Concerns Emerge Even As Dividends Rise

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AT-A-GLANCE

• Nasdaq & Russell 2000 dividend payments are running 20% higher from a year ago
• Nasdaq dividend payments soared 1,300% over the past 15 years
• Investors are pricing slow growth in dividends over the next decade
• Inflation may create upside risks for dividend payments during the 2020s

Between March 2009 and November 2021, the Nasdaq 100 was the great outperformer among U.S. equity indices -- rising 1,500% compared to gains of around 600% for the S&P 500® and Russell 2000 (Figure 1). Since their peaks in 2021, the Nasdaq 100 and Russell 2000 have fallen by 27% (as of May 18, 2022) while the S&P 500 is 17% off its high (Figure 1).

Figure 1: The Nasdaq 100 was the big outperformer from 2009 to 2021

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The Nasdaq’s extraordinary performance was not driven merely by multiple expansions as investors piled in into technology stocks over the past decade. By and large it was driven by fundamentals. While dividends paid by S&P 500 firms have risen an impressive 165% over the past 15 years, dividends paid by Nasdaq-listed firms rose by over 1,300%. Essentially, dividend payments on the part of technology firms went from nearly non-existent to abundant in a decade and a half (Figure 2).

Figure 2: Nasdaq dividend growth far outpaced that for S&P 500® dividends

Despite the tremendous growth in Nasdaq dividends, the index still pays a relatively low dividend yield of 0.83%, compared to 1.54% for the S&P 500 and 1.46% for the Russell 2000. Although Nasdaq dividend payments have soared over the past decade, the level of the index soared along with them, implying that investors in Nasdaq stocks tend to see them as growth stocks even as many of the largest firms have developed into mature enterprises.

The history of Russell 2000 dividends is much shorter, with only about six years’ worth of data available. Over the past six years, Russell 2000 dividend payments have risen slowly, more akin to the S&P 500 rather than Nasdaq.

Even as equity prices have corrected sharply thus far in 2022, dividend payments continue to run ahead of previous years. Compared to the same period in 2021, year-to-date dividend payments are up 19% for Nasdaq stocks (Figure 3), up 20% Russell 2000 (Figure 4) and up 9% for the S&P 500® (Figure 5).

While dividend payments are rising thus far in 2022, investors appear to be nervous for two reasons:

1. Rising input costs and slowing growth could dent dividend growth going forward
2. Rising long-term bond yields, by definition reduce the net present value of future cash flows, including dividends.

Thus far in 2022 wages are surging by nearly 6% per year even as productivity growth has been negative. Meanwhile, producer prices, another measure of input costs, have jumped 15.7% year over year as bond yields have surged across the curve in anticipation of higher interest rates going forward.

Figure 3: Nasdaq dividend payments are 19% higher than from a year-ago in 2021

Figure 4: Russell 2000 dividend payments are up 20% compared to mid-May 2021

Figure 5: S&P 500 dividend payments YTD are showing around 9% growth over 2021

The market’s pessimistic view of future dividend growth is apparent in the pricing of annual dividend futures on all three indices. For the S&P 500, annual dividend futures suggest that investors expect a decline in dividend payments in 2023, in comparison to 2022, followed by a long period of essentially no growth lasting until 2028. In inflation-adjusted terms, taking into account the break-even inflation spreads between yields on Treasury Inflation Protected Securities (TIPS) and standard U.S. Treasuries, investors appear to anticipate a decline in dividend payments of about 1/6 over the coming 10 years in real terms (Figure 6).

Investors in the Russell 2000 Annual Dividend Index Futures appear to take a similar view, pricing little in the way of dividend growth from small cap stocks over the next five years (Figure 7). By contrast, investors in the Nasdaq Annual Dividend Index Futures price somewhat faster growth, with dividends continuing to rise by about 20% over the next five years from 2021 levels. Even so, anticipated growth of 20% is slow compared to the blistering pace of Nasdaq dividend growth over the past dozen years (Figure 8).

Indeed, there are many reasons to be sceptical of the idea that dividend payments will continue to grow rapidly in the 2020s, including the fact that corporate profits are near a record as a percentage of GDP, which might not bode well as input costs soar and as economic activity potentially slows amid tighter fiscal and monetary policy. That said, there is one reason to be optimistic: inflation. If inflation remains protracted, that could drive growth in corporate revenues as firms raise prices to meet higher input costs. During the 1970s, dividend payments didn’t quite keep pace with inflation but growth in dividends did outperform growth in equity index prices (see our video on Headwinds for Corporate Profits here, and our article on the Cautious Scenario for Dividend Growth here)

Figure 6: Investors in S&P 500 Annual Dividend Index Futures price slow growth in the 2020s

Figure 7: Investors also anticipate slow growth in Russell 2000 dividends

Figure 8: Investors price somewhat faster growth in Nasdaq dividend payments

This post contains sponsored advertising content. This content is for informational purposes only and not intended to be investing advice.