Those who swear by dividend-paying stocks haven’t exactly been rewarded for their devotion this year.
Dividend-oriented funds have lagged the market by a wide margin, in both Canada and the United States. On Monday alone, several of those funds on both sides of the border were down by 2 per cent or more, as some long-term Treasury yields spiked to their highest levels in well over a decade.
In many cases, stocks with the most generous payouts have been the poorest performers. And to top it off, dividend cuts are on the rise.
Hang in there, dividend investors.
“Despite a challenging environment, keep in mind that over the long run, dividends matter a lot, accounting for the lion’s share of equity returns,” Hugo Ste-Marie, a strategist at Scotia Capital, wrote in a report published last Wednesday.
To illustrate that point, the Scotia report broke down what a $100 investment in the Toronto Stock Exchange benchmark in 1956 would look like today. With dividends, it would have grown to $29,000. Without dividends, you would be left with just $3,600.
In other words, dividends contributed nearly 90 per cent of total returns over the past seven decades.
Few need to be convinced of the power of dividends in a country where dividend investing is elevated nearly to the level of national pastime.
This year is more of an exception to the rule.
Of the 10 largest U.S. dividend exchange-traded funds, seven are in negative territory year-to-date. And none of them have posted even half of the return of the S&P 500 index, which is up by 13 per cent this year after factoring in dividends.
It looks worse the deeper you dive into the numbers.
Last month, Bespoke Investment Group wrote that the 100 stocks in the S&P 500 that pay no dividends were up by an average of 20.7 per cent so far this year.
The 100 stocks in the index with the highest dividends, on the other hand, were down by 3.2 per cent.
A similar pattern is at play in the Canadian market. The Dow Jones Canada Select Dividend Index has lost 4.0 per cent on the year, versus a gain of 3.4 per cent in the S&P/TSX Composite Index with dividends included.
Clearly, the market is penalizing dividend payers. Why? Because of bond yields.
For the past two decades or so, interest rates have been on a steady trajectory downward. This megatrend reduced the yields on high-quality bonds and savings vehicles to minuscule levels, forcing hordes of income investors into the stock market.
For example, the benchmark yield on 10-year Government of Canada bonds hit a low of 0.43 per cent in mid-2020. That’s hardly enticing when the S&P/TSX Composite Index pays a dividend yield of around 3 per cent.
For years, the Canadian stock market enjoyed a competitive advantage of sorts over most of the fixed-income space. No more.
The colossal inflation problem that emerged from the pandemic has flipped the script in financial markets. The Canadian 10-year now yields 4 per cent. Short-term U.S. Treasury bills yield about 5.5 per cent.
And now that “higher for longer” has become the financial refrain of the moment, the pressure on dividend stocks has increased.
The silver lining of that sell-off is that the TSX is now teeming with rich payouts and cheap dividend names.
More than 20 per cent of stocks in the TSX benchmark index carry a yield of greater than 5 per cent, Craig Basinger, chief market strategist at Purpose Investments, wrote in a report. Two years ago, that proportion was 8 per cent.
“Dividend-paying companies are now paying more to remain competitive with higher bond yields,” Mr. Basinger said. The average valuation on those names is also about 15 per cent below historical norms, he added.
Some very large and stable dividend payers now carry yields of 6 per cent or higher. Among them are telecoms, such as BCE Inc. BCE-T and Telus Corp. T-T; big banks, including Bank of Nova Scotia BNS-T and Canadian Imperial Bank of Commerce CM-T; and the two largest pipelines, Enbridge Inc. ENB-T and TC Energy Corp TRP-T.
“I look at that as a tremendous opportunity,” said Ryan Bushell, president and portfolio manager at Newhaven Asset Management in Toronto.
Clearly, with rates and yields at their highest levels in many years, savers and income investors have a lot more options these days outside the stock market.
But dividend stocks have a couple of advantages when it comes to inflation, Mr. Bushell said. The first is the potential for dividend increases. And the second is that many businesses can pass on some inflation through pricing power.
“With stocks, even if inflation stays high and yields don’t come down as much as hoped, you have some inflation protection that you don’t have in the fixed-income side,” Mr. Bushell said.