It’s easy to feel a little unmoored by the markets this year. The pandemic storm hit in the spring and then the markets shrugged it off this summer. While the storm might be behind us, there’s a chance we’ve merely slipped into its eye because the U.S. election is shaping up to be a particularly alarming one.
In turbulent times like these investors can steady themselves by looking to the past and focusing on the long term. That’s what I’m going to do today from the point of view of dividend investors with the aid of the extensive database of Kenneth French, professor of finance at Dartmouth College.
I start by combining U.S. and Canadian studies that break down the markets into portfolios by dividend yield. In each country, the high-yield portfolio follows the 30 per cent of stocks with the highest yields and the low-yield portfolio follows the 30 per cent with the lowest yields. The zero-yield portfolio tracks stocks that do not pay dividends. In each case the portfolios are reconstituted once a year and are weighted by market capitalization (or size) much like broad market index funds.
Prof. French explicitly provides the total returns of the market portfolio in Canada. But he slices the U.S. market up in many ways. My proxy for the U.S. market is the professor’s portfolio that tracks the total returns of the largest 30 per cent of stocks in the United States and is weighted by market capitalization. It’s similar to the S&P 500 but offers what I deem to be an internally consistent measure of the market over many decades.
The accompanying table shows the compound annual growth rates of the different portfolios (including reinvested dividends) in both countries. The domestic results are presented in Canadian dollar terms and the U.S. results are shown in U.S. dollar terms.
The main period of comparison begins at the start of 1977 and goes through to the start of 2020. I’ve also included U.S. results from the end of June, 1927, through to the end of June, 2020. (Alas, similar Canadian figures are not available for the longer time period.)
Notice that the markets in the two countries provided similar returns (not including currency movements) over the 43 years through to the start of 2020. The U.S. market generated annual gains of 11.4 per cent versus 10.2 per cent gains in Canada. It was a good period for stocks.
Similarly, the high-yield portfolios outpaced the markets in both countries. The Canadian high-yield portfolio fared particularly well with gains of 14.1 per cent versus 12.4 per cent in the United States.
On the other hand, the low-yield groups trailed the markets by roughly half a percentage point annually in both countries.
The zero-yield portfolios showed the biggest difference between the two countries. Non-dividend payers performed remarkably poorly in Canada with annual gains of just 3.1 per cent while they fared relatively well in the U.S. with annual gains of 11.6 per cent.
I believe the difference is largely owing to structural factors. For instance, our market contains a large number of non-dividend-paying resource firms. These firms can be a huge boon in some periods. For instance, the zero-yield portfolio shot well ahead of the Canadian market in the late 1970s as inflation gripped North America and resource prices soared. (Resource firms were something like the Teslas and Zooms of the day.) But over the much longer term the darlings of the late 1970s lagged badly.
Dividend investors should note that the return pattern in the U.S. during the 1977 to 2020 period is similar to that of the longer period from the middle of 1927 through to mid-2020. The similarity should provide some reassurance that the outperformance of the high-yield portfolios was not because of the declining interest rate environment of recent decades.
The very long-term gains also came despite the many wars, periods of social unrest and pandemics that were seen over the past nine decades. History provides at least some hope that our two nations will be able to muddle through their current difficulties.
However, I would caution dividend investors to moderate their medium-term return expectations. In my view, dividend stocks are unlikely to provide annual returns north of 10 per cent over the next decade because the markets are currently at relatively lofty levels – particularly in the United States. Single digit returns strike me as the more likely outcome for the 2020s.
Similarly, dividend investors should be aware that stocks with the most extreme yields tend to be riskier and deserve extra scrutiny. Instead, stocks with merely generous yield have offered good odds in the past and may provide some comfort to income-seeking investors in these uncertain times.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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Norman Rothery