20 April 2020
The speed and narrowness of the recent market pullback, as well as the large accumulation of cash holdings, suggests a market that is not trading on fundamentals. Since the end of February, investor portfolios have been forced to endure the pains caused by a global coordinated societal shutdown. While the impact to developed market economies is nowhere near over, developed market equities appear to have digested the initial shock and are starting to price for the future.
The primary question facing portfolios that invest for income is, in an environment where increasing social disruption has shocked the real economy, how stable are dividends? The drop in consumer demand at a time of high corporate debt levels has caused many investors to question whether companies will continue to generate the cash flows needed to return regular cash dividends to shareholders.
We believe factor investors should position for a market that will resume trading on longer-term fundamentals. As the economic disruptions of the global pandemic continue to threaten dividends, the Dividend Aristocrats methodology is uniquely suited to target the most stable dividend payers. The primary stock selection component of the Dividend Aristocrats family of strategies is long-term track record (5-20 consecutive years) of maintaining (or raising) the regular cash dividend delivered to shareholders. Firms that will be able to maintain their dividend income stream will be keen to reaffirm this in their earnings reports. As such, the Q1 earnings season marks an interesting opportunity for strategies like Dividend Aristocrats, which target these firms.
In terms of regional exposure, we continue to favour the US on a relative basis for equity investors. While the US may lag some developed European economies (e.g. Germany) and already trail some Asian countries (e.g. China and South Korea), in terms of reopening, we believe the underlying fundamental strength (pre-pandemic) will help the resilience and recovery of US equity prices as the market returns to fundamentals. After the January rebalancing in US Dividend Aristocrats, the average company has increased their dividend for 37 consecutive years. Additionally, 51 constituents have been increasing their dividend for over 40 years (see Figure 1 below).
For investors concerned about an over valuation of the US dollar – driven in part by an increasing stockpiling of dollar denominated cash holdings – the SPDR® S&P® U.S. Dividend Aristocrats EUR Hdg UCITS ETF provides access to the US equity dividend story with an exposure that is fully hedged back to euro.1
The foundation of the Dividend Aristocrats strategies is the long-term dividend track record. For this reason, while constituents in these strategies will not be immune from dividend cuts, it is as important as ever that investors recognise the value of dividend stability. This family of indices is uniquely positioned for the current environment, as it selects companies where the management teams have a demonstrated commitment of seeking to preserve regular cash dividends.