Note: The latest Standard & Poor's earnings spreadsheet (October 14) puts the annualized dividend yield at 2.19% and the indicated rate at 1.97% (The indicated dividend is the estimate for the next four quarters, based on what was paid in the most recent period).
Note: This update includes a new chart showing the long-term inflation-adjusted growth of dividends compared to equities.
The bottom of the 1982 bear market was a major turning point for stock dividends. For more than a century, the market's dividend yield had averaged nearly 5%. But since 1982 the yield has essentially been cut in half, falling as low as 1.1% in 2000. (See the chart.)
What happened? Investors shifted their focus from income streams to price appreciation. As a first-wave Baby Boomer, I see this shift as a result of three things:
A New Investor Class
The 401(k) plan was introduced in 1980. The following year the Economic Recovery Tax Act permitted all employees, in addition to those not covered by an employee retirement plan, to contribute to an IRA. The result has been the massive growth of a new investor class with a limited understanding of markets and risk. The bulge of Boomers became a windfall for Wall Street (the oldest having just turned 35 in 1981).
The popularity of tax-deferred savings vehicles reduced the appeal of dividend income. The goal of retirement savings is to grow the nest egg. Thus, the distinction between dividend yield and price appreciation quickly lost relevance. New companies saw little need to pay dividends. Many existing companies reduced their dividends and redirected those earnings to corporate growth (not to mention executive compensation).
The Disappearance of Risk
From the market bottom in 1982 to the peak in 2000, the S&P 500 increased by an astonishing annualized rate of 15% in nominal terms. Investor optimism flourished, and the perception of risk disappeared along with the secular bear that had savaged the market from the mid 1960s to 1982. The crash in 1987, which seemed so terrifying at the time, sparked the shortest bear market in modern history — a mere three months in duration with no accompanying recession.
The Gaming of the Market
With risk in hibernation, these accelerating market gains triggered an appetite for speculation. "Why invest only in my company's plan? I need a brokerage account!" For many people, trading replaced investing, encouraged by the likes of CNBC's Mad Money, Fast Money, and the Million Dollar Portfolio Challenge. In taxable trading accounts, dividends became little more than a recordkeeping nuisance. In IRAs, tracking dividends was completely irrelevant. In-the-know investors moved their IRA accounts to online brokerages for easy trading on the Internet.
But, alas, the investment world has undergone a dramatic change. Risk has returned with a vengeance. Aging Boomers may finally recognize the value of dividend income, especially as their paycheck days draw nearer to a close. Perhaps dividends will someday reemerge as a mainstay of investing. The one certainty is this: it won't happen overnight. But if the current flight from equities continues, publicly traded companies may eventually rediscover the power of dividends to coax a risk-adverse generation back to the markets.
For further thoughts on investor psychology, see Robert Shiller's Irrational Exuberance. Chapters three and four offer a compelling analysis of the factors shaping our current market climate.
