The market scenario of barely positive dividend growth in nominal terms, and negative growth in real terms, over the coming decade contrasts sharply with the performance of dividends in past decades.  During the 2010s, S&P 500 dividend payments rose by 155% after rising close to 40% in each of the previous two decades.  Even after adjusting for inflation, dividend payments rose by 6% during the 1990s, 12% during the 2000s and 116% during the 2010s. 

Part of the reason why dividend futures have such a cautious view of the coming decade may be due to corporate profits have expanded to a near record percentage of GDP (our video on challenges facing corporate profits here).  Since 1995, corporate profits have varied from as low as 7% to as much as 12.5% of GDP, according to the U.S. Department of Commerce.  A large part of the reason why dividend payments rose vigorously during the 2010s was because corporate profits surged from 2010 through 2012 and remained high for the rest of the decade.  In 2021, corporate profits added up to over 12% of GDP (Figure 2).

Looking ahead, corporations are faced with soaring input costs and potentially slow growth in revenues.  Producer prices rose nearly 14% during the past year amid higher commodity prices, supply chain disruptions and a growing fragmentation of the global economy.  Moreover, the U.S. economy is within 1.5-2.5 million jobs of being back at full employment even as employers have 11.2 million job positions listed, according to the Fed’s JOLTS survey.  As such, wages are surging, rising at 5.6% year-on-year, according to the latest Federal Reserve data.  Finally, interest rates are beginning to rise, which could eventually lead to an increase in the cost of financing corporate debt.  For all these reasons, dividend futures take a cautious view of the pace of growth in corporate earnings and cash flows. 

Beyond reflecting investor beliefs about future growth in corporate cash flows, dividend futures also reveal deeper insights into the equity markets.  The 11 S&P 500 Annual Dividend Index Futures contracts from 2022 to 2032 indicate that investors expect S&P 500 companies to pay out around 590 index points worth of dividends over the coming decade.  What is remarkable is that the expectation for the total amount of dividends to be paid out over the next decade has barely changed since the end of 2017 even as the S&P 500 has rallied from 2,700 to 4,650 (Figure 3).

How is it possible that the S&P 500 could have rallied so much even as investors beliefs about the nominal value of dividends has barely changed? There are two likely explanations: lower long-term bond yields (up to early 2021) and quantitative easing.

According the various equity valuation models, equity market valuations should be equal to the net present value (NPV) of future dividends, free cash flows or corporate earnings.  As bond yields fall, the NPV of future cash flows rises.  The opposite is true when bond yields rise.

From 2016 to 2020, the NPV of anticipated future dividends tracked the movements of the S&P 500 closely. In 2018 and 2019 the NPV of anticipated future dividends rose because long-term bond yields were falling.  Both the S&P 500 and the NPV of dividends fell sharply in the initial stage of the COVID-19 pandemic in 2020.  Then, between April 2020 and December 2021, the NPV of anticipated future dividends rose by around 50% while the S&P 500 nearly doubled (Figure 4).

The S&P 500’s outperformance relative to the NPV of future dividends came as the Fed expanded its balance sheet by $4.8 trillion from $4.1 trillion to nearly $9.0.  Other central banks such as the European Central Bank (ECB) and the Bank of Japan (BoJ) engaged in even larger balance sheet expansions relative to the size of their economies (Figure 5).  These QE programs likely helped equity prices peel away from expectations for future growth in dividends and corporate profits.

All of this raises the question: what happens to equity prices now that central bank balance sheets might be about to shrink?  On April 5, 2022, Fed Governor Lael Brainard said the Fed would likely begin a “rapid” reduction of its balance sheet beginning in May 2022.  The timing was not a surprise, but the “rapid” pace was unexpected.  Within 24 hours of her comments, bond yields from 3Y to 30Ys maturities saw their yields rise by as much as 30 basis points (bps) and they rose further in subsequent days as the Fed made clear that it intended to sell $95 billion of U.S. Treasuries per month.  The Fed also put markets on notice to expect rate hikes in increments of 50bps rather than the usual 25bps.

As the Fed gets ready to reverse QE, drawing down its balance sheet, the S&P 500 has diverged even further from the NPV of future dividends.  Between March 14 and April 5, the S&P 500 rebounded by over 8% even as the NPV of future dividends fell.  What this means for equity investors isn’t clear yet, but the answer may come into focus in coming months.