By Guest .Blogger Doug Rowat
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The dividend cut-parade has begun.
Plagued by the devastating coronavirus lockdown, more than 40 S&P 500 companies have cut or suspended their dividends so far this year. In almost every case, it’s unsurprising the companies that are doing the slashing given their coronavirus-sensitive business models: Carnival, Boeing, Schlumberger, Walt Disney, Delta Airlines and Marriott International to name but a few.
But regardless of how well-telegraphed these dividend cuts may have been, investors who rely on their portfolios for income are going to have to reconcile themselves to getting less of it. Not owning these stocks specifically doesn’t mean that you’ve escaped a reduction in your cash flow. More dividend cuts are coming and dodging all the cutters will be like dodging raindrops in a thunder storm. Also, most of the companies that have already cut are widely held by both mutual funds and ETFs. Vanguard Group, for instance, is the largest holder of Boeing, Disney and Schlumberger. So, if you own any kind of broad-based investment vehicle your income stream has probably already been dinged. No income investor is getting out of this coronavirus crisis unscathed.
So, how bad could it get?
According to a recent research note from Morgan Stanley, the market is currently implying a 15% drop in S&P 500 dividends this year. And if we examine our most recent economic catastrophe—the 2008-09 financial crisis—the S&P 500 saw a massive 27% decline in dividend payouts from peak to trough. So a dividend decline of between 15% and 30% this time around is a reasonable assumption.
S&P 500 dividends per share – long term
Source: Bloomberg
However, there is a silver lining.
First, the Morgan Stanley note argues that expectations of a 15% decline in dividends may be overly pessimistic: “we suspect many management teams will be reluctant to cut dividends and be willing to use some cash on hand to support dividends.” Morgan Stanley further states that “companies will always do their best to protect dividend payments and there is substantial empirical data on the strong signaling effects of dividends and stock prices.” In other words, senior executives, who understand the importance of share price performance in relation to future equity financings (not to mention their own compensation) will bend over backwards to protect those dividends.
Second, the 27% drop in dividends during the financial crisis was very short lived. The entire dividend decline spanned only about 9 months (July 2008 to March 2009). Companies then immediately began to raise dividends, returning to pre-crisis highs within three years. Now, it can be argued that the coronavirus crisis may last longer than the financial crisis, but it should also be noted that the rise in dividends following the financial crisis very closely tracked the recovery in the broader equity market. This is always the case. And in case you’ve been under a rock, equity markets have been skyrocketing since their March 2020 lows—surely a good sign for dividend outlook. Indeed, the Morgan Stanley note goes on to add that “if investors believe dividends will only fall 15% in such a terrible economic year, it should make them feel better about this stream of dividends in the future.”
And finally, if you’ve prudently built a balanced and diversified portfolio with multiple asset classes and various sector and geographic exposures, you have even less concern regarding a reduction in your income stream. US treasuries, Government of Canada bonds and even most high-quality corporate bonds are in no danger of default. Further, if you have diversification within the equity component of your portfolio, the effect of broader market dividend declines can be further mitigated.
Every portfolio, for instance, should have Canadian bank exposure. Reliable dividends are critical to the reputation of our big banks making it extremely unlikely they will ever cut. Indeed, none of the big five Canadian banks has cut dividends in at least the past 80 years (National Bank, the sixth largest, cut its dividend in 1993) and none cut, of course, during the financial crisis:
S&P/TSX Canadian Bank Index dividends per share (white line) vs S&P500 dividends per share (orange line) – Canadian banks held steady during the financial crisis.
Source: Bloomberg
But if for some reason you have no confidence in the payouts of our Canadian banks, you might find comfort in other sectors such as US health care. Many of the largest US health care companies (Johnson & Johnson, Pfizer, etc.) have actually RAISED dividends this year.
Regardless, the point here is that diversification is always the key to limiting your dividend downside.
So, more dividend cuts are coming. Brace for it. Fortunately, these cuts are likely to be short lived and can be ameliorated through proper portfolio diversification. However, if you’re taking income from your portfolio, you may simply have to temporarily adjust to a more modest lifestyle. One thing this crisis has taught us is that we’re all going to have to make sacrifices.
Think you’re above doing that? Tell that to a frontline worker.