March 1, 2010 - Groundhog Day Comes Late
Groundhog Day came late in February for the stock market. Last Thursday’s worsening weekly unemployment claims data spooked stock market investors worried about job growth as February winter storms negatively impacted the data. In that labor report, the stock market saw its shadow
and it appears that investors are in for six more weeks of winter weather affected reports contributing to stock market volatility. Everything from retail sales to manufacturing to the job market is likely to have been affected by the unusually bad winter weather in February. The most significant of these may be the Employment report for February, due this week on Friday morning, which is likely to show another month of job losses that were exaggerated by the winter storms.
In the last Weekly Market Commentary entitled Investing for Volatility, we described ways to invest in a low-return, volatile market. One of these ways is to focus on yield rather than solely on price appreciation. Our favorite asset class remains High-Yield Bonds. However, another way to incorporate more yield into a portfolio is through dividends. Indeed, higher dividend yielding sectors have been better performers lately. The added advantage of incorporating a focus on dividends now is that March and April tend to be the time of year when most companies increase their dividend payment. In the current environment, a boost to the dividend payment may signal more confidence in sustained growth by business leaders than their guidance on the earnings outlook helping to lift stock prices along with the dividend payout.
The past two years have been tough on dividends. In fact, 2009 marked the worst year on record for dividends since 1955, resulting in a 21% decline in dividends per share for the S&P 500 companies as a whole. In both 2008 and 2009, 32 S&P 500 companies suspended their dividends while only 11 initiated a dividend payment.
Dividends finally appear to be on the rebound. Currently, 366 of the S&P 500 companies pay a dividend. A total of 49 companies in the S&P 500 increased or initiated a dividend so far this year while only two companies have decreased or suspended their dividend. Of the 49 positive dividend actions, there have been fi ve companies initiating a dividend payment in the S&P 500 so far this year and all of them were in the Consumer Discretionary and Information Technology sectors.
It may seem strange to think about the Information Technology sector when discussing dividends. Historically, tech stocks rarely offered any dividends, preferring instead to reinvest that cash back in to their growing businesses or to fund growth through acquisitions. But the sector has become much more attractive to yield-focused investors. It used to be the financial sector that dominated the dividend payers, contributing over 20% of the S&P 500 total dividends. But with the impact of the financial crisis on the make-up of the index and the suspension of dividends for some companies the sector now makes up a below average 9% of the dividends paid by S&P 500 companies. The Financial sector now has a smaller contribution than the Information Technology sector.
We expect dividend payments to rebound in 2010, including those from the Financial sector as TARP loans are repaid and dividends are reinstated. One of the reasons we believe dividends are turning the corner is that companies now have the ability to pay the dividends. The dividend payout ratio (the last four quarters of dividends per share divided by the last four quarters of earnings per share) is low indicating an ability to increase the payout. The aggregate S&P 500 dividend payout ratio is currently 36%. This is below average, and even with increases to dividend payments this ratio is likely to fall back to the lows of the 2000s as earnings growth rises more quickly in the coming quarters. With the payout ratio near its lows, companies have ample reserves to pay dividends. Another factor supporting the ability to pay dividends is that cash balances are also high.
Importantly, not only do companies have the ability to increase their dividend payments, they also have the incentive. Investors may already be increasingly turning to dividends as a gauge of financial health. After all, dividends cannot be restated or written off. The simple clarity of a dividend increase speaks loudly amid the uncertain economic environment and weather-distorted economic reports.
IMPORTANT DISCLOSURES: The opinions voiced in this material are for general information only and are not intended to provide specifi c advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your fi nancial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Investing in international and emerging markets may entail additional risks such as currency fluctuation and political instability. Investing in small-cap stocks includes specific risks such as greater volatility and potentially less liquidity.
Stock investing involves risk including loss of principal Past performance is not a guarantee of future results.
Small-cap stocks may be subject to higher degree of risk than more established companies’ securities. The illiquidity of the small-cap market may adversely affect the value of these investments.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rate rise and are subject to availability and change in price.
© LPL Financial
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