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Dividend Growth in Bear Markets

Bear markets can be triggered for any number of reasons. They can last for a number of months or a number of years and can affect the whole market or certain sectors. No two bear markets are the same.

Dividend growth investing has always been a good place to invest in the market over time but following bear market periods it particularly shines. Companies that are committed to growing their dividends because of their quality and disciplined capital allocation weather these storms better and/or recover faster.

Looking at three of the most recent significant drawdown periods of the last 20 years – the early 2000 tech bubble, the 2008 financial crisis and the fourth quarter of 2018 – we will analyze how dividend growth performed relative to the S&P 500 in terms of down capture and time to recover. We use the S&P 500 Dividend Aristocrats as a proxy for Dividend Growth. The Aristocrats is an index the 64 companies (as of March 31, 2020) in the S&P 500 that have increased their dividend annually for the last 25 years.

2000 Dot Com Bubble

In the late 1990s, the advent of the information age and growth of the information technology sector drew speculators into equity markets and created a flurry of Initial Public Offerings.  Valuations of companies that had anything to do with the internet rose dramatically. Often these companies had little or no revenues but the fear of missing out meant investors took a leap of faith.

Unfortunately popularity does not always equate to profit and by early 2000, the bubble burst leading to a two-and-a-half-year bear market that lasted from March 2000 to October 2002 which was elongated by the September 11th attacks in 2001.

How did Dividend Growth perform?

By the time the bear market started in March 2000, the technology sector made up such a substantial part of the index that as the sector started to wane it took the index down with it. However, since these nascent technology companies were early in their life-cycle they did not pay dividends. As a result, dividend growth companies were, for the most part, immune to the pain of the two-and-a-half year bear market. While the broader market saw a drawdown of 47%, dividend growth appreciated until a violent drawdown in March 2003 on the back of the Iraq war. The impact of the tech bubble on the market lasted over 6 years as the S&P 500 did not break even from its March 2000 level until October 2006. By comparison, the Dividend Aristocrats over the same period had more than doubled in value.

2008 Great Financial Crisis

The 2008 Financial Crisis was the worst bear market and recession since the Great Depression in the 1930s. It started in October 2007 and lasted until March 2009 eroding over 55% of the value of the S&P500. The bear market was spurred on by weakness in the US housing market that infiltrated other aspects of the economy and systemically weakened the financial system. Lower mortgage lending standards and increased housing speculation led to a surge in popularity of securitized mortgage backed securities (MBS) that were comprised of subprime mortgages (lower quality with higher chances of default). These MBS’s were then traded throughout the financial system and held on the books of the big banks. When default rates started to rise, there was a realization that these MBS’s were much higher risk than initially thought. When the investment banks Bear Sterns collapsed in March 2008 and Lehman Brothers in September 2008, it shook the entire financial system sending equity markets spiraling downward.

How did Dividend Growth perform?

The bear market of 2007-2009 affected all aspects of equity markets. Even the best performing sector of 2008 (Consumer Discretionary) lost over 15%. Selling was indiscriminate regardless of the fundamentals of companies. As a result, even dividend growth companies were not immune to the drawdown. The Dividend Aristocrats declined over 47% (vs. over 55% for the S&P500). However, it made up for it during the subsequent recovery getting back to break-even 2 years faster than the S&P 500 – April 2010 vs. April 2012 for the S&P 500. Often after these sell-offs, investors focus on companies with stronger fundamentals to get back into equities which prompts the faster recovery of dividend growth companies. Dividend Growth is a good proxy for strong fundamentals.

Fourth Quarter of 2018

While not a true bear market, in the fourth quarter of 2018, we saw a violent correction of almost 20%. The sell-off was driven by a number of factors related to concerns of a of recession in 2019. They included, slower corporate earnings growth, trade tensions between the US and China, and a potential increase in interest rates. It started in October when the market lost 7% but stabilized in November. However, when the market wobbled again in December, momentum continued to drag the market down over 8%.

How did Dividend Growth perform?

Dividend Growth companies performed a little better over the period than the S&P 500. However, given the fear of recession the impact was felt broadly across all sectors of the equity market. As a result, the Dividend Aristocrats declined around 14% while the S&P500 declined 19%. In January 2019, there was a quick recovery fuelled dividend growth companies. The Dividend Aristocrats recovered by February 19th while the S&P 500 recovered in April.

Looking at the COVID-19 crisis, it is too early to say how the market and dividend growth will fare from peak to trough to peak. However, we can look at the drawdown that took place from the S&P500 all-time highs on February 19th to the bottom on March 23rd.

The drawdown that took place was over 33% in a little over a month. It is the fastest drawdown in history and was brought on by panic and fear over the spread of COVID-19 and the ensuing lockdown. While we have not seen a lockdown of this magnitude for over 100 years, fear and panic are nothing new in equity markets. Over the period, even the best performing sector – the defensive Consumer Staples sector – was down 24% suggesting indiscriminate selling similar to what we saw in 2008. Also similar to 2008, this crisis will cause fundamental changes for companies and the economy. However, there is also a case to be made that a number of companies were the “babies thrown out with the bath water” and as we saw in 2008, it is likely that quality companies recover faster.

Volatility is common to all markets – from orange juice to stock markets. It is caused by different factors and fears and can impact companies and sectors differently. While it is impossible to pinpoint the moment when one will take place, it is most important to accept that they will happen and prepare your portfolio for it. A consistent approach that stays the course from peak to trough and back again is always more effective than trying to chase what may be working for a short period of time. Historically, dividend growth provides an attractive place to stay the course. While it might not always be on the way down, it has shown a way to preserve and to grow wealth over time and through all market and economic cycles.

Important disclosures

Disclaimer: This is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Data and information for this report were sourced from Morningstar. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at www.bristolgate.com.

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This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.

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