The Behavior of Dividends in Bear Market Environments
A 90 Year History of Outperformance When You Need it Most
April 17, 2014
Asset managers seek lower investment risk exposure that does not sacrifice return potential. For a number of reasons, providing a smoother ride increases the likelihood of success, whether in the accumulation or in the distribution phase.
For many investors, the definition of risk is very simple: It isn’t basis risk, tracking error, standard deviation, or Vega. It is simply “How much am I likely to lose in the worst of times, and how long can it take for me to be whole again?” In this mindset, it is helpful to demonstrate how an investment strategy historically fared during the “worst of times.”
Reality Shares studied empirical data from Robert Shiller’s work (Shiller S&P data) and looked at a string of the past ten “bad markets.” For purposes of this exercise, we looked at each of the market environments over the past 90 years where the S&P 500 (price) fell 15% or more peak to trough, and label them as “bad markets.” We analyzed how much “The Market” fell, and how long it took to get back to even (that is, to reach prior highs) and compared the performance of the market itself to its’ dividends distributed during that timeframe.
The results were significant and might be quite unexpected to many. In each of the ten periods viewed, dividends fell by far less than market price, with the minimum outperformance being 16% (and the maximum being 57%). Furthermore, the duration in the decline of dividends was far shorter in every instance of these “bear” markets. In 6 of the 10 bad market events that we observed, dividends either remained steady or increased even though the market itself was plummeting. (Note – we used monthly closing data for this exercise.)
Key to the following graphs:
• The origin of the x-axis is always the point in time that the market last hit a high. The end of the x-axis is the point in time that the S&P 500 price first recovers to its previous high value. Think of this as the end of the bear market being analyzed in each instance.
• The y-axis measures the value (indexed to 100) of the S&P 500 and its dividends from the beginning of the period analyzed to the end. This indexation makes the percentage moves evident and enables visual recognition of amounts of out-and under-performance.
First Major Drop – 1929 Crash and the Great Depression
September 3, 1929, through September 30, 1953. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
As one can see from the data above, the Great Depression was a terrible time to be invested either in the market or its dividends. This was an obvious manifestation of the terrible economic reality of the time and the confluence of economic, fiscal, monetary, and regulatory mistakes that produced a maelstrom. However, dividends, from peak-to-trough fell almost 30% less than the market as a whole, and recovered full value almost 7 years ahead of the market Even during this stressful time, it was a far less unpleasant experience to have exposure to dividends than to the market.
Second Drop – 1961
December 1, 1961, through December 31, 1963. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
This was a short-lived, yet significant drop in the markets against the backdrop of the first Cuban blockade, etc. While the peak-to-peak bear market lasted only a year and 9 months, dividends never fell, even for a month. In fact, they rose nearly every month during this stretch, ending almost 10% higher for the duration.
Third Downturn – 1966
January 3, 1966, through July 31, 1967. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
Another relatively historically minor (yet still painful to investors) drop in the 1960’s took place during a period of escalation in Vietnam, among other things. Dividends dropped only a maximum of six tenths of a percent during this period, and took a mere six months to recover. This would barely be noticeable compared to the 17% drop in the market which took over a year and a half to recover.
Fourth Plunge – The End of the Sixties
December 2, 1968, through December 30, 1971. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
This is a more interesting observation period, as there was more going on behind these numbers. As is plain to see, dividends delivered a positive performance at the worst of times, and outperformed the market price index by 33% when one needed it most. Dividends were never again lower than they were at the start of this bear market. Dividends did incur a negligible peak-to-trough decline at this time of 3.8%, and descended from an interim high of $3.19 in September of 1970 to a low of $3.07 in December of 1971. While it took until April of 1973 to regain that interim high (2 yrs and 7 months from peak-to-peak), the drawdown was much smaller and the pullback was shorter-lived than for price. This data actually demonstrates some of the powerful diversifying effects that isolated dividends could have on a portfolio if investors had this available to them.
Event #5 – A Really Nasty Bear Market
March 1, 1973, through December 31, 1979. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
Financial historians recognize the ’73-’74 bear market (oil embargo) as one of the nastier market events on record. Once again, we witnessed dramatic dividend outperformance. The deepest decline since the depression took 43% off of the price of the S&P at this time. During this highly distressing time dividends grew a strong 13.6% from the pinnacle of the market to its nadir at the end of 1974. Interestingly, dividends rose every month between March of 1973 and December of 1974! This would have been a great time for investors to have exposure to pure dividends as a diversifier. Dividends did actually decline 0.8% ($3.71 to $3.68) from September of 1975 to December of that year but only took until April of 1976 to recover their previous peak (6 months). Dividends increased every month between April of 1976 and the official end of this bear market in the summer of 1980. This certainly was not a bear market for dividends. Between March of 1973 and July of 1980, when the market was able to complete its full recovery, the market price essentially returned nothing for 7 years and 4 months. Dividends rose 88.6% during this identical period.
#6 – The “Double-Dip”
April 1, 1981, through October 30, 1982. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
With interest rates being pushed to astronomical levels by the Federal Reserve in an effort to kill off inflation once and for all, the market experienced significant stress. This pullback was also relatively short-lived, but took a good bite out of market price. Dividends, however, rose an impressive 8.1% during the market downturn and posted an outperformance of 26.7% versus market price. Once again, dividends rose every month throughout this time of market stress.
#7 – The ’87 Crash
August 3, 1987, through July 31, 1989. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
We are mostly familiar with the steep crash of ’87 and relatively quick recovery period. This crash is mainly attributed to speculative buying, portfolio insurance, and delta hedging. Fortunately, none of those phenomena had anything to do with the underlying economic reality. Dividends reflected a healthier world, rising every month during this period, outperforming by 24.8% peak-to-trough, and rising 19.6% in the time it took the market price to get back to where it started.
Drop #8 – The 1990 “Mini-Crash”
June 1, 1990, through February 28, 1991. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
Another short, relatively shallow (hence “Mini-Crash”), but very unpleasant, market environment occurred in 1990. We witnessed a quick 15% haircut in stock prices during the second half of 1990, with the first Gulf War on everyone’s minds. These market fears had little to do with companies’ propensity to return cash to shareholders in the form of dividends. Dividends rose during this difficult period in the market, outperforming by 18.4% peak-to-trough.
Old Number Nine – The Tech Wreck
January 3, 2000, through January 31, 2007. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
The bursting of the highly speculative “dot-com” era bubble was dramatic, and the magnitude of this fed into the real economy as was manifested in the 6.4% decline in aggregate dividends from March of 2000 to June of 2001. This pullback in dividends, though, paled in comparison to the price of the market, as dividends fell 34.9% less than the price of the market during the pullback. While it took the market well over 7 years to recover to its previous peak, dividends made a full recovery back to their post pullback highs in just over a year and a half.
#10 – The Housing Bust
January 2, 2007, through June 29, 2012. Past performance does not guarantee future results. Source: Robert Shiller, Reality Shares Research
Frequently referred to as the greatest economic calamity since the great depression, the housing bust threatened to rend the very fabric of the entire financial system. The economy suffered a genuine hit from this turmoil, and dividends were cut by 24%. This number, however, paled in comparison to the 50%+ drop in market price at the time. The recovery time for dividends was, once again, far shorter than that of the market. It is worth noting that the bulk of this decline of the dividends was attributable to one sector (financials), which had taken on an outsized allocation in the market.
We believe it is evident that dividends historically outperform stock prices during periods of market stress, generally as some examples show by very wide margins. In fact, over 90 years of very different “bear markets,” dividends have outperformed market price every time. Furthermore, dividends have a powerful diversification impact on a portfolio. Dividends have actually demonstrated only a .23 rolling annual return correlation to the S&P 500 over the past 13 calendar years. In fact, the return stream from dividend growth exhibits such a different pattern than that of any other identifiable asset class that many academics think of dividends as an asset class by itself (Source: Société Générale, Reality Shares Research).
Many readers will be thinking that investing in dividends absent the market price is difficult to accomplish, and that there are few vehicles available to the investor that can obtain this exposure. The Reality Shares Isolated Dividend Growth Index family seeks to deliver precisely the exposure to pure dividend growth absent stock price volatility investors are so hungry for. 90 years of bad market performance information isn’t conclusive proof that the pattern observed here will continue, but it is strong evidence that investors might well be served by diversifying into dividends before the next bear market.
We have provided an illustration here that demonstrates that dividends provide lower historic downside than equities. In a future post we will argue, plausibly, that all of this opportunity for lower correlation, lower standard deviation, and lower downside risk does not necessarily come at the expense of return potential, and that returns from pure dividend growth, provide a compelling investment choice.
Basis Risk = The risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other. Tracking Error = A divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark. Standard Deviation = A measure of the dispersion of a set of data from its mean. Vega = The measurement of an option’s sensitivity to changes in the volatility of the underlying asset. S&P 500: A broad stock market index based on the market capitalization of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 was developed and continues to be maintained by Standard & Poor’s Financial Services LLC, and is considered to be a bellwether for the US economy. Correlation = A statistical measure of how two securities move in relation to each other.
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