Sunday, February 19, 2012

If history is any indication, high dividend stock outperformance should continue

At times when faced with stressed financial conditions, it is helpful to look through history for periods that bear similarities to the current environment. Obviously no two periods are ever the same, but the period of mid 40s to early 50s in some ways resembles markets of today.

US 10-year treasury yield

Throughout WW-II and for some time after, the Fed conducted what could amount to QE by capping treasury yields. It allowed the US Treasury to finance the war effort at historically low rates by continually purchasing treasury securities. As an example, below is an excerpt from the FOMC minutes of February 29, 1944.

In the mid 40s the stock market had a fairly sharp correction after a strong rally, as the war-based industries had to shift focus toward the private sector (the familiar shift from government stimulus toward reliance on the private sector). From that point on the market did not materially appreciate until the early 50s.


As expected it was the high dividend stocks that outperformed during that period. The chart below from Barclays Capital shows the relative performance of high to low dividend stocks.

Source: Barclays Capital
The outperformance lasted for some five years through the stress period. In 1951 the Treasury-Fed Accord eliminated the Fed's obligation to the US Treasury to purchase its securities at a fixed rate (which was forcing the Fed to grow balance sheet indefinitely.) This event began the normalization of the Fed's monetary policy and ended the outperformance of high dividend stocks.

The chart below compares the Vanguard High Dividend ETF (VYM) with the overall market (SPY). Over the past year, VYM has outperformed SPY by close to 7%.

VYM vs. SPY (Bloomberg)

Based on the similarities between the post WW-II period and now, this high dividend stock outperformance should continue until the Fed ends the period of easy monetary policy. And from all the indications we have, the Fed's extraordinary accommodation should be in place for some time to come.
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