Dividend Stocks Do Worse

We often say 1 images worth a thousand words:

markets

It’s a fact that dividend stocks have done worse than indexes since the beginning of the year. How can this be possible? Aren’t we suppose to invest in dividend stocks to avoid high volatility and because they perform better in bearish markets? Take the index you want, dividend stocks underperformed the overall stock market in a situation where they should outperform.

Why 2015 is so different?

Is it the start of a whole new cycle where dividend stocks won’t perform in bearish markets?

Should you kick your divided investing strategy to the curb?

I was surprised to see that dividend investing hasn’t protected investors from market fluctuations this year. This is why I dug deeper and found answers about my own investing strategy.

 

Diversification issues in Canada

This is not a secret for any serious investors; the word “diversification” in the Canadian stock market doesn’t exist. It’s even worse when you look solely at dividend payers. Many oil related stocks (former oil income trusts) pays great dividend and are part of most Canadian dividend growth investors’ portfolios. Then, you have 50% of dividend payers coming from financials where roughly 41% of this group is formed by the big 5.

When you consider the barrel of oil fell faster than a rock over the past 18 months, it is no surprise that all oil related dividend stocks underperformed the market by a great margin. Then, who financed the oil companies in Canada? Canadian banks! They form the biggest group of dividend payers in Canada. Canadian banks face a mature market with very limited place to growth thanks to the technical recession (occurred due to a drop in oil prices). The housing market is slowing down, oil companies won’t borrow more money and chances are Canadian banks will have to look closely at their default rates and increase the provisions on their balance sheets soon enough.

The core of a dividend investing strategy is not at stake to explain why Canadian dividend stocks underperformed the overall market. It is simply a matter of overall diversification. If I have one country easily explained, the US one will be more challenging as diversification is not only an issue, but it’s a great strength of this stock market.

 

Why US Dividend Stocks underperformed too?

While the VIG.TO greatly underperforms the TSX, the XDV is roughly 2% under the S&P 500. Still, this situation is abnormal considering dividend stocks are usually concentrated among value stocks that protect investors went the Street goes south.

The first explanation I see is the fact that many dividend payers in the US make 50% or more of their revenue in foreign currencies. Since the US dollar has strengthened compared to all other currencies over the past two years, this had greatly affected multinationals’ financial results in US dollars. The buzz words in most financial report I read over the past year are “revenue in constant dollars”. Companies keep posting their results in constant dollars to waive the negative impact incurred by a strong US dollar. This explains a part of the poor performance, but not all. I had to dig deeper to satisfy my curiosity.

The second explanation is more complex; it is a chain of events, which, when put together, makes for a whole new story telling us why dividend stocks have a hard time performing this year and leave dividend investors with not much but the dividend payments in hand this year.

First, it has been several years when interest rates are super low. Combined with a stock market that is always going higher, income seeking investors started to leave the bond and GIC markets to buy something riskier but with a better paycheck called dividend stocks.

Second, with this important amount of money entering into dividend stocks, we started to see stock prices rising faster than the overall market.

Third, continuing into the same direction, many companies approved massive share buybacks in the last three years. This has supported their bullish stock trend even higher and convincing many income seeking investors they had made the right choice. We all know that after 4-5 years of bullish markets, the average investor becomes more “courageous” and is willing to take on additional risk for the sake of better investment returns.

Fourth, unfortunately, the investor is not more courageous, but rather naïve. This is why he hits the wall each time volatility is knocking on his door. Income seeking investors are not too sure they should have taken that amount of risk and they are now seriously reconsidering dividend investing as a “safe” investment strategy.

Fifth, many dividend stocks are trading at premium or, at best, at fair value at the moment. This means many stocks will drop in value as they follow the general market trend. Income seeking investors, will turn their backs and move toward bonds and we will take a pause in this impressive dividend stock rally.

 

Now What? Dividend Investing is Dead, Welcome Penny Stocks Trading?

Not really…

In fact, this is probably a great time to identify long time dividend growth stocks that are currently trading at a discount. Their dividend payments are not at risk and you will generate a very good yield while waiting for the next rebound.

I made an interesting list of 6 Aristocrats getting hurt by the stock market that should be on your watch list at the moment. Here’s the link with more details on them.

I don’t like people looking at short term for something that has been a proven long term investing strategy. While I took the past 9 months as an example of short term because I’m sure you read or heard about dividend stocks not doing well this year. However, this has nothing to do with a solid long term investing strategy that is dividend growth investing. The dividend payment will still be there in the meantime and over the long run, the strategy still works perfectly fine.