Dividend paying stocks — a popular trade of the low-interest rate era of the past several years — may have found new life in China’s economic troubles.
With China’s surprise move last week to devalue the renminbi having stirred concerns about flagging economic growth and a higher risk of global deflation that could well pull bond yields lower, investors have renewed their interest in owning stocks that pay attractive dividends.
The dividend trade has been a mainstay of portfolios since central banks slashed interest rates in the wake of the financial crisis. However, for much of this year, companies that typically pay high dividends, such as utilities and real estate investment trusts, or Reits, sold off in a sign that the trade may have finally run its course.
A slowing global economy and ongoing rout in commodity prices has cast the timing of interest rate increases by the Federal Reserve later this year in doubt. With the yield on long-dated US Treasuries falling over the past month, a sustainable dividend yield from a blue-chip company looks an attractive real return for investors and one that can compound over time.
“Post renminbi devaluation last week, people are inquiring about how long the deflationary environment exists and how to play it,” says Nick Lawson, global co-head of macro at Deutsche Bank. “Now we are seeing a return to dividends.”
The utilities sector of the S&P 500, for example, has fallen nearly 4 per cent so far this year. Over the past month, though, the area was the top performing sector in the index, with a gain of nearly 5 per cent. Reits have climbed back off the canvas, rising from the year’s lows even if they remain far off the highs for 2015.
Dividend payers also seem like a relatively safe place at a time when other areas of the market are under pressure from varying forces. Companies more directly exposed to China, such as industrials and basic materials, have been hurt of late. China’s devaluation has fuelled fears that its economy was in worse shape than investors thought.
Falling oil prices have crushed energy stocks, which have dropped a dramatic 14 per cent so far this year.
Interest in dividend stocks comes at a time when companies have been in a position to pay out record amounts of them.
With cash balances on corporate balance sheets high in recent years — and stock market investors receptive — companies in the S&P 500 have favoured both dividends and share repurchases. Pressure from activist shareholders and reluctance by corporate executives to embark on capital expansion projects during a lacklustre economic recovery have further supported the trend.
Dividend payouts reached a record $94bn in the second quarter, topping the previous quarter’s shortlived record, according to S&P Dow Jones Indices.
Some analysts expect the combined value of dividends and share buybacks could reach $1tn this year.
Whether investors will continue to reward dividend stocks depends largely on expectations about the timing and pace of rate rises by the Fed.
“The conventional wisdom is that a slower China and a China more willing to devalue its currency puts downside risk on how fast and how aggressively the Fed will tighten, in which case the longer term outlook for interest rates comes down,” says Dan Suzuki, senior US equities strategist at Bank of America Merrill Lynch. “To the extent that that is true, it provides some boost for dividend stocks.”
The yield on the 10-year Treasury bond is about 2.12 per cent versus about 2.4 per cent a month ago.
Buying dividend payers now is not without risk, however. After a multiyear rally, these shares are not cheap. Investors may well receive an attractive dividend, but run the risk that the value of their shares could fall sharply if current global concerns alarm US based markets.
“It will be interesting to see if people are happy to pay the premium for that equity income,” says Mr Lawson. “What one has to say is what premium would I pay for that income. That is the relative value game that investors will play across the world.”
If fear about China’s economy eases, the global economy perks up and rate expectations change, dividend payers will be vulnerable to selling, investors say.
“These sectors are expensive and the valuation is rate sensitive,” says Russ Koesterich, global chief investment strategist at BlackRock. “That is the risk that investors are taking getting in at these levels — you are making an implicit bet not even that rates don’t go back to 3 per cent, but that they are not going back to 2.5 per cent.”
“It is a short lease on life,” he says.