20 August Can the dividend

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Can the dividend 20 August 201

Can the dividend environment?

The search for income from h paying stocks has been a ver post the Global Financial Cris after Fed Chairman Ben Bern

Grace Tam Vice President

Global Market Strategist J.P. Morgan Funds

after Fed Chairman Ben Bern the Fed may taper the bond- and high dividend stocks hav negative impact on bond pric that rising rates would also d historical performance of glo were rising and explain why from high dividend stocks

Ben Luk Market Analyst

Global Market Strategy Team J.P. Morgan Funds

from high dividend stocks.

Resilient dividend stocks pe Investors often have a perce particularly after they saw a tapering concerns. But given the past couple of years som the past couple of years, som response to the potential tra mean that the dividend incom Our analysis using historical the dividend income theme i rising rates environment. Du 3-month periods with over 25 3 month periods with over 25 month total return of global broad MSCI AC World (USD) I We use the same method to falling rates environment (wh decrease in US 10-year Treas 3-month total return basis ou 3 month total return basis ou cumulative outperformance o during market downturns, wh high dividend stocks were ab

*The global high dividend unive quintiles (top 40% of stocks) ra model updates each stock’s divi

d theme thrive in a rising rates 13

d theme thrive in a rising rates

high-yielding fixed income products and high dividend- ry popular investment theme over the past several years sis amid the very low interest rate environment. However, nanke stated in his testimony before Congress in May that nanke stated in his testimony before Congress in May that

buying program in the coming months, high-yielding bonds ve seen a major correction. Investors understand the

ces when interest rates are rising. Nevertheless, is it true derail dividend stocks? In this paper, we look at the obal high dividend stocks when US Treasury bond yields

rising rates do not necessarily mean underperformance

erformance despite rising US yields

ption that rising rates are negative for high dividend stocks, sell off in the May/June correction triggered by the Fed’s the very strong inflows into dividend income products over me profit-taking in the asset class was very reasonable in me profit taking in the asset class was very reasonable in

nsition of US monetary policy. However, does this now me theme is effectively over for investors?

data from January 1995 to July 2013 in Chart 1 shows that s not over, as high dividend stocks held up quite well in a ring periods of rising US yields (which we define as rolling 5bps increase in US 10-year Treasury yields) the average 3- 5bps increase in US 10 year Treasury yields), the average 3 high dividend stocks* is +4.5%, slightly outperforming the ndex.

look at the performance of high dividend stocks during a hich we define as rolling 3-month periods with over 25bps sury yields). The results show that high dividend stocks on a utperformed the broad index by 1.7%, resulting in a

utperformed the broad index by 1.7%, resulting in a of +328% since 1995. With significant outperformance hile remaining relatively resilient during rising rates, global ble to maintain long-term outperformance.

erse is a monthly rebalanced portfolio based on the top two anked by dividend yields in the MSCI AC World (USD) Index (i.e. our

idend yield in the index on a monthly basis and selects the top

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Performance of high dividend stocks in line with the broad when US yields are falling

Chart 1: Rolling 3-month average total return from January 1995 to Ju

6%

Rising Rates Environment Falling Rate

4.5% 4.3%

2%

1.8%

4%

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management, Augus Note: Periods of rising/falling US yields are defined as rolling 3-month periods from January 1995 to July 2013. Refer to page 1 for the definition of high divid

0%

High Dividend Universe AC World High Dividend Univer

High dividend stocks are not just about defensives

In many investors’ minds, high dividend-paying stocks mainly co and telecom). During a rising rates environment when the US ec energy, industrials and technology), which are strongly tied to t defensives. In fact, Chart 2 shows that within the high dividend s

li l ) t f d th MSCI AC W ld (USD) I d hil cyclicals) outperformed the MSCI AC World (USD) Index, while g US yields over the past 18 years.

Within the high dividend universe, non-defensives have ou Chart 2: Rolling 3-month average total return during periods of rising

9%

4.3%

2.3%

5.6%

7.9%

6.3% 6.2%

0%

3%

6%

9%

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management, Augus Note: Periods of rising US yields are defined as rolling 3-month periods when to July 2013. Defensives include Telecom, Utilities, Health Care and Consume Technology, Consumer Discretionary and Financials. Refer to page 1 for the d

0%

d index when US yields are rising and much stronger

uly 2013

es Environment All

3.0%

2.2%

st 2013.

s when the US 10-year Treasury yields increased/decreased over 25bps dend universe.

0.1%

rse AC World High Dividend Universe AC World

onsist of defensives (utilities, health care, consumer staples conomic recovery is getting stronger, cyclicals (materials, the economic cycle, naturally tend to outperform

stocks universe, global non-defensives (financials and

l b l d f i d f d d i i d f i i

lobal defensives underperformed during periods of rising

utperformed defensives in a rising rates environment US yields from January 1995 to July 2013

5.8% 5.1%

4.6%

2.8% 2.4% 2.3% 1.9%

st 2013.

the US 10-year Treasury yields increased over 25bps from January 1995 er Staples. Non-defensives include Energy, Industrials, Materials, definition of high dividend universe.

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When we take a look at the breakdown of the high dividend stocks universe in the MSCI AC World (USD) Index,

defensives make up only 34%, while financials and cyclicals weightings are 24% and 42%, respectively (Chart 3).

Therefore, it is actually the non-defensive sectors that account for 2/3 of the high dividend stocks in the world index. This also explains why the performance of global high dividend stocks managed to largely match that of the broad index during periods of rising US yields.

Non-defensives make up 2/3 of the high dividend stock universe in the MSCI AC World Index

Chart 3: Composition of the high dividend universe of the MSCI AC World (USD) Index

Industrials 9%

Energy Financials

24% Energy

13%

on. Disc.

4%

I.T.

9%

Materials Telecom

7%

Utilities 6%

24%

Con. Disc.

4%

Tech.

9%

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management, August 2013. Refer to page 1 for the definition of high dividend universe.

Attracti e opport nities in high di idend non defensi es

Con. Stap. 7%

11%

Health Care 10%

Attractive opportunities in high dividend non-defensives While defensive stocks (+4.0%) on average have tended to pay higher dividend yields relative to non-defensive stocks (+3.8%) within the global high dividend universe over the past 18 years, investors should also focus on other factors that could drive total returns besides higher dividend yields, such as the ability of a company to generate and sustain its such as the ability of a company to generate and sustain its earnings and dividends over time.

In fact, Chart 4 shows that annualized earnings per share (EPS) growth over the last decade was much stronger for high dividend non-defensive stocks (+8.1%), relative to high dividend defensive stocks (+5.4%). Earnings growth for technology (+12.4%), industrial (+25.0%) and material (+10.5%) stocks were particularly stronger than the universe over the past 10 years. As we believe the global macro environment will continue to improve in what remains of 2013 and into 2014 due to a pickup in US and European economic growth, non-defensive stocks would be in the right position to potentially outperform the broad market.

Non-defensives have a stronger EPS growth than defensives in the high dividend universe

Chart 4: Earnings per Share Index, rebased 2003 = 100

500

High Dividend Non-Defensives

200 300 400

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management, August 2013. Refer to page 1 for the definition of high dividend universe.

High Dividend Defensives

0

100

'03 '05 '07 '09 '11 '13

In terms of dividend per share (DPS) growth within the global high dividend universe, Chart 5 shows that annualized dividend growth was largely the same between defensives (+6.9%) and non-defensives (+6.5%) over the past decade. If we break down the non-defensive segment, it was mainly financials that dragged down the DPS growth of the overall non-defensive segment with an annualized dividend growth non defensive segment with an annualized dividend growth of only +3.0%, while other cyclical sectors including

technology (+17.3%), industrials (+20.1%) and materials

(+8.4%) had relatively stronger DPS growth.

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Both high dividend defensives and non-defensives have a similar pace of DPS growth

Chart 5: Dividends per Share Index, rebased 2003 = 100 250

100 150

200

High Dividend Defensives

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management,

0

50

'03 '05 '07 '09 '11 '13

High Dividend Non-Defensives

August 2013. Refer to page 1 for the definition of high dividend universe.

Compelling valuations for high dividend non-defensives As “chasing for income” has become a fashionable

investment theme, it is reasonable to question whether the valuations of high dividend stocks have become expensive after a few years of re-rating. Traditional high dividend defensive stocks are currently trading at a 12-month forward P/E ratio of 14.9x, a premium of 1.12x relative to the MSCI AC World Index. However, what investors may not realize is that high dividend non-defensive stocks are trading at 11.7x, a discount of 0.88x relative to the broad index, with

technology, financials and energy stocks trading at a

di f d i l ( h )

discount of 0.93x, 0.87x and 0.74x, respectively (Chart 6).

High dividend non-defensives are trading at a discount to the broad world index

Chart 6: Weighted average 12-month forward P/E Relative to MSCI AC World

1.4x

1.0x 1.2x

High Dividend Defensives

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management,

0.6x

0.8x

'03 '05 '07 '09 '11 '13

High Dividend Non-Defensives

August 2013. Refer to page 1 for the definition of high dividend universe.

Note: Ratio above 1 indicates more expensive relative to the MSCI AC World index.

An investment theme for all seasons

Chart 7: MSCI AC World (USD) Cumulative Total Return by Quintiles (ranked by Dividend Yield) with Monthly Rebalancing Index, rebased 1995 = 100 de , ebased 995 00

600 800

1,000

Quintile 1

Quintile 2 Quintile 3 Quintile 4 Quintile 5 AC World

0 200 400

Source: MSCI, FactSet Alpha Tester, J.P. Morgan Asset Management, August 2013.

0

'95 '97 '99 '01 '03 '05 '07 '09 '11 '13

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Investment implications

As history suggests that high dividend equities do not necessari believe investing in this asset class is more than a purely defens all seasons, as high dividend defensive stocks tend to outperfor cyclicals tend to outperform when the economic outlook is impr dividend stocks effectively pushes the risk-reward ratio in a favo This also explains why global high dividend stocks have delivere (Chart 7). In fact, since a large portion of the global high dividen were able to benefit from the non-defensives’ high income and environment. We believe investors should be able to continue to

Past performance is not a guarantee of future results. Any forecasts c relied upon as advice or interpreted as a recommendation. Opinions, are based on current market conditions constitute our judgment and a are based on current market conditions constitute our judgment and a provided herein should not be assumed to be accurate or complete. T purchase or sale of any financial instrument. The views and strategies specific securities, asset classes and financial markets are for illustra interpreted as recommendations or investment, product, accounting, responsibility or liability whatsoever to any person in respect of such m Management. These views do not necessarily reflect the opinions of a J.P. Morgan Asset Management is the brand for the asset manageme

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ily underperform when US bonds yields are rising, we sive strategy. It is actually a long-term investment theme for rm during the downturn, while high dividend financials and

roving. Thus a portfolio combining both types of high ourable direction.

ed consistent outperformance over the past two decades nd universe consists of financials and cyclicals, investors

earnings growth opportunities even in a rising rates o benefit in 2014 as well.

contained herein are for illustrative purposes only and are not to be estimates, forecasts and statements of financial market trends that are subject to change without further notice The information are subject to change without further notice. The information This material is not intended as an offer or solicitation for the

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