Dividends Still Dependable for Inflation Protection

Inflation bites, but it’s made even worse when the traditional hedges, including gold and real estate, aren’t delivering for investors.

In fairness to gold, it is performing less poorly than broader equity and fixed income benchmarks this year, but the well-documented rub with bullion is that it offers no income. Speaking of income, dividends have well-deserved inflation-fighting reputations. More to the point, dividend growth is a credible, validate inflation-beating strategy.

Fortunately, equity income is picking up some of the slack and while many high-dividend stocks are performing admirably this year, plenty of other dividend payers are slumping. In other words, dividend equities, broadly speaking, are simply proving less bad than the S&P 500.

Past Performance Doesn’t Mean Much

It’s frequently said that past performance isn’t a guarantee of future returns and that’s wisdom worth paying attention to regarding dividend stocks. After all, the asset class, not surprisingly, lagged during the recently deceased decade-long bull market in growth stocks.

“Dividend payers may not be top-of-mind for investors seeking high risk-adjusted returns, because the last decade hasn’t been kind to them,” according to AllianceBernstein research. “Over seven of the last 10 years through 2021, the MSCI USA High Dividend Yield Index and the FTSE High Dividend Yield Index underperformed the S&P 500. High-dividend payers are often seen as old, stodgy companies, like utilities or food manufacturers, with limited growth potential. As investors flocked to high-flying technology and internet growth companies, dividend stocks seemed like antiquated investment options.”

Fortunately, the new inflationary era could usher in a fresh era of relevance for and out-performance by dividend-paying equities.

“We think the last decade was an anomaly. When widening the lens, we found that stocks in the top two quintiles by dividend yield delivered superior returns over the past four decades. In our view, the second quintile is particularly attractive on a risk-adjusted basis, as it avoids riskier companies with unsustainably high payout ratios. And our research suggests that this long-term return potential comes with a bonus: attractive performance in an inflationary world,” adds AllianceBernstein.

Dancing with Dividends the Right Way

As advisors know, not all dividend payers are created equal. This is something not all clients are cognizant of, meaning this is a credible value-add conversation.

Acknowledging that not all dividend-paying firms are the same is critical in inflationary environments because clients need income AND exposure to companies and strategies that thrive when consumer prices surge, as is happening today.

“Examples can be found in different parts of the market. Health insurers benefit from higher inflation because they price their book annually but most of their costs are renegotiated for higher rates on a three-year rolling basis. As a result, accelerating inflation is good for their margins. Auto insurers enjoy similar industry dynamics,” concludes AllianceBernstein.

The point: A new dividend dawn is here and it will pay for advisors to be selective.

Related: This is the Dividend Defense Against Inflation