Investors Expect Real Dividends to Decline in 2020s

If those levels bear out, such a decline in the real value of dividends would be without recent precedent. During the 1990s, dividend payments rose by 38% in nominal terms and by 6% in real terms. Between 2000 and 2010, dividends rose by 41% in nominal terms and by 12% in real terms. In the most recent decade, from 2010 to 2020, they increased by 155% in nominal terms and by 115% in real terms. As such, the market’s current expectation for a 10% rise in nominal dividend payments and a 15% decline in real dividend payments over the next decade is unusual in the context of recent history.

That said, it is worth noting that the 1990s, while not a great decade in terms of real dividend growth, showed spectacular gains for equity investors. With just 6% growth in real dividends and 38% nominal growth between the end of 1989 and the end of 1999, the S&P 500 delivered a price return of +317% and a total return, which includes reinvested dividends, of 434%.

Part of the reason why stocks did so spectacularly during the 1990s, was that inflation and interest rates fell. In the first year of that decade, inflation excluding food and energy, varied between 4.4% and 5.6%. By the end of the 1990s, core inflation had fallen to around 2%, where it remains today. Falling inflation allowed for a decline in long-term interest rates as well. In 1990, 30-year yields varied between 8% and 9.2%. By 1998 and 1999, they ranged from 4.7% to 6.5% (Figure 2).

Falling inflation and declining long-term bond yields probably helped equities to stage their enormous 1990s rally despite lagging growth in corporate earnings and dividend payments. Equities are, after all in theory, a discounting machine. They are supposed to discount the future value of earnings, dividends and other cashflows into present value. The further inflation and interest rates fall, the more valuable those future cash flows become in present value terms.

Falling inflation and long-term rates, however, don’t entirely explain the 1990s equity rally. By the end of the 1990s investors had become, by all appearances, extremely optimistic about the future. With recessions in 2001 and 2008-09, dividend growth disappointed, and between 2000 and 2009 equities had a total return of negative 5%. This decade-long negative return came despite a continuation of low inflation rates and continued decline in long-term bond yields (Figure 3).

Following the challenging first decade of the new century, the 2010s were in many ways the perfect decade for equity investors. Dividend payments soared in both real and nominal terms. It was as though the growth in corporate profits that investors had dreamt of in the 1990s finally came to fruition during the 2010s following a decade-long series of interruptions. In addition to strong growth in dividends, inflation remained quiescent and long-term bond yields continued the decline that began in the early 1980s, ending 2019 at around 2.3% on the 30-year Treasury, less than half of their levels at the beginning of decade (Figure 4).

The extent to which equities depend on low interest rates is apparent in several ways. On a long-term basis, the inverse relationship between equity valuations and the level of 10-year Treasury yields is readily apparent. When long-term bond yields are low, as they were in the 1950s and 1960s and as they have been in recent decades, equity markets can support high levels of valuation. After all, future cash flows discounted at low rates are worth much more in present value terms than future cash flows discounted at higher rates. Additionally, low yielding bond markets are a less attractive alternative for equity investors than are higher yielding bond markets (Figure 5).

As for bond yields, their direction may depend on several factors:

1. Whether inflation expectations remain contained.
2. The willingness of investors to absorb a large supply of U.S. Treasuries coming on the market.
3. How long the Fed maintains its bond-buying program.

For the moment, break-even inflation spreads appear to have stopped rising at around 2.5% annualized inflation over the next decade. While substantially higher than they have been in recent years, inflation expectations are very much in line with the levels from 2004 to early 2008 and from 2010 through 2014 (Figure 6).

On the fiscal side, the U.S. budget deficit may have peaked and could begin slowly subsiding, although the U.S. government will likely continue to run large deficits for some time. Finally, the Fed’s willingness to keep buying assets depends crucially on how quickly the labor market recovers and how transitory recent price pressures really are.

As for the markets’ pessimistic seeming assumptions about dividends, there might be a silver lining embedded within the S&P 500 Annual Dividend Futures: It’s easier to exceed pessimistic assumptions than optimistic ones. That said, one should bear in mind the dividend equation:

Dividends = GDP * Corporate Profits as a % of GDP * The Dividend Payout Ratio

Corporate profits have been running at a robust 10-11% of GDP in recent years and have rarely been higher (except from 2011 to 2013). As such, it may not be easy for profits to grow faster than the economy as they did coming out of the global financial crisis (Figure 7), but the economy itself might grow strongly given the fiscal and monetary stimulus as well as the increases in household wealth (+15% in the past year) and high household savings rates (around 20% of income saved, triple the pre-pandemic savings rate).

Finally, as Germany, Japan and Switzerland have demonstrated, it is possible for long-term bond yields to fall below the levels recently seen in the U.S. While most of the attention has recently been focused on the risk of higher inflation and higher bond yields, one should not forget that risks are two-directional. That said, the extremely low bond yields in Europe and Japan have not pumped up equity markets in those countries to levels comparable to valuation levels currently seen in the U.S.

• S&P 500 Annual Dividend Futures price negative real dividend growth over the coming decade
• Equities rallied in the ‘90s despite slow real dividend growth as interest rates and inflation fell
• Higher inflation and bond yields pose a risk to equity valuation levels
• Low expectations for dividend growth are easier to beat than high expectations