2020 was a year of contradictions; we saw the U.S. unemployment rate go from a 50-year low to its highest rate in 80 years, while the S&P 500 rose 18%. All during a historic global pandemic. However, not all asset classes participated equally in the roller-coaster rise that was 2020.
High dividend stocks lagged the S&P 500 by 30%. This trend began well before 2020, with valuations on dividend stocks cheapening over the past four years while broad equities appreciated.
While history won’t necessarily repeat itself, the last time we saw this big of a performance differential was in 1999. Thereafter, dividend stocks outperformed equities for the next seven years.
Signs of potential opportunity
Source: Bloomberg. Data represents close Best P/E ratios as of December 31, 2016 and as of January 31, 2021. High dividend stocks represented by the S&P 500 High Divided Index
We see not only a valuation opportunity but an income one as well. With rates hitting new lows in 2020, many companies’ stocks now offer dividend yields that are higher than their respective corporate bonds yields. Moreover, dividends offer growth potential over time whereas bond coupons are fixed. Last year, the dividend distribution on Morningstar Dividend Growth Index grew by 10% whereas the yield on the Markit iBoxx USD Liquid Investment Grade Index1 contracted by over 12%. An additional consideration for non-qualified accounts is the preferential income tax treatment dividends receive over bond interest.
For these reasons, combined with our more constructive outlook on economic growth ahead, we have been adding to dividend stocks in our portfolios over the past several months. While we enter 2021 moderately pro-risk, we are staying well-diversified and flexible as we may see bouts of volatility.