Historical Perspective
Here’s something you may not have realized – from 1927 to 2021, approximately 5% of total returns in the S&P 500 came from price change alone. The other 95% of gains came from reinvested dividends.
Over this time period, the annualized returns from reinvested dividends far exceeded that of returns from the stock price alone.
Relationship During Quantitative Easing
The relationship of dividend returns to price returns has flipped since the Great Financial Crisis in 2008, with the annualized return of reinvested dividends (7.58%) providing roughly one-half that of stock price changes (13.65%). The reason being that lower interest rates, the result of Quantitative Easing, enhances the value of future cash flows relative to immediate distributions, much to the benefit of stock prices.
And although investors tend to believe that the near future will resemble the recent past, it is important to realize that this relationship tends to move in cycles, with returns from dividends often outpacing price returns for long periods of time, and we could be reaching another inflection point in this cycle.
Rising Interest Rates and Equity Duration
As we noted before in Gravity is Gone (May 3, 2022) rising interest rates punish the value of future cash flows more than near term cash flows. We can see this in bond performance as short duration bonds have outperformed long duration bonds year to date.
Applying this same logic to stocks, dividends represent the most immediate return of cash to investors and so far, high dividend paying stocks have outperformed year to date, returning -3.7% for high dividends vs. -17.1% for the broader S&P 500 Index as of 10/31/2022.
If interest rates continue to climb, it is reasonable to expect this outperformance to continue.
Important Disclosures & Definitions
Equity Duration: the duration of a stock is the average of the times until its cash flows are received, weighted by its present values. High-duration stocks are exposed to substantial discount-rate risk (i.e., changes in yield), whereas low-duration stocks are primarily exposed to cash flow risk.
Great Financial Crisis: a severe worldwide economic, banking and real estate crisis that occurred between 2007 and 2009. It was the most serious financial crisis since the Great Depression (1929).
Quantitative Easing: a monetary policy strategy used by central banks where they purchase securities in an attempt to reduce interest rates, increase the supply of money and drive more lending to consumers and businesses.
S&P 500 High Dividend Index: measures the performance of 80 high yield companies within the S&P 500 Index and is equally weighted to best represent the performance of this group, regardless of constituent size.
S&P 500 Index: widely regarded as the best single gauge of large-cap US equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
One may not invest directly in an index.
Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.
AAI000178 01/31/2024
