Playing Defence in 2023: Dividend Yield Stocks

Key Takeaways

• 1. Dividend reinvestments can help offset some effects of inflation.
• 2. Companies that consistently grow dividends historically outperformed their peers.
• 3. Dividend growers historically showed better performance with lower volatility.

Earning income in portfolios is especially challenging in the current market environment. The US Federal Reserve has kept interest rates close to zero throughout the pandemic to keep the global economy afloat. This resulted in an overcorrection, and inflation rose significantly in 2022.

To control inflation, the Fed is now recorrecting by raising interest rates throughout 2022 and has vowed to raise them further in 2023. This risks another type of overcorrection by sending the economy into a recession. However, the Fed’s rationale is that they have no instrument to control runaway hyperinflation, but that they can re-correct a recession (again) through lowering rates as well via new rounds of Quantitative Easing.

Citi analysts do not expect rates to rise much further¹. Inflation may continue to run high into 2023, and real yields (the yield you receive after deducting the effect of inflation) on cash and fixed income may remain low.

Offsetting the effects of inflation

Since 1990, the average US inflation rate has been 2.74%² per annum, while the gains from reinvesting dividends in the S&P 500 (an index that is a type of representation of the stock market), have been 2.19%² a year. Reinvesting dividends may be one of the best ways to counteract the detrimental effects of inflation.

Figure 1 illustrates how reinvesting dividends can help offset some effects of inflation while achieving positive returns.

Figure 1: Reinvesting dividends helps to counteract the adverse effects of inflation.

Source: Haver Analytics as of Sept. 30, 2022. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.

Looking within Asia ex-Japan, the Consumer Price Index, which tracks inflation via the price of a basket of goods, had increased 2.9%² per annum on average since 1995, while the dividend yield was 2.5%³. Here we see that on a regional basis, dividend reinvesting may also be able to offset the effects of inflation.

Companies whose dividends grow consistently, have less volatility on returns

Companies whose dividend payments have grown year on year, exhibit both higher annual returns and lower volatility as compared to companies with high dividend rates. Stocks with high dividend pay-outs tend to cut their dividends when times are bad, and this reduces total returns and increases volatility. Dividend growers, however, tend to be higher-quality, financially robust businesses that hold up in down markets and can grow their dividend payout ratio. This ultimately makes for a steadier ride amid choppy markets.

Figure 2: Dividend growers historically showed higher performance with lower volatility

Source: Citi Global Investment Lab, Bloomberg. Data as of Jul 28, 2022. Starting period for performance and volatility September 21, 2015. World Equities: Growers is the MSCI World Dividend Growers Quality Select Net Total Return Index, ‘High Yielders’ is MSCI World High Dividend Yield Net Total Return Index. US Equities: ‘Growers’ is S&P Dividend Aristocrats Select Net Total Return Index, ‘High Yielders’ is S&P 500 High Dividend Yield Select Net Total Return Index.

Companies whose dividends grow consistently outperform indices

Historically, companies that consistently grew their dividends outperformed their benchmark index (an index is the weighted average of the return of the peers of the company). Citi’s Office of the Chief Investment Strategist (OCIS) team’s view is that quality, dividend grower companies can continue to outperform going forward4. Dividend-growing companies are typically indicative of strong balance sheets (meaning less relative debt) and strong cashflows. Our dividend grower basket has several global pharmaceutical and software companies.

Figure 3: Dividend growers indexes vs parent indexes

In conclusion, dividends stocks may protect investors from inflation that they can’t get from sitting on cash or investing into fixed income. Amongst divided stocks, companies that have grown their quarterly dividend or annual dividend rates consistently indicate stronger fundamental metrics and lower volatility in their share prices and stock prices.

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Disclaimers

Sources

• 1. Citi Private Bank Office of the Chief Investment Strategist (OCIS), Outlook 2022.
• 2. Haver Analytics as of Sept. 30, 2022
• 3. Bloomberg as of Sept. 30, 2022. Dividend yield was obtained from the dividend yield of the MSCI Asia ex-Japan Index.
• 4. Citi Private Bank Office of the Chief Investment Strategist (OCIS), World Investment Navigator, March 2022.

For all charts: Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is no guarantee of future results. Real results may vary.

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