With inflation rising and interest rates set to increase from historic lows, there’s no doubt that investors are considering their options and working out how best to navigate this changing environment.
Bonds face challenges in a rising rate environment – in the year to date (10 May), the Bloomberg Global Aggregate Index, an index of global investment-grade bonds, was down 12% in USD terms[i]. Risk assets like equities also face headwinds, as rising rates may lower what investors are willing to pay for potential future cashflows. Holding cash may not be ideal because inflation will erode its value in real terms. However, one sweet spot for the current climate could be found in dividend-paying equities.
The good news is that we appear to be entering a favourable period for companies that can grow and pay dividends. During periods of high inflation – greater than 5% – companies that pay high dividends tend to do better versus the broader equity market. This is according to research from Goldman Sachs, with a data set for the S&P500 that goes back to 1940. It suggests that a focus on dividends could provide inflation mitigation[ii].
To further bolster this, in the high-inflation 1970s, the S&P500 delivered total returns of 77% in USD terms[iii]. Of these total returns, about three-quarters were attributable to dividends and dividends reinvested. Looking at the last 20 years, dividends and dividends reinvested have made up about half of the total returns of the MSCI AC World Index[iv]. In other words, half of the 315% returns (in the 20 years ending 30 April 2022). Dividends are a very important component of total returns even in a moderate- to low-inflationary world. They are likely to be an even more important component as inflationary pressures mount.
What about the current dividend environment?
Dividends are currently in abundance and the outlook for dividend growth appears positive. In the 12 months ending 31 March 2022, the companies in the MSCI AC World index paid out almost USD1.3 trillion (tn) in dividends[v]. In 2021, the dividends global companies paid in the index were 17% higher than 2020[vi]. The global economic recovery has supported both an earnings recovery and a dividend recovery from the lows of the 2020 Covid-19 recession.
Dividends are currently in abundance and the outlook for dividend growth appears positive.
Even in 2020, amidst the economic and earnings headwinds, members of the index paid out over USD1trn in dividends[vii]. This underscores the resilience of dividends and their dependability as a source of return across the market cycle. Looking ahead, company earnings are forecast to grow around 10% in 2022[viii] and we expect to see similar growth in dividends. Despite accumulating worries around higher input costs due to inflation, elevated costs of capital, and the potential effects on margins, the most recent quarterly earnings results have been very encouraging. Of the 80% of S&P500 companies that have reported on their first quarter earnings, 80% have beaten estimates[ix]. There has also been a pick-up in share buybacks. This points to the confidence that companies have in rewarding shareholders, and bodes well for the dividend outlook.
On top of this, the cash on company balance sheets is at historic highs and the pay-out ratios remain relatively low. Pay-out ratios are the percentage of profits returned to investors as dividends and for the MSCI AC World the pay-out ratio is currently 42%[x]. This compares with an average of 58% over the last 15 years[xi]. Overall, conditions remain supportive for dividends and many companies have the potential to pay out a higher level of profits earned as dividends.
Where are we seeing opportunities?
The energy, materials, real estate and industrials sectors have seen the fastest pick-up in earnings and pay-outs. Banks and financials are also seeing their margins expand. Further, cash piles are high in sectors including healthcare and technology, so the prospect for dividend payments remains positive across a broad base of sectors.
Companies that pay good dividends often have sound environmental, social and governance (ESG) credentials. We build ESG analysis into all our investment research. We have an ‘engage-ist’ mindset with the companies in which we invest because we aim to raise ESG standards across the corporate sector.
Finally, valuations for global equities remain reasonable. The MSCI AC World is currently trading at 15.0x on a forward price-to-earnings basis, which is well below the five-year average of 17.6x[xii]. Despite recent market turbulence, interest-rate hike expectations, and inflationary pressures, much of the risk is already priced in.
To counter inflation risk, we would suggest considering an allocation to global equity dividends. Dividends provide a dependable source of return and investors can find opportunities across the globe.
[i] Bloomberg, May 2022
[ii] Goldman Sachs February 2022
[iii] Goldman Sachs February 2022
[iv] Jefferies, Factset April 2022
[v] Bloomberg April 2022
[vi] Bloomberg, MSCI, abrdn May 2022
[vii] Bloomberg, MSCI, abrdn May 2022
[viii] Bloomberg consensus forecasts May 2022
[ix] JP Morgan May 2022
[x] Bloomberg, MSCI May 2022
[xi] Bloomberg, MSCI May 2022
[xii] Bloomberg, MSCI May 2022