NEW YORK (TheStreet) -- The big three headlines surrounding Ireland's debt problems, China's actions to slow lending, and the delay in tax cut negotiations kept the U.S. stock markets volatile, but unchanged last week as individual investors stayed on the sidelines. The positive news was easier to miss. What we found most interesting last week was the key developments in support of an emerging investment theme: the return of the dividend.
Individual investors have remained net sellers of U.S. stocks during every week during the second half of 2010 despite solid gains. In 2010, the biggest individual money flows were out of the lowest-yielding asset classes -- cash and large-cap U.S. stocks -- and into higher-yielding asset classes like bonds (specifically high-yield bonds) and foreign stocks. While investors are unlikely to pay up for growth, demand for stocks is unlikely to require lower valuations. Instead dividends may be a key theme in the stock market as investors increasingly seek yield. A steady yield is attractive for 2011 given an outlook for modest price gains coupled with above-average market volatility.
While U.S. investors have been reluctant to embrace dividends, there were some signs last week they are beginning to pay more attention.
Setting the tone for last week was the news on the prior Friday (Nov. 12) that Intel was raising its dividend. Intel shares jumped 1.5% that day after announcing a 14% increase in the dividend.
On Wednesday of last week, the Federal Reserve (Fed) issued guidelines, including a stress test, for evaluating proposals by large banks to increase dividends. The Fed encouraged banks to have their capital plans filed by January 7, 2011 and indicated that it expects to provide a response to the banks by the end of the first quarter. We expect the top banks to receive regulatory approval on dividend increases sometime in early 2011.
After the market closed on Tuesday of last week, Comerica , not one of the "systemically-important" 19 banks subject to the above Fed guidelines, became the first among the large U.S. banks to raise its dividend, doubling the payout to 10 cents. The stock climbed the following day.
After the close on Thursday of last week, Nike announced a 15% increase to the dividend, powering a 4% gain for the stock on Friday.
For most of the time since the March 2009 lows, stocks of companies that do not pay a dividend outperformed those that pay dividends.* However, as the pace of economic growth has slowed and bond yields reached new lows, the performance of dividend-paying companies has been catching up. For example, last week, the
companies that pay a dividend outpaced those that do not.
The first quarter is typically when S&P 500 companies announce the annual increase in the dividend. This year, companies are sitting on record amounts of cash, and the percentage of their earnings they are currently paying out in the form of a dividend is below 30%, this is both an all-time low and well below the average of about 45% over the past 50 years. We expect significant dividend increases favoring the stocks of dividend payers in the coming months.
As yield becomes more scarce, investors are willing to tolerate more risk to obtain it. Individual investors have shown a strong preference for yield this year which may prompt them to increasingly turn to higher-yields offered by many stocks. Of the 500 stocks that comprise the S&P 500 Stock Index, over 100 pay a yield that is higher than that of the 10-year Treasury note. The yields offered by the stocks in the S&P 500 Consumer Staples (3.2%), Telecommunications Services (5.4%), and Utilities (4.4%) sectors are considerably higher than that of the 10-year Treasury note (2.9%).
*According to LPL Financial and FactSet.
Jeffrey is Chief Market Strategist and Executive Vice President at LPL Financial.