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You can kiss 10% stock returns goodbye

MarketWatch logo MarketWatch 2/28/2017 Mark Hulbert

Editor’s note: The opinions in this article are the author’s, as published by our content partner, and do not necessarily represent the views of MSN or Microsoft.

Maybe you’re expecting the stock market over the coming decade to match its historical annualized total return of 10%. 

Fuggedaboutit. We’ll be lucky if the S&P 500 (SPX) gains 4% annually on a price-only basis over the next decade or so.

This sobering forecast is based on the outsized role that dividends play in stocks’ long-term return. Assuming dividends represent the same proportion of the stock market’s future return as they have in the past, the market’s current rock-bottom dividend yield suggests that investors should lower their expectations about future total return.

How crucial are dividends? Over the past 80 years, dividends have accounted for 41% of the S&P 500’s annualized total return. And though dividends’ importance have declined somewhat in recent decades, their role has still been substantial: Over the last 15 years, they have accounted for nearly a third of equities’ total return.

This will no doubt come as a surprise to millennial investors who have cut their eye teeth in an era when the market’s dividend yield has been so low as to seem inconsequential. But the data doesn’t lie: Since 2002, dividends have accounted for 29.4% of the S&P 500’s annualized total return.

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Consider what even this lower recent percentage means for the future: The S&P 500’s current dividend yield of 2.02% translates into a total return forecast of 6.87% annualized — of which price appreciation would represent 4.85% annualized.

The only way that stocks could do better would be for corporate earnings to grow faster in the wake of the market’s low dividend yields. There’s a strong basis for expecting them to do so: According to a theory that traces to economists Merton Miller and Franco Modigliani, investors should be indifferent to a firm’s dividend payout ratio, since any amount a company chooses not to distribute as dividends will be available to invest in future growth. (Miller won the Nobel Prize in Economics in 1990; Modigliani in 1985.)

But there is only modest empirical support at best for their theory in recent decades. The S&P 500’s inflation-adjusted EPS growth rate has not been significantly higher when dividend yields have been lower, and vice versa.

In fact, there is some evidence that, at the individual firm level, dividend payout ratios and earnings growth rates are related in precisely the opposite way than what Merton and Modigliani predicted. In a 2003 study published in the Financial Analysts Journal, Robert Arnott of Research Affiliates and Cliff Asness of AQR Capital Management found that companies with higher dividends actually had higher earnings growth, not lower. A follow-up study found that the same was true in 11 foreign countries as well.

All of which suggests we cannot easily wriggle out from underneath the implications of the market’s low dividend yield. Your retirement planning should proceed accordingly.

For more information, including descriptions of the Hulbert Sentiment Indices, go to www.hulbertratings.comor email


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