Dividends: Some Common Sense Considerations

Includes: AGD, AOD, DVY
by: FiatFxWorld

Let me make two observations regarding current investor attitudes: there is a huge belief in dividend stock investing, yet a fair amount of bearishness and skepticism regarding the world economy and the stock market. These two beliefs do not seem to be compatible, and one of the camps will eventually be proved wrong.

Given the zero interest rate environment, investing in large, international, diversified dividend-paying stocks appears to be a rational choice - what alternative is there? Many have decided so, and it's reflected in the large number of posts with titles like 'top dividend stocks' or 'build your dividend portfolio'. Yet, in a Japan-like deflationary, zero-growth scenario these stocks will struggle to increase their revenues, maintain margins and dividend payouts. Their valuations may contract further as markets start discounting lower earnings for many years to come. They may fare better than some of their riskier brethren, but that's only a relative consideration. The excellent 25-year track records of certain companies, reflect a healthy and growing economy for the past 25 years. It tells us little about the next decade or two. Click to enlarge:

Japan: valuations have followed bond yields lower in an inflationary environmentClick to enlarge

The current market outlook is uncertain, with risks coming from every corner of the world, the ongoing deleveraging in the west, and policy/political risk. The worry is that growth will decline from the current slow pace and possibly contract, while policymakers are running out of bullets. These risks appear to be very widely recognized, and although it doesn't mean they can not materialize, investors are to some degree discounting them and will not be completely surprised. Judging from articles and comments on Seeking Alpha, and other sources such as fund flows and trailing fund betas, most participants are seeing darkness ahead. The rally last week hasn't materially changed this picture. Click to enlarge:

Macro HF rolling beta: macro HFs are net shortClick to enlarge

How can we reconcile the rosy expectations for dividend stocks, with a pessimistic view of the market in general? Are the two considering different time horizons (dividend stocks the longer-term)? Is it simply a bet on the safer, lower-beta part of the market? Are things so bad that we should stick to the safest names? Or is it in essence the same bet, but the first is more appealing to common sense and intuitive? (We all want income.)

After all, if the economy goes down, and the banks go into liquidation, we will not continue buying consumer goods at the same pace. If a trade war erupts and trade with China collapses, many of the top dividend payers will be directly affected (higher production costs and lower sales). And if Europe freezes, it will affect these international companies as well.

This is not the first nor the last contradiction in the market and in investors' attitudes. It is worth bearing in mind however, that for the most part dividend stocks and the broader market will move together in the future, and it is not entirely clear, which one will produce higher returns. The focus on safety of international dividend-paying firms - even if it appears logical - is an illusion. We live in an uncertain world.

Disclosure: The author is long some dividend-paying stocks.