Dividend Protection and the Coronavirus Contagion

Dividend Protection and the Coronavirus Contagion

It's important for individuals to maintain a consistent exposure to equities, despite episodes of market mayhem like the one we're seeing now; allocating to a low-volatility dividend strategy may make that easier.


2020 markets have proven to be a wild ride year to date. The year began seemingly as an extension of 2019, with equity markets racing to new highs daily. However, signs of weakness began to emerge as fixed income yields dropped to record lows and metal miner and energy prices continued to soften. A dueling risk on / risk off sentiment was evident in the market as both US Utilities and Information Technology competed as the top performing sectors, up over 8% at their early February year-to-date highs. Fast forward to mid-February and risk-off has suddenly won out as investors grapple with pricing in the global impact of the coronavirus contagion which has continued to spread.

Number of S&P 500 Companies Citing “Coronavirus” on Q4 Earnings Calls (138)
Graph: Number of S&P 500 Companies Citing “Coronavirus” on Q4 Earnings Calls (138)

Source: Factset, as of February 14, 2019. 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.

As a result, the VIX has surged approximately 277% since January lows, shooting up as high as 45.67. It has risen almost three-fold in the past week as traders look to hedge against further tumult.

CBOE Volatility (VIX) Index
Graph: CBOE Volatility (VIX) Index

Source: Bloomberg, December 31, 2018 – February 27, 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.

As of the time of this writing, the S&P 500 suffered its worst week sell-off since the 2008 crisis and the 10-year US Treasury yield shed more than a quarter of a percentage point this week, dropping to 1.127% for the first time. Amidst the sell-off, six of the eleven S&P 500 sectors are in correction territory, having fallen over 10%, with the Information Technology sector down over 14% (through yesterday). Energy which had begun to come under pressure late last year due to oversupply concerns, remains the worst performing sector year to date, due to airline restrictions, declining global trade and an anticipated hit to overall GDP associated with the coronavirus contagion. Defensive, dividend-paying sectors such as Utilities, Real Estate and Consumer Staples have been more resilient than the S&P 500 Index so far during the sell-off. Investors typically look to these sectors for lower beta insulation as well as income.

US Sector Performance Year-to-Date vs Corona Contagion Sell-Off
US Sector Performance Year-to-Date vs Corona Contagion Sell-Off

Source: Bloomberg, based on GIC sector classifications. Data as of February 27, 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.

Market mayhem is difficult for anyone to time. As such, it is important for investors to maintain prudent equity exposure; the US market capitalization-weighted indices have become inherently and increasingly overweight Information Technology and technology-oriented stocks within Consumer Discretionary. Low volatility, dividend strategies may have complementary exposures to sectors such as Utilities, Consumer Staples, and Real Estate. Investing in such a strategy allows investors to continuously stay invested in the market with a more palatable volatility profile as a result of increased exposure to those non-cyclical sectors. Additionally, this type of strategy may provide a much-needed source of income, as fixed income yields continue to fall to record lows.


Definitions:

Beta measures the sensitivity of an investment to the movement of its benchmark.  A beta higher than 1.0 indicates the investment has been more volatile than the benchmark and a beta of less than 1.0 indicates that the investment has been less volatile than the benchmark.

Capitalization-weighted refers to an approach where individual components of an index or asset class are weighted according to their market capitalization, so that larger components carry a larger percentage weighting. 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 Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a measure of market expectations of near-term volatility as conveyed by S&P 500 stock index option prices.

Defensive sectors are comprised by companies that generally pay dividends and have relatively stable earnings regardless of the state of the overall stock market. These companies tend to perform better than the broader market during recessions. However, during an expansion phase, they tend to perform below the market.

The Global Industry Classification Standard (GICS) is an industry taxonomy developed in 1999 by MSCI and Standard & Poor's (S&P) for use by the global financial community. The GICS structure consists of 11 sectors, 24 industry groups, 69 industries and 158 sub-industries into which S&P has categorized all major public companies.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

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.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

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