While AI and the Magnificent 7 have been exceedingly visible in their leadership, we spotlight two other trends with a clear impact on portfolio performance and how to approach U.S. equities as the economic environment inevitably evolves.
July 11, 2024
By Ben Graham, CFA
The S&P 500 continues to surge in 2024 despite a myriad of concerns, and leadership remains narrow. The result is a bull market that many investors find unappealing, as the surge to record highs may appear unjustified from an economic perspective, or frustrating for portfolios that lack sufficient positions driving most of the market’s gains.
Beyond the market’s narrow focus, certain recognisable trends of outperformance persist in 2024. One of these threads is commonly associated with outperformance, while the other stylistically continues to be a force in the market.
Low dividend yields continue to be highly correlated with outperformance, meaning that higher-yielding equities are underperforming lower-yielding ones.
Interestingly, as some of the mega-cap tech stocks graduate from the no-yield classification to the bucket with ultralow yields of one percent or less (recent dividend initiators include Meta Platforms and Alphabet), the no-yield bucket is one of the worst-performing segments, rising only 3.4 percent year to date, on average. The no-yield segment of the market has underperformed all other segments, on average, except for stocks with yields greater than three percent.
However, the average data doesn’t tell the full story. Many of the no-yielding stocks have actually performed quite well. When accounting for the upside/downside ratio of no-yield stocks, the return profile improves dramatically.
Low-yield dividend payers lead the market, while the highest-yielding equities are the worst segment.
Source – RBC Wealth Management, FactSet; data through 7/9/24
Our study indicates that high dividend yield continues to be a critical factor in 2024 underperformance. Conversely, many no-yield stocks and the low-yield group as a whole are correlated with outperformance. For example, stocks with yields of less than one percent have rallied 18.0 percent year to date, on average, exceeding the S&P 500’s strong 17.8 percent return.
The reason this best-performing bucket is so close to the benchmark return is because the study takes an equal-weighted approach to the averages, and the cap-weighted nature of the S&P 500 means that the largest companies, which also happen to be some of the best performers, have an outsized impact on index-level returns.
Another more consistent driver of outperformance over time is higher earnings estimate revisions.
This year, companies that have seen their 2024 consensus earnings estimate rise have outperformed those that have seen earnings per share (EPS) estimates fall.
When we segmented the change in EPS estimates into six categories from worst to best, we found that with each improvement in the EPS change bucket, average share price performance has climbed. For example, stocks with earnings estimates that declined more than 10 percent (the worst segment) fell 5.1 percent year to date, on average. But stocks with earnings estimates that rose more than 10 percent (the best segment) rose 26.6 percent on average.
Positive estimate revisions are one of the more traditional indicators of equity outperformance, which holds true in 2024 despite all the competing crosswinds present in the market.
By connecting the threads of dividend yield and earnings estimate revisions, it becomes clear to us that recent high-performing stocks in the S&P 500 typically show below-average dividend yields and above-average earnings estimate revisions.
The top 10 performing stocks in the S&P 500 in 2024 have returned 94.7 percent on average, significantly outperforming the S&P 500’s 17.8 percent gain. The average dividend yield of this outperforming group is 0.7 percent, roughly half that of the market, while the average 2024 estimate increase for this group is 17.0 percent, more than 7x higher than that of the market.
To identify future investment opportunities, we think it helps to understand recent market movements because they can provide context for forward-looking decisions.
Currently, we are in a market characterised by narrow leadership, low-dividend outperformance, and a scenario where inflation is slowing and unemployment is still manageable. When these factors change, we believe the high-quality equities that have been underperforming will likely benefit.
Using the Dividend Aristocrats basket (S&P 500 companies that have increased their dividends in each of the past 25 consecutive years) as a proxy for underperforming, high-quality stocks, this basket of companies is mired in its worst multiyear performance stretch on record.
Over the past 20 years, 2023 was the worst year of underperformance for the Dividend Aristocrats compared to the S&P 500, as the table on the previous page shows. So far, 2024 is on pace to be the second-worst year. Furthermore, four of the five worst years of underperformance have occurred since 2019.
Dividend Aristocrat underperformance continues to trend near the lowest levels on record, with the three worst years on record coming since 2020.
Notes: (1) Dividend Aristocrats are companies that have grown their dividends in each of the past 25 years. (2) S&P 500 returns are total returns. (3) 2024 results are year-to-date through 7/9/24.
Source – RBC Wealth Management, FactSet
The result of these outcomes is a stretch of never-before-seen underperformance of the Dividend Aristocrats compared to the S&P 500.
Given the significant degree to which this investment style has been out of favour, the probability that high-quality stocks will outperform when the investment landscape changes is much better today than on average, in our view. Notably, the Dividend Aristocrats have historically delivered their strongest performance during and following economic slowdowns.
From our vantage point, the fundamental thesis for these high-quality equities is supported by attractive valuations compared to the broader market and business models that have historically weathered economic volatility better than the market at large.
While we are in a frustratingly narrow market, we think it is important for investors to stay disciplined and consistent by executing on their investment plan and identifying future opportunities. We believe high-quality dividend-paying stocks are in a favourable position for when the investment landscape changes again, as it is sure to do.
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