All dividend payers are not created equal—it’s a conclusion we’ve come to almost a decade after launching our first dividend-focused Indexes. Different types of dividend payers will have a tendency to perform differently as the market environment ebbs and flows.
• Playing Offense: Dividend-paying stocks may not seem to be a way to go on offense, but not every dividend-paying stock finds itself in the Utilities and Telecommunication Services sectors. In particular, we believe there are relatively lower-yielding dividend payers with significant growth potential. These companies may be best positioned in an environment of economic growth and even rising interest rates, especially if they feature relatively low debt.
• Playing Defense: This more “classic” approach to dividend-paying stocks focuses in many cases on stocks with relatively higher dividend yields, placing more emphasis on the defensive sectors: Utilities, Telecommunication Services, Health Care and Consumer Staples. In times of volatility, in many cases characterized by falling interest rates, these types of strategies may deliver outperformance.
The 2015-to-2016 Inflection Point
While true inflection points are very difficult to predict, they are always interesting to study in hindsight. The transition from 2015 to 2016 might be one such turning point in market sentiment toward different types of dividend-paying stocks.
2015: Dividends Trail; 2016: Dividends Lead
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• 2015: For context, the U.S. 10-Year Treasury note saw its interest rate increase by approximately 10 basis points (bps)1—and usually a rise such as this can be a headwind for higher-yielding dividend-payers, such as those seen in the WisdomTree Dividend ex-Financials Index. On the other hand, the WisdomTree U.S. Quality Dividend Growth Index held up best, with a methodology that led to only minimal exposure to high-yielding dividend payers and a preference for those with low leverage.
• 2016 Year-to-Date: Over this period, the U.S. 10-Year Treasury note saw its interest rate decrease by approximately 40 bps2—with volatility and uncertainty ratcheting up. WisdomTree’s two most defensively positioned large-cap U.S. dividend strategies—the WisdomTree Dividend ex-Financials and the WisdomTree High Dividend— Indexes were strongest. It is interesting as well that the WisdomTree U.S. Quality Dividend Growth Index—not in its most favorable environment—also outperformed the S&P 500 Index over this period.
We’re Watching Three Critical Signals as 2016 Continues3
1) Valuation: One of the most popular types of strategies in 2016 has centered on “low volatility” or “minimum volatility.” The MSCI USA Minimum Volatility Index is up 1.91% thus far in 2016, with a price-to-earnings (P/E) ratio of more than 21x; the S&P 500 Low Volatility Index is up 1.40% over the same period, with a P/E ratio of more than 20x. On the other hand, the WisdomTree High Dividend Index has a P/E ratio of 18.3x, and the WisdomTree Dividend ex-Financials Index has a P/E ratio of 15.8x. Valuation is always an indication of potential risk, and it’s interesting to us that the two most defensively oriented WisdomTree dividend strategies have substantially lower P/E ratios (and better performance thus far in 2016) than those focused more explicitly on volatility. Time will tell if this continues.
2) Sectors: Thus far in 2016, in the S&P 500 Index, Telecommunication Services is up more than 12%, with the Utilities sector in a close second at almost 9%. Combined with Financials being the worst performing sector (down 6.5%), it is not surprising that the WisdomTree Dividend ex-Financials Index has done well. The broader but still defensively oriented approach would be the WisdomTree High Dividend Index, which contains exposure to all 10 sectors.
3) Interest Rates: The market’s expectations of the U.S. Federal Reserve (Fed) have adjusted compared to the start of 2016, but the 10-Year Treasury note’s interest rate has likely responded more to volatility and uncertainty than any expectations of changes in the Federal Funds Rate. Something we look at closely is the difference in P/E ratio between the WisdomTree High Dividend Index—18.3x—and the WisdomTree U.S. Quality Dividend Growth Index, which is closer to 16.5x. In a falling interest rate environment, income-producing equities (WisdomTree High Dividend Index) can have a source of strong demand, keeping the P/E ratio high. In more normalized interest rate environments, we believe that higher earnings growth potential and higher quality (WisdomTree U.S. Quality Dividend Growth) would command greater demand.
1Source: Bloomberg, for period 12/31/14 to 12/31/15.
2Source: Bloomberg, for period 12/31/15 to 3/4/16.
3Source: Bloomberg, for all three points, with period “thus far in 2016” referring to 12/31/15 to 3/4/16. Point-in-time data refers to 3/4/16.
Important Risks Related to this Article
Dividends are not guaranteed, and a company’s future ability to pay dividends may be limited. A company currently paying dividends may cease paying dividends at any time.