment rate has risen to a historical 14.7%, the highest since records began in 1948, wiping out over nine years of jobless gains in less than a month, while the Citi Economic Surprise Index, which measures the pace at which economic indicators are coming in relative to consensus forecasts, has reached a historical low.

EXHIBIT 1: OPPOSITE DIRECTIONS

Source: Bloomberg, Citi Economic Surprise USA Index, S&P 500 Index. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

In the recent rally, market leaders have been the large cap stocks that were significantly outperforming before the COVID-19 outbreak, resulting in a surge in already elevated market concentration. As of mid-May, Value (Russell 1000 Value) trailed Growth (Russell 1000 Growth) by 20%, the third widest spread based on calendar year returns going back to the 1970s. While the S&P 500 was 13% below its February record peak, the median underlying stock traded 21% below its historical high. The five largest companies (Microsoft, Apple, Amazon, Facebook and Alphabet) made up 21% of the S&P 500, exceeding the 18% level reached in March 2000.* As a result, prospective earnings multiples, currently based on pre-pandemic estimates, have reached a 19-year high.

EXHIBIT 2: TRIUMPH OF THE OPTIMISTS

Source: Bloomberg, BEST P/E Ratio as of May 2020. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Historically, sharp declines in market breadth have signaled periods of market reversals / drawdowns. Narrow breadth can last for extended periods of time, however past episodes have signaled below average market returns and eventual momentum reversals leading to larger than average prospective drawdowns. In addition to the Tech Bubble, breadth narrowed ahead of the recessions in 1990 and 2008 and the economic slowdowns of 2011 and 2016.

For investors looking to put money to work, where does one go? It feels a bit painful to pay a historical premium to invest into an arguably decelerating market with a multitude of economic unknowns, yet maintaining equity exposure during this inflection period is critical to growing assets over the long-term.

EXHIBIT 3: MISSING JUST A HANDFUL OF TRADING DAYS CAN GREATLY IMPACT LONG-TERM RETURN

ANNUALIZED 20-YEAR RETURN

Source: Bloomberg, S&P 500 Index, as of April 1, 2020. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Timing the market “bottom” during this turbulent environment is tempting. However, historically the worst trading days have clustered near the best making market timing nearly impossible for even the most seasoned investors. For example, equities were down 12% overall in March 2020. Yet three of the best days of equity returns since 1933 and six of the best trading days over the last ten years also occurred that month. As the chart above illustrates, missing just a handful of these days can significantly impair long-term annualized return.

Within equities, allocating funds to sustainable dividend income stocks appears attractive amid the current historically low-rate environment, given the stability and insulation dividends can provide from price fluctuations. We note that in recessions, the difference in stability (or lack thereof) of prices compared to dividends is striking.

EXHIBIT 4: DIVIDENDS PAID ARE FAR LESS VOLATILE THAN SHARE PRICE

Source: Bloomberg. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Together, the Information Technology and Consumer Discretionary sectors make up over 35% of the S&P 500 Index. The trailing dividend yield of these sectors is less than 1.5%. As a result, the S&P 500 Index may not be equipped to provide adequate dividend income for many investors. The largest dividend yields typically come from sectors that make up smaller segments of the broader market, namely Utilities, Real Estate, and Consumer Staples. As one can see in Exhibit 5, over the last two years, dividends significantly helped boost the returns from these sectors.

EXHIBIT 5: BIGGER INCOME FROM THE SMALLER SECTORS

Source: eVestment, as of April 30, 2020. Based on 2-year trailing period. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Lastly, now more than ever it is critical to consider valuations and the underlying fundamentals of companies you are investing in, particularly when searching for dividend income. It is important to look beyond dividend yield and consider whether a company has the earnings profile to continue to support their dividend payout. A sustainable dividend-aware allocation can bolster equity diversification with respect to sector concentrations inherent in the market cap weighted index. Moreover, it may provide the extra income boost needed for those who are searching for yield in this low-rate environment.


* As of May 12, 2020

Definitions:

BEST P/E Ratio is the Bloomberg estimate of P/E and is the consensus based on the average estimate from a selection of analysts.

A capitalization-weighted index is a type of market index with individual components that are weighted according to their total market capitalization. Market capitalization is the total dollar market value of all of a company's outstanding shares; it is calculated by multiplying a company's shares outstanding by the current market price of one share.

The Citigroup Economic Surprise Indices are objective and quantitative measures of economic news defined as weighted historical standard deviations of data surprises (actual releases vs Bloomberg survey median). A positive reading of the Economic Surprise Index suggests that economic releases have on balance been beating consensus. The indices are calculated daily in a rolling three-month window. The weights of economic indicators are derived from relative high-frequency spot FX impacts of 1 standard deviation data surprises. The indices also employ a time decay function to replicate the limited memory of markets.

COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease. The virus causing the novel coronavirus disease is known as SARS­CoV-2.

Dividend yield is a financial ratio that shows how much a company pays out in dividends each year relative to its share price.

NASDAQ is a global electronic marketplace for buying and selling securities, as well as the benchmark index for U.S. technology stocks. Nasdaq was created by the National Association of Securities Dealers (NASD).

The price-to-earnings (P/E) ratio is a stock's price divided by its earnings per share.

The Russell 1000 Growth Index is an unmanaged index of those companies in the large-cap Russell 1000 Index chosen for their growth orientation.

The Russell 1000 Value Index is an unmanaged index of those companies in the large-cap Russell 1000 Index chosen for their value orientation.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The Tech bubble (also known as the dot-com bubble and the Internet bubble) was a stock market bubble caused by excessive speculation in Internet-related companies in the late 1990s.

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