Rising Interest In Dividends
By Jeremy Schwartz

The 1980s and 1990s witnessed one of the greatest equity bull markets in U.S. history, and dividends were largely an afterthought to capital gains. It was followed by a 10-year bear market in the 2000s to be sure; but in total, the 30-year span from 1980-2009 witnessed solid returns approaching an average of 11 percent per year for the U.S. equity markets.

U.S. bond returns over recent 30-year periods were also some of the best on record. Interest rates fell from their peak in the early ’80s; 10-year U.S. government bond rates decreased from rates in the teens to a rate under 4 percent by 2010. This sent bond returns skyward. Figure 1 compares historical 30-year U.S. bond and U.S. equity return patterns across time.¹



Unfortunately, the same type of bond rates that were available during the ’80s do not exist in U.S. government debt today. Interest rates on bonds are essentially as low as they have been in the last 40 to 50 years, leading many to believe that interest rates on bonds have nowhere to go but up. If that happens, the return to bonds, which have seen an influx of capital in recent years, may suffer.

Dividends As Inflation Hedge
Compounding worries about this recent “bond bubble” are fears of government debt and deficits driving up future inflation. Inflation erodes the purchasing power of bonds and leads to higher interest rates, which would be a double whammy for bond investors. Inflation averaged 4.39 percent from 1965 to 2009, which means that the purchasing power of $1 in 1965 was reduced to 14 cents by 2009.²

Dividends historically provided a hedge against inflation, or the loss in purchasing power, because dividend growth was greater than the rate of inflation. Over the last 45 years, the S&P 500 dividends grew at a rate of 4.99 percent per year, which was about 60 basis points higher than the inflation rate. The WisdomTree Dividend Index, a dividend-weighted index of the broad U.S. markets, had dividend growth of 5.62 percent per year over those 45 years. Note that the first two decades—the 1970s and 1980s—had average inflation rates of 6.22 percent, more than double the 2.73 percent inflation rates of the 1990-2009 period. Critically important, dividend growth from 1970-1989 outpaced the 6.22 percent inflation rate (see Figure 2).



Investors looking for inflation protection often turn to TIPS, or treasury inflation protected securities. The problem with TIPS bonds is that interest rates offered to investors today are tiny. As of June 30, 2010, interest rates on 10-year TIPS bonds and on 30-year TIPS bonds were just 1.15 percent and 1.73 percent, respectively. Despite the tiny yield, investors have flocked to these bonds for fear of unknown inflation.

Income-focused investors have sought out alternatives: principally, dividend-paying equities. The investment mantra of the ’80s and ’90s was growth of capital and the total return of equities without any regard to income. This was not the case for equities historically, when the average dividend yield on the S&P 500 prior to 1982 was 5 percent, and equities were viewed principally for their ability to provide dividend income checks. Since 1982, however, the dividend yield on the S&P 500 Index averaged just 2.6 percent, and during the 2000s, just 1.7 percent. Investors became enamored with the search for capital gains and were less concerned with dividends.

Previous Page

1  |  2  |  3  |  4  |  5

Next Page