Kristina Hooper, CFP®, CAIA, CIMA®, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
The first quarter of 2013 ended with a bang—and some important milestones. The S&P 500 posted a respectable 10.61% gain, including dividends, closing Thursday at a record high and eclipsing its previous closing high set in October 2007. The Dow, which had surpassed its previous high reached in 2007 earlier this month, also finished the quarter strong: its 11.93% gain for the quarter was its best first-quarter performance in 15 years.
But it’s not just about shattering performance records. We’re now hitting some dividend milestones too. In 2012, companies in the S&P 500 paid out $310.5 billion in dividends—a 10-year high for rolling 12-month periods. From 2007 through 2012, dividends grew 14%, according to Barron’s. Meanwhile, the number of companies in the S&P 500 paying dividends has hit a new 13-year high of 405 or 81% of the index. Additionally, the S&P 500 aggregate payout ratio is finally back up to its 10-year median level with a 30% payout. This is a substantial improvement from the fourth quarter of 2011, when the payout ratio was 27.6%, and the fourth quarter of 2010, when the payout ratio was 26.3%.
Despite all of this progress for stocks, the response from investors has been fairly subdued. As we chronicled in The Upshot (“The Great Reversal
”) on Feb. 19, while cash is coming off the sidelines, more money is going into bonds than into equities. In the first two months of 2013, $51.2 billion moved into taxable fixed-income mutual funds, $9.6 billion into tax-free bond funds and $34.5 billion into balanced funds. That compares with flows of $21.9 billion into domestic stock funds and $36.5 billion into international stock funds. And in taxable fixed income, a lot more money is going into core as opposed to areas offering higher yields: a considerable $12.98 billion went into intermediate-term fixed income.
It’s hard to understand recent allocation decisions given that we’re facing a period of financial repression—whereby artificially low interest rates are making it tougher for investors to achieve positive real returns—and we’re likely to remain in this environment for years to come. While investors clearly recognize the perils of overweighting cash and are reducing their exposure to it, they don’t seem to realize the dangers of overexposure to core fixed income.
Investors need to understand that financial repression is a tool that enables governments to grow their way out of debt primarily by pushing rates lower than GDP growth. When debt-financing costs fall below the pace of economic growth, a country’s debt-to-GDP ratio declines. Add inflation and the erosion of government debt accelerates. But while financial repression eats away at government debt, it also consumes personal savings. Cash is certainly vulnerable in this environment, but so is core fixed income, which is eking out a small positive real return.
This disconnect between the investment environment and investor behavior is even more pronounced if you consider short-term expectations for inflation. The most recent University of Michigan consumer sentiment survey shows that consumers see inflation hitting 3.2% over the next year, well above current core and headline inflation. However, while inflation expectations have risen, they’re not yet impacting investment decisions.
Even without substantial inflation, investors are well advised to have adequate exposure to asset classes that are able to generate positive real returns during financial repression. The possibility of significant inflation some time in the future as a result of the dramatic stimulus we’ve seen over the past few years only underscores the need for asset classes that have historically performed well in inflationary environments. For example, investors should consider commodities, real estate and TIPS. And investors should not overlook dividend-paying stocks, particularly since dividend growth, historically, has far outpaced inflation.
The Upshot is available as a subscription for financial professionals only. New issues will be delivered via email every Monday. Your email address must be in our records for your subscription to take effect.