After a horrible year, can investors be more optimistic about the prospects for equity income next year? It depends.
- Dividend bear markets typically last far longer than total return bear markets
- Banks look set to be allowed to pay dividends from next year
- The speed of the dividends cuts may mean a quicker recovery
It has been a dismal year for income investors. In the face of falling earnings, companies have cut dividends and while some have resumed payments, many have not. With the economic outlook still uncertain, there is a major question mark over dividends in 2021
Recent research from Schroders suggested a worrying historical precedent. It showed that dividend bear markets typically last far longer than total return bear markets with the average running to nine years, compared with only 1.8 years for real total returns. The group suggests that while companies may restore dividends after a cut, dividends continue to grow more slowly.
In this environment, furlough payments may also act as a constraint on dividends. In many countries in Europe, companies that have accepted furlough payments are not allowed to pay dividends. While UK furlough is due to end in March, other European countries have extended it for far longer.
Nevertheless, there are more encouraging signs. Banks, for example, look set to be allowed to pay dividends from next year, providing they can show that they are sufficiently well-capitalised. Some companies have found themselves able to cut costs during the pandemic, which has improved earnings and makes dividend payments more likely. Some have already resumed payouts now they have greater visibility on the economy.
Schroders suggests that the speed of the dividends cuts may mean a quicker recovery. Like the market fall and rise in March and April, dividends may fall hard and bounce back, rather than the drawn-out rise seen in previous dividend bear markets.
In the longer-term, it may be that the make up of income markets change. In the UK, the oil majors may not be the force they once were for dividend investors. The top five holdings in the FTSE 100 are now HSBC, AstraZeneca, GlaxoSmithKline, Unilever and Diageo as market capitalisations have changed. In Europe, it is plausible that companies such as SAP and other technology companies start to pay or increase dividends. It may be that dividend investors are no longer confined to stodgy blue chips struggling to stay relevant in a changing world.
Income investors need dividends: bond yields are at rock bottom and inflation expectations are likely to rise again in 2021. Next year cannot be worse than this year, but investors will still have to tread carefully.