As the U.S. market has hit new highs recently, there is some concern that we are in a stock market bubble. For the U.S. market as a whole1 as of January 31, 2021, the trailing price-to-earnings was 32x and the forecasted 2021 price-to-earnings was 23x. These valuations can be compared with the price-to earnings during the tech bubble of 31x. The long-term average of the U.S. market’s price-to-earnings since January 1970 has been 17x. No one knows when the U.S. market will next decline into bear market territory (decline of 20% or more). But there appears to be at least one dividend-oriented strategy which might help protect on the downside.
We looked at two main dividend-oriented strategies—Dividend Growth and High Dividend. As a proxy for Dividend Growth strategies, we used the S&P 500 Dividend Aristocrats Index2 which consists of a list of companies—mainly well-known, large-cap, blue-chip companies—in the S&P 500 with a track record of increasing dividends for at least 25 consecutive years; and as a proxy for High Dividend the DJ Select US Dividend Index3, a broad market index which tracks stocks with the highest dividend yields. In addition, we compare both indexes to the S&P 500 Index. Since data was available for DJ Select US Dividend Index starting in February 1992, we compared the performance of the three indexes from February 1992 through December 2020.
The table below measures the performance and standard deviation as well as the downside capture ratio of the two dividend strategies. The downside capture is the ratio calculated by taking the fund's monthly return during the periods of negative benchmark performance and dividing it by the benchmark return (in this case the S&P). The lower the downside capture indicates that the strategy goes down less than the benchmark during periods of negative returns. In addition to downside capture, the table also shows the return of the dividend strategies when investors arguably “needed downdraft protection most”—during the three Bear markets since February 1992, including the short-lived Covid crash between January and March 2020 (Bear markets so defined as having a peak-to-trough decline of 20% or more.)
1 Based on MSCI U.S. Index
2 The S&P 500 Dividend Aristocrats Index was launched in May 2005. Performance data before that date was backfilled.
3 The DJ Select US Dividend Index was launched on November 3, 2003. Performance data before that was backfilled.
It can be seen from the table below that dividend-oriented strategies have historically performed well relative to the S & P and done so with lower downside capture. Of the three Indexes, the S&P 500 Dividend Aristocrats Index had the lowest standard deviation. What can be seen from the table as well is that although both dividend strategies’ downside ratio was below 1.00, the S&P 500 Dividend Aristocrats Index had a decidedly lower downside capture (a good thing) than the DJ Select US Dividend Index.
In terms of the last three Bear markets, both dividend strategies had positive performance during the bursting of the tech bubble (peak to trough from 9/2000 through 10/2002). During the Great Financial Crisis (peak to trough 11/2007 through 3/2009), the S&P 500 Dividend Aristocrats Index went down less than both the S &P and the DJ Select US Dividend Index. In fact, the DJ Select US Dividend Index went down more than the S & P. This was due to the high composition of stocks such as Financials in the highest yielding cohort in the DJ Select US Dividend Index during this period. This helps account for the lower (e.g. better) downside capture of the S&P 500 Dividend Aristocrats Index than the DJ Select US Dividend Index during the Great Financial Crisis and since February 1992. Again, during the recent Covid market crash, the S&P Dividend Aristocrats Index went down less than the DJ Select US Dividend Index.
Based on the last three bear markets, higher quality dividend growth stocks as represented in the S&P 500 Dividend Aristocrats Index offered more consistent downside protection than the highest paying dividend stocks as represented by the DJ Select Dividend Index.
DISCLOSURE: The opinions expressed herein are those of DCM Advisors, LLC (“DCM”) and are subject to change without notice. This material is for informational purposes only and is not financial advice or an offer to sell any product. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable. All investment strategies have the potential for profit or loss. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. DCM is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about DCM including its advisory services and fee schedule can be found in Form ADV Part 2, which is available upon request.
