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Market Outlook

Play Offense and Defense With Dividend Payers

2023 Outlook

Equity investors faced wild market swings in 2022. On more than 52% of the year’s days, the S&P 500 Index produced gains or losses of +/-1%. This was the highest rate since 2008 and the second-highest since the 1950s.1

High inflation, rising rates, increased geopolitical tensions, and weakening growth drove returns on the market’s down days. Hope drove the upside. Hope that inflation would soon slow, that the Federal Reserve (Fed) would pivot from its aggressive rate hikes, and that a strong labor market would dampen recessionary spirits in economic and fundamental data.

Hope is a good thing, but it isn’t a strategy. In this environment, while defensive positioning may be a better approach, it ignores the inevitability of an inflection point. The Fed can’t hike rates forever. Eventually earnings cynicism will find a bottom and optimism will be repriced. In the meantime, positioning portfolios for the fundamental weakness washing over the world, while acknowledging the potential for future positivity, takes combining offense with defense.

Dividend-paying firms support that mix.

Defensively, dividend payers have a consistent track record of returning value to shareholders but aren’t overly allocated to defensive market segments. And, they typically have a strong relationship to the value factor — a pro-cyclical exposure. As a result, dividend-focused strategies may help investors cautiously position for a cyclical recovery, without needing to pinpoint the timing of the pivot.

Navigating Inflation-Driven Downturns with Dividends

While inflation has declined from its peak, it’s still at a four-decade high. Consumer inflation expectations also remain near 40-year highs.2 While aggressive Fed policy has led to some improvement, defeating inflation will take some time. In the early 1980s when CPI was this elevated, it took 15 months for inflation to stabilize below 3%.

History shows, however, that dividend stocks thrive in prolonged inflation-driven markets. Since 1948 — including three periods of high inflation in the 1950s, 1970s, and 1980s — high-dividend stocks significantly outperformed their low-dividend peers and the broader market when 12-month average CPI inflation was in the top two quintiles (above 3.25%). See the following chart.

Dividend Stocks Outperform When Inflation Is High

Dividend Stocks Outperform When Inflation Is High

With high inflation placing downward pressure on profit margins and monetary tightening squeezing aggregated demand, negative earnings revisions have picked up for 2023. The bottom-up consensus earnings per share (EPS) estimates for 2023 have been cut by 7% to $233 since their June 2022 peak, compared to a historical average decline of 3% in the quarter leading into a new year.3 And with leading economic indicators falling deeper into negative territory — flashing warning signs of a recession —additional earnings downgrades are highly likely.

Despite these growth headwinds and downside revisions, more than 90% of firms report they plan to keep or increase their dividend.4 In fact, the median decline in dividends paid by S&P 500 companies in the past 12 US recessions since World War II was just 1%. And there was no decline in four of those recessions when inflation was above 5%, in 1974, 1980, 1981, and 1990.5

Given that dividend payments are more stable than stock price movements – providing an income cushion for total return — dividend strategies have had reduced drawdowns and lower volatility during bear markets, on average. In the 13 bear markets since 1960, high dividend stocks outperformed low dividend paying firms, as well as the broad market by an average of 12% and 8%, respectively.6

In fact, high dividend equities have demonstrated consistent outperformance, as they outpaced low dividend paying firms and the broader market in 11 of those 13 bear markets, as shown in the following chart.

Dividend Stocks Outperform During Bear Markets

Dividend Stocks Outperform During Bear Markets

High dividend stocks underperformed only twice — during the Global Financial Crisis (GFC) and the COVID-19 pandemic — when the respective impairment of the banking system and the public health system caused many companies to cut or suspend their dividends.

Unlike those two periods, our current economic downturn is driven by typical slowing of aggregated demand on the back of monetary tightening. And so far, dividend stocks have shown similar resiliency to what we saw during most other bear markets, outperforming the broad market by 16% year to date.7

Positioning for the Central Bank Policy Pivot

While central banks will continue to tighten until inflation is under control, disinflationary forces have started to emerge as the tightening has begun to transmit to the broader economy. The ISM PMI Price Index indicated decreasing prices for the first time since May 2020.8 Global supply chain pressures are back in line with historical levels.9 Wage inflation has fallen to its lowest level in one year,10 and rent increases have slowed.11 

Disinflationary, however, is not deflationary. It just means declining inflation.

After all, our current headline inflation figure is still above historical levels, even if it is slowly declining. Yet, at some point, these disinflationary forces will accelerate and translate to persistent downward trends in consumer prices. At that point, central banks will shift their focus to growth worries and begin easing.

A policy pivot could potentially renew sentiment toward more cyclical segments of the market and usher in hope for earnings positivity off a very cynical base. But the timing is uncertain. While a pivot is getting closer, as the Fed enters the later stages of its hiking cycle and earnings continue to be revised lower, the change in trend is unlikely to occur right away.

Dividend strategies can serve as a bridge to move portfolios smoothly from a defensive stance to a more hopeful environment.

While slightly more defensive than the broader market, they are less defensive (and more offensive) than low volatility strategies, as shown in the following chart. This has led to more upside capture by dividend yield strategies over the past decade versus the full-blown defensive low-volatility strategies (72% vs. 56%).12

Dividends Play Better Offense Than Low Volatility

Dividends Play Better Offense Than Low Volatility

Allocating to Undervalued Dividend Stocks for 2023

Despite dividend stocks’ leading performance in 2022, their attractive valuations and investors’ light positioning point to more upside potential.

After underperforming the broad market for three consecutive years, dividend stocks’ relative valuations were within the bottom decile over the past two decades based on price-to-forward-earnings, price-to-book, and price-to-cash-flow ratios at the beginning of 2022.13 Even given their significant outperformance year to date, their relative valuations are well below their long-term median (31st percentile based on price/forward 1-year earnings; 25th percentile based on price/cash flow; 21st percentile based on price/book).14

Holdings indicators produced by State Street Global Markets, using aggregated and anonymized custody data of $43.7 trillion in assets,15 show that investors’ holdings of dividend stocks have declined since the GFC, as dividend stocks underperformed growth stocks for most of those years. During the pandemic, investors’ underweight in dividend stocks reached its highest level in two decades, as growth beat dividend yield exposures by 21% on an annualized basis in 2020 and 2021.16

Although investors have been rebuilding their positions in dividend stocks amid elevated market volatility, allocations increased only to the 20th percentile over the past 20 years, indicating a significant underweight by historical measures.17 If dividend stocks continue showing resilience amid elevated market volatility and economic downturns, mean reversion in investors’ allocations may further support dividends’ performance in 2023.

Implementation Ideas

To take advantage of dividend payers’ unique mix of defensive and offensive characteristics as markets brace for more volatility, while remaining hopeful about the future, consider:

Companies that have consistently increased their dividend for at least 20 consecutive years

The 80 highest dividend-yielding companies within the S&P 500 Index

The 100 highest-yielding international stocks that have passed certain fundamental sustainability and earnings growth screens


Bio Image of Michael W Arone

Michael W Arone, CFA

Chief Investment Strategist

Bio Image of Matthew J Bartolini

Matthew J Bartolini, CFA, CAIA

Head of SPDR Americas Research


Bio Image of Anqi Dong

Anqi Dong, CFA, CAIA

Senior Research Strategist

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