Dividend-paying stocks in major developed economies such as Europe and the United States should offer investors solid returns in the long run, amid slower growth and low interest rates. In fact, we could see dividends playing the same prominent role they did back in the early 1980s.
With investors concerned about slower growth, a lack of political leadership in the face of a sovereign debt crisis in Europe and wrangling over the debt ceiling in the United States, a gap has formed between Europe’s bond yields and dividend yields. Average dividend yields on European stocks (as measured by the MSCI Europe Index) were above 4% at the beginning of 2012, clearly outstripping returns on Germany’s 10-year bonds, which hovered around 2%.
Dividend yields on European stocks are now at levels similar to the early 1980s. U.S. dividend payers could follow suit. We believe the contribution of dividend yields to total equity returns should grow in an environment of modest total returns. We could see the contribution of dividend yields to total U.S. equity returns on a 15-year rolling basis double to roughly 60%, or higher, within a decade.
The benefits of a dividend strategy in the face of economic uncertainty are threefold. First, dividend-paying stocks are likely to generate positive returns during periods of accelerating or low economic growth. Second, a dividend strategy has proven to be effective when inflation is modest or falling. Third, in times of low or negative market returns, dividends tend to play an increasingly significant role in generating overall returns for equity investors.
Japan is a case in point: Investors who turned to dividend-paying stocks in the past decade enjoyed solid returns even as Japan’s overall equity market declined. European equities dropped by more than a third from a February 2011 peak to their September trough. Equities in emerging markets were also not left unscathed, despite avoiding the debt problems that have gripped many developed markets.
We expect global economic growth to slow between 2011 and 2012. Germany and the rest of the euro zone, in particular, are suffering a pronounced slowdown. China is also expected to experience slower growth. We believe average equity market returns are likely to be lower than their long-term average in the coming years, which suggests a more prominent role for dividends as part of total equity-market returns.
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