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Dividend Investing Amid Historic Inflation and Rate Hikes

June 29, 2022

Read Time 6 MIN

As the market adjusts to high inflation, rising rates and market volatility, we believe a dividend strategy may offer investors more than just yield.

Dividend paying companies have been en vogue for much of the last 15 years as investors searched for yield beyond traditional income investments throughout the prolonged low rate environment. As the tide turns and the market adjusts to elevated inflation, rising rates and increased market volatility, dividend investing may offer more than just yield. Investors may be well served by considering current trends through a historical lens.

Could We Be Returning to Dividend Normalcy?

The Federal Reserve (Fed) has aggressively raised rates in the U.S. to combat disruptive inflation. This follows an unprecedented period of easy monetary policy following the Global Financial Crisis, during which rates remained near zero. For the better part of the last decade, asset prices marched higher and investors were left searching for income.

Dividend equity strategies became a common allocation for investors seeking yield. Assets tied to these strategies ballooned through the 2010s and into the 2020s as bond yields, bank accounts and other interest bearing assets provided little to no income for investors. There was one notable trend through this period: the average equity investor began to accept low- to zero-dividend levels from companies that reinvested capital to grow their business instead of returning profits to shareholders. In fact, this trend began in the 1990s in line with the rise of tech companies that were hyper focused on growth, pushing the dividend yield of the S&P 500 Index to 2% or less for much of the last two decades.

Declining S&P 500 Index Dividend Yield

January 1930 – March 2022

Declining S and P 500 Index Dividend Yield

Source: S&P, Nasdaq. For illustrative purposes only. Past performance is no guarantee of future results.

The Volatility Anomaly Among Non-Dividend Paying Companies

As Daniel Peris, author of several books focused on dividend investing, put forth in a recent podcast, the low volatility associated with non-dividend paying companies in recent decades is truly a historical anomaly. In the past, non-dividend-paying stocks have exhibited higher volatility relative to dividend payers. One simple reason for this is that the dividend component of a company’s stock return is far more predictable than its price movements. Looking back to the 1970s, the last time we faced real inflation pressure, high dividend yielding stocks provided a far lower volatility profile relative to non-dividend paying companies (and the U.S. equity market as a whole).

In recent years, investors seem to have normalized the reinvestment of cash flows by businesses and volatility has declined in turn. The volatility spread between non-dividend paying stocks and high-yielding dividend payers has been tighter than at any point in the last 50 years. As volatility spikes in the markets, we could very well see a return to historical norms if investors focus more on cash flows than valuations and reward those companies sharing profits and punish those that have long reinvested for growth.

Will Stock Volatility Characteristics Turn Back the Clock?

Rolling 10 Year Standard Deviation 1/1970 – 3/2022

Will Stock Volatility Characteristics Turn Back the Clock?

Source: Kenneth French Database, Dartmouth; Morningstar. For illustrative purposes only. Past performance is no guarantee of future results.

Dividend Growth Companies Underdelivering

Dividend growth companies have been the darlings of equity income investors throughout this period of low yields and low volatility. These dividend growth companies haven’t necessarily paid high dividends but have operated in a way that enabled them to consistently grow their dividends. Many investors have looked to dividend growth stocks as core portfolio equity allocations for their quality characteristics and their ability to participate in market appreciation.

Dividend growth companies have delivered in that sense. They have offered defensive characteristics through many of the U.S. market corrections since the Global Financial Crisis, more so in some cases than high yielding dividend paying companies. But that dynamic changed in a significant way in 2022. Dividend growth stocks have been somewhat defensive relative to the S&P 500 Index, but it is the high dividend yielding stocks that have truly offered a lower volatility and drawdown profile this year. Could this be a signal of what’s to come?

S&P 500 Index Corrections of 10% Since Global Financial Crisis

As of 5/31/2022

S and P 500 Index Corrections of 10% Since Global Financial Crisis

Source: Morningstar. U.S. Dividend Growth Stocks: S&P US Dividend Growers Index. U.S. High Dividend Yield Stocks: FTSE High Dividend Yield Index. For illustrative purposes only. Past performance is no guarantee of future results.

Look Beyond High Yield

A company can lure investors with tempting yields, only to experience financial distress, dividend cuts, and share price decline due to unsustained financial health. Though they have rewarded investors in many periods, the highest yielding companies have historically presented a risky proposition when it comes to volatility and downside risk.

When examining dividend paying stocks historically, those with the highest yield have featured the largest drawdown since the 1950s. The lowest yielding dividend paying stocks also feature elevated volatility and significant relative maximum drawdown.

Those stocks in the middle, from a dividend yield perspective, have offered the most compelling risk-adjusted return experience. But, as detailed above, things can change.

Highest Yielding Companies Have Higher Risk Profile

1950 – 2021

Highest Yielding Companies Have Higher Risk Profile

Source: Kenneth French Database, Dartmouth. US Companies grouped into quintiles by dividend yield. For illustrative purposes only. Past performance is no guarantee of future results.

Dividend Investing from a Position of Strength

Dividend paying stocks have offered many benefits to investors historically, but blindly investing in companies that grow their dividends or pay the highest yield can also have negative consequences. I haven’t even mentioned the premium at which many of these reliable dividend paying companies have traded through this low yield market environment. Many investors have overpaid for yield and have suffered through the repricing of the markets.

The Morningstar® US Dividend Valuation IndexSM approaches dividend investing from a position of strength. It targets high dividend yielding U.S. companies with strong financial health and attractive valuations. This allows investors to gain exposure to high yielding companies, but hones in on those that have less of a likelihood of cutting their dividends and aren’t trading at excessive valuations relative to the Morningstar equity research team’s assessment of fair value.

The Morningstar US Dividend Valuation Index Construction Process

The index selects stocks from the intersection of three primary screens applied to U.S. equities:

High Dividend Yield
Top 50%
of eligible securities as measured by trailing 12-month dividend yield
Attractive Valuations
Top 70%
most attractively priced as measured by Morningstar Star Score, a forward-looking valuation assessment assigned by equity research analysts
Strong Financial Health
Top 50%
of their peer group as measured by distance to default score, a proven predictor of future dividend cuts

The VanEck Morningstar Dividend Valuation ETF (DURA) seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of the Morningstar US Dividend Valuation Index, which is intended to track the overall performance of high dividend yielding U.S. companies with strong financial health and attractive valuations according to Morningstar.

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Important Disclosure

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

An investor cannot invest directly in an index. Returns reflect past performance and do not guarantee future results. Results reflect the reinvestment of dividends and capital gains, if any. Certain indices may take into account withholding taxes. Index returns do not represent Fund returns. The Index does not charge management fees or brokerage expenses, nor does the Index lend securities, and no revenues from securities lending were added to the performance shown.

S&P US Dividend Growers Index is designed to measure the performance of U.S. companies that have followed a policy of consistently increasing dividends every year for at least 10 consecutive years.

FTSE High Dividend Yield Index measures the investment return of common stocks of companies characterized by high dividend yields.

The S&P 500® Index consists of 500 widely held common stocks covering industrial, utility, financial and transportation sector; as an Index, it is unmanaged and is not a security in which investments can be made.

The S&P 500® Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2021 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

The Morningstar® US Dividend Valuation IndexSM was created and is maintained by Morningstar, Inc. Morningstar, Inc. does not sponsor, endorse, issue, sell, or promote the VanEck Durable High Dividend ETF and bears no liability with respect to that ETF or any security. Morningstar® is a registered trademark of Morningstar, Inc. Morningstar® US Dividend Valuation IndexSM is a service mark of Morningstar, Inc.

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