Goldman Sees Big Disconnect In Market Pricing For Dividends

Goldman thinks the market might be too pessimistic on the outlook for dividends.

Obviously, the pandemic forced corporate management teams to reassess their priorities around spending, including and especially buybacks and payouts.

COVID-19 represented an existential economic threat, and briefly plunged the world into a literal depression for the first time in a century. For a month or two, folks were asking somewhat metaphysical questions.

I often quote myself on that point, and I’ll do so again here. The following passage (from an April piece) retains most of its potency eight months later:

When abstraction collides with the tangible

Economic data and asset prices ostensibly reflect something real, whether that means the production of goods, the provision of services, cash flows, operating income or even sentiment, which, while hard to measure, is real too.

Although monetary accommodation in the post-GFC world impaired price discovery, we mostly spoke in terms of engineered disconnects between prices and fundamentals. In some cases, those disconnects became patently absurd.

But, in almost all cases, there was still something there. The prices for fixed income may not have represented the risk associated with a given borrower, and equities were of course distorted by the very same dynamics (as the voracious appetite for corporate issuance allowed management teams to plow the proceeds from record bond sales into EPS-inflating buybacks), yet through it all, sovereign borrowers still had tax bases. There was still an economy to reference. Corporations, even unprofitable ones, still had operations.

Now, there’s a very real sense in which the underlying “stuff” (so to speak) does not exist. Economies are shuttered. Tax payments have been delayed. Rather than take in revenue, governments are handing out cash. Businesses are idled. Corporate titan after corporate titan is withdrawing guidance.

This is a temporary state of affairs, but the point is simply that some of the assets you own are, for the time being anyway, claims on things that don’t exist.

Against that backdrop, companies were compelled to stack the proverbial sandbags, both by issuing equity and tapping the debt market for some $2 trillion (between high-grade and junk borrowers in the US).

Buybacks should recover in 2021 assuming the economic outlook improves and vaccine rollout goes smoothly. In the same vein, Goldman’s David Kostin says “dividends will rebound next year and continue to grow throughout the next decade.”

In a note dated Friday, Kostin contrasts those expectations with market pricing. “The 2021 dividend contract implies a 5% decline in S&P 500 dividends next year, and the 2022 contract indicates a further 1% decline,” he wrote.

“In fact, the dividend yield curve is inverted through the next decade, with every contract through 2029 trading below 2019 levels, implying average annual dividend growth of -1% from 2019-2029,” Kostin went on to say, before observing that “since 1951, S&P 500 realized 10-year dividend growth has never registered a CAGR of less than 2.2%.”

That would appear to be quite the mispricing, although I’ll leave it to readers to make that judgment for themselves.

Obviously, expectations for reasonably robust dividend growth are predicated on the same assumptions that underpin forecasts for healthy profits — namely, a sustainable economic recovery which itself rests on a successful vaccine distribution effort.

Goldman’s GDP forecast for the US economy in 2021 remains well above consensus, although it’s lower than it was a few weeks back.

As for earnings, Goldman still sees S&P EPS of $175 next year. That’s also above consensus. “This earnings recovery is the primary reason we forecast a 5% rise in S&P 500 dividends in 2021 and a 4% CAGR through 2029,” Kostin remarked, on Friday afternoon.

Just a casual reminder: Over the medium- to long-term, growth (whether in the US or globally) won’t run at anywhere near the pace we’re likely to see in 2021 as the world rebounds from the COVID collapse.

In fairly short order, the pace of expansion will likely decelerate to “status quo,” and for developed economies, that’s synonymous with “anemic.” If the “scarring” effect and structural damage from the pandemic are worse than optimists imagine and the fiscal impulse in advanced nations isn’t sufficient, growth could end up being more sluggish still.

With that in mind, remember that if you want to stay on the “right” side of the inequality equation, all you need to do is ensure the rate of return on your capital exceeds the growth rate. That’s one way to conceptualize of your dividend stocks.