With reversal from decade-plus-old tailwind of yields grinding lower, chief market strategist says other factors are rising in importance
While dividend stocks have long been a portfolio mainstay for income-oriented investors, those seeking yield from the space shouldn’t expect the same easy sailing they might have experienced in the past decade or so, according to one investing leader.
“If you went back 10 years, it didn’t matter how you got exposure to dividends,” says Craig Basinger, chief market strategist at Purpose Investments. “But now the whole dividend space is very different.”
As Basinger notes, the trend of yields grinding lower over the past few decades has largely been a tailwind for dividend-paying companies. But over the past two years, that dynamic has reversed into a headwind amid central banks’ aggressive rate-hiking.
“Earnings variability has become very important,” he says. “We’re seeing all these other factors – the company’s business model, its ability to manage higher yields on the debt side, its ability to pass on inflation – rise up in significance.”
Debt considerations weighing heavier
Looking across the dividend space, Basinger says the pockets suffering the most are companies carrying a lot of debt on their balance sheets. Financial leverage isn’t necessarily a curse, he’s quick to stress, but the tighter environment for borrowing has made some risk factors – such as when the bonds on a company’s balance sheet are due, and how much of that is in variable-rate versus fixed-rate debt – more material than before.
“If you come across highly levered companies with a lot of variable debt, those are down the most,” he says.
Drawing on Bloomberg data, a recent report from Purpose also showed that variability among defensive dividend strategies has widened among dividend strategies in Canada. That rising variance, Basinger says, comes down to composition: those with more cyclical yield are faring better than those with more utilities and REITs.
While the dividend factor might appear weak of late, Basinger says dividends also still warrant attention as an inflation-hedging tool. Over the long run, he says dividends have demonstrated a very strong ability to keep up and even outpace inflation.
He concedes nobody should expect that every year – especially with the consumer price index now at 4% in Canada – but notes that inflation tends to be a positive for nominal earnings, which is what dividends are paid out of.
“From an inflation perspective, they’re a good hedge to maintain purchasing power. And that’s what the dividend factor did last year when inflation was the big story,” he says.
Beaten-down valuations – a long-term opportunity?
What’s loomed large over the last couple of months, Basinger says, has been the story of rising bond yields with a more resilient economy than most expected. That’s created a downward force on dividend stocks, pushing down valuations.
“The Dow Jones Canadian Select Dividend Index in Canada is trading at nine and a half times forward earnings, which is much cheaper than its historical norm,” he says.
Valuations for US dividend payers are even more compressed, Basinger notes, at levels reminiscent of the trough they saw in 2008. Against that backdrop, he and his team are seizing on potential opportunities in the pipeline space and in US healthcare.
Even with near-term headwinds, he argues dividends still make sense particularly for those who are bracing for a recession. He points out that dividend stocks, particularly in Canada and the US, typically have a lower beta than the broader stock market as they tend to hold up better during recessionary and bear-market periods.
“With a slowing-growth environment because of financial conditions tightening so much, we can expect yields to come back down, which will help lift valuations in the space,” he says. “I can’t say if this will be a blow-off top in yields or not, but this has certainly created an enticing opportunity in my mind.”
