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Dividend Stocks: Less Of The Upside And More Of The Downside
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Dividend Stocks: Less Of The Upside And More Of The Downside

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Dividend Stocks: Less Of The Upside And More Of The Downside

While bubble-spotting among equity investing tilts is often futile, the ever-increasing call for investors to buy high-quality dividend-paying stocks has become as over-used a term as 'long-term investor', and 'buy-the-dips'. It seems the general belief is that a 3-5% dividend yield will provide 'protection' to cushion volatility as it offers income above Treasuries. Back in September we highlighted both the apples-to-unicorns comparison that is dividend yields to TSY yields and moreover, how risk (and ultimately capital loss) should play a critical part in the decision of asset allocation. Today we take a quick look at dividend stock performance over the last few years and find something intriguing - and not often mentioned - that dividend stock portfolios appear to significantly underperform in sell-offs and marginally underperform in rallies. So if you want a high beta crowded trade, admittedly with some carry, buy high quality dividend-paying stocks.

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Eviudently, based on Goldman's high quality dividend-paying stock focused portfolio, when markets significantly sell-off, dividend-paying stocks will tend to notably underperform (up to 5% over the last 4 years). Unfortunately, the upside beta is not as tilted in your favor with underperformance in extended rallies and furthermore only around 1% outperformance in modest sell-offs. Of course, during these moves, the dividend will indeed cushion the moves - well shift it up - but the point is that the performance of the portfolio itself is adjusting for the dividend relative to the market and so there really is no free lunch.

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One more item of interest is the growing belief that corporations will borrow to fund buybacks or increased dividends. The latter is a little less financially flexible for the corporation, however, the market seems to believe this will happen as forward option implied dividend expectations (basically a way to look through forward option prices to infer expectations of dividends) are set to grow significantly over the next two years with the dividend yield looking to reach 2.5% in the next 2 years (for SPY this is). It certainly seems like markets are 'decided' that this is the way it will be and crowded trades such as this never end well.

Charts: Bloomberg



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