Dividend growth will underpin US equity outlook
IN today's age of income investing, the income growth properties of the US equity market are particularly compelling. Sustained dividend growth should continue to support US stock market performance, and I believe that the S&P 500 Index is capable of exceeding 2,400 before the inauguration of the next US president.
Income is hard to come by in the current environment. We are in an unusual phase in financial history during which neither capital nor labour has pricing power, meaning neither can generate much income. Average earnings in nominal and real terms have barely grown, while capital sits in cash deposits or in government bonds yielding very little.
I believe there are some structural reasons for this. The power of labour to command a greater share of economic value added has been undone around the world by policy initiatives focused on labour mobility.
In most developed countries, labour's share of GDP has been in sustained decline. Even in the US economy - which added a record three million jobs last year - labour's share sits at 50-year lows.
Employment growth has been offset by weak wage growth. Productivity gains have invariably passed to the owners of capital, allowing operating margins to rise.
Meanwhile, the propensity of developed nations to accumulate savings faster than income growth compresses yields everywhere. Wealthy nations with excess savings and little economic growth, such as Japan, Germany and Italy, can only export capital, thereby lowering yields. Quantitative easing (QE) from central banks merely exaggerates the yield compression. Bond-buying programmes further crowd these countries out of their own domestic sovereign and credit markets, compounding the effects abroad.
Income assets in demand globally
If we are to believe Thomas Piketty, author of Capital in the 21st Century, income will become even more prized. He argues the capital/income ratio is set to rise for the rest of this century.
Private capital stands at 450 per cent of income today and is set to approach 700 per cent by 2100. Net savings (after capital appreciation) are currently rising approximately twice as fast as income. An ageing population will constrain income growth, which further exaggerates the problem, even as rates of return decline. In short, Piketty describes a world in which too much capital chases too little income.
In this financial climate of depressed bond yields we can expect investors to value highly an asset class that not only offers a current real yield but one which has consistently grown its income by a double-digit amount each year.
This is precisely what the S&P500 has offered. At the close of Q3 2014, it notched up its 15th consecutive quarter of double digit dividend growth. Dividend per share growth over 12 months to Q3 2014 was 11.3 per cent. Over the 15-quarter period, dividends per share have averaged 14.2 per cent growth. It is little wonder the US equity market has been one of the most rewarding asset classes in recent years.
Is this set to continue? I think so. Moreover, there is no other asset class that offers this level of sustained income growth in US dollar terms. Emerging markets offer limited dividend growth (in US dollar terms) due to currency headwinds and falling returns on equity.
In Europe, we should see positive single digit dividend growth, but a lot will depend on the euro/dollar level. Japan, as always, is a wildcard and the outlook is largely dependent on the effectiveness of corporate governance reforms, and the capacity of investors to convince companies to distribute excess cash.
Dividend growth in US market
In contrast, dividend per share growth for the S&P500 is likely to continue to grow at double-digit levels. This is above earnings growth but the payout ratio is 32 per cent.
We can anticipate a fall in dividends from energy companies, but this should be more than offset by dividend growth from the financial sector which is still low.
It is notable that S&P500 dividends benefit from a high level of diversification, unlike other benchmarks where dividends are concentrated in just one or two sectors, or even a handful of stocks. A total of 421 stocks in the S&P500 pay a dividend and nine out of 10 sectors grew dividends in the last 12 months.
Six of these grew dividends by 10 per cent or more. Consumer discretionary, IT and industrials were among these, emphasising that the regulatory risk to dividends is lower than elsewhere.
In the age of income investing, the income growth properties of the S&P500 will continue to be highly valued by investors. According to our estimates, S&P500 dividends could exceed US$48 by 2016.
If we assume a 2 per cent dividend yield, which is the 10-year median, the S&P500 could exceed 2,400 before the next US president is inaugurated in January 2017. Indeed, a level of 3,000 is achievable before the decade is out.
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