When stock markets are volatile, investors often turn to the greater stability of dividends. A danger in dividend investing may be over-exposure to traditional income sectors during all market conditions.
Volatility has increased in equity markets recently and throughout 2018 has been far more volatile than 2017. Market analysis shows a worldwide deterioration in market sentiment and the risk environment over the last 12 months, in particular in September and October 2018. Investors are fearful the US-China trade war might spiral out of control; they worry about the international effect of the US Federal Reserve’s relentless raising of interest rates, which has squeezed liquidity, strengthened the US dollar, and made conditions tougher for emerging markets.
Despite current macro worries, company fundamentals are generally strong. Many companies have very healthy levels of cash and have been using it to pay higher dividends to investors. Over time, dividend payments tend to be less volatile than companies’ share prices. Dividend’s greater steadiness, compared with share prices, may be due to company directors’ conservatism. Company directors may be reluctant to immediately cut dividends when profits fall. Similarly, when net profits rise, they feel a duty to share them with shareholders but are often cautious and do not increase quickly in case the higher earnings prove temporary. Company directors may be exercising a smoothing effect on dividends.
Some sectors have higher dividend yields than others, often because they contain mature, low-growth but highly stable companies. Examples are the telecoms and utilities sectors. Higher growth companies, by contrast, may find more benefit in reinvesting their profits to seek more growth: for example, information technology companies.
Dividends are only one part of the picture and there is no guarantee that the highest yielding companies are always those with the highest total returns. Over the past year, the best performing MSCI World sector was the lowest yielding information technology sector, despite the sharp selloff in tech stocks over recent weeks. The highest yielding sectors, telecoms and utilities, have a negative price return over 12 months.