Dividend growth expected to hit 65-year low

Over the past quarter century, investors have turned to dividend-paying stocks as lifeboats in an ocean of volatility.

However, traders are expecting that to change, and in a pretty monumental way.

Players in the swaps market — generally institutional investors exchanging contracts over expected moves in market variables — are pricing in the lowest growth in dividends since 1950, according to a Goldman Sachs analysis. The current pricing levels imply a growth rate of just 1.3 percent a year, which would be down sharply from the average 5.8 percent growth in the 65-year period.

If the expectations are correct, it would mark a major change for retail investment strategy.

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"Strategically, we are partial to dividends, which have historically generated a meaningful share of total return for US equities," Goldman strategists said in a note to clients. "However, on a tactical basis, rising interest rates pose a risk to high dividend yield stocks."

Dividends
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Specifically, expectations that the Fed will continue to raise rates in the years ahead are weighing on expected returns for dividend-paying stocks. In December, the Federal Open Market Committee, which is the monetary policy arm of the central bank, approved the first hike in the funds rate it uses to target the trajectory of interest rates.

A rising funds rate likely would push up yields on government bonds, making them more attractive than riskier dividend-paying stocks.

Consequently, some investment advisers are telling clients to change their perspective on dividends.

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"For 30 years, investors have gotten used to falling interest rates and easy-money policies. That's not going to be the case in 2016," Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch, told clients in her look-ahead for the year. "Our simplest advice for the year: Do the opposite of what worked for you before."

As it pertains to dividends, BofAML's advice is "dividend growth over high dividend yield," looking for rate of gain rather than absolute payout.

Dividend payoffs slowed dramatically as 2015 came to a close, with the final three months — which included the Fed's rate hike — showing a 70 percent decline in rate of dividend gain, from $12 billion during the same period in 2014 to $3.6 billion. For the year, the pace of dividend increases fell 29.4 percent, according to S&P Dow Jones Indices.

However, the stumbling equity market in 2016 could help dividend payers, particularly if history holds true and a weak January portends a weak year.

Dividend payers as a group are off, though performing better than the broader market. The Vanguard Dividend Appreciation Index exchange-traded fund is down 3.7 percent in the new year, compared with the S&P 500's 6.1 percent decline.

"Firms that have returned cash to shareholders via buybacks and dividends have outperformed for 25 years. The pattern was repeated (in 2015) and the trend will likely continue in 2016 given our muted equity return forecast," Goldman said.

"The US equities whose performance suffers most from rising interest rates are 'bond proxy' sectors and stocks with low betas and high dividend yields. The firms that benefit from rising yields tend to receive a fundamental earnings boost from higher rates become less attractive," the firm wrote.

It has been the "bond proxy" sectors, utilities specifically, that have weathered the early storm best. Utilities are up narrowly year to date, while the nine other S&P 500 sectors are negative.