Cuts like a knife

DOUG  By Guest .Blogger Doug Rowat


The dividend cut-parade has begun.

Plagued by the devastating coronavirus lockdown, more than 40 S&P 500 companies have cut or suspended their dividends so far this year. In almost every case, it’s unsurprising the companies that are doing the slashing given their coronavirus-sensitive business models: Carnival, Boeing, Schlumberger, Walt Disney, Delta Airlines and Marriott International to name but a few.

But regardless of how well-telegraphed these dividend cuts may have been, investors who rely on their portfolios for income are going to have to reconcile themselves to getting less of it. Not owning these stocks specifically doesn’t mean that you’ve escaped a reduction in your cash flow. More dividend cuts are coming and dodging all the cutters will be like dodging raindrops in a thunder storm. Also, most of the companies that have already cut are widely held by both mutual funds and ETFs. Vanguard Group, for instance, is the largest holder of Boeing, Disney and Schlumberger. So, if you own any kind of broad-based investment vehicle your income stream has probably already been dinged. No income investor is getting out of this coronavirus crisis unscathed.

So, how bad could it get?

According to a recent research note from Morgan Stanley, the market is currently implying a 15% drop in S&P 500 dividends this year. And if we examine our most recent economic catastrophe—the 2008-09 financial crisis—the S&P 500 saw a massive 27% decline in dividend payouts from peak to trough. So a dividend decline of between 15% and 30% this time around is a reasonable assumption.

S&P 500 dividends per share – long term

Source: Bloomberg

However, there is a silver lining.

First, the Morgan Stanley note argues that expectations of a 15% decline in dividends may be overly pessimistic: “we suspect many management teams will be reluctant to cut dividends and be willing to use some cash on hand to support dividends.” Morgan Stanley further states that “companies will always do their best to protect dividend payments and there is substantial empirical data on the strong signaling effects of dividends and stock prices.” In other words, senior executives, who understand the importance of share price performance in relation to future equity financings (not to mention their own compensation) will bend over backwards to protect those dividends.

Second, the 27% drop in dividends during the financial crisis was very short lived. The entire dividend decline spanned only about 9 months (July 2008 to March 2009). Companies then immediately began to raise dividends, returning to pre-crisis highs within three years. Now, it can be argued that the coronavirus crisis may last longer than the financial crisis, but it should also be noted that the rise in dividends following the financial crisis very closely tracked the recovery in the broader equity market. This is always the case. And in case you’ve been under a rock, equity markets have been skyrocketing since their March 2020 lows—surely a good sign for dividend outlook. Indeed, the Morgan Stanley note goes on to add that “if investors believe dividends will only fall 15% in such a terrible economic year, it should make them feel better about this stream of dividends in the future.”

And finally, if you’ve prudently built a balanced and diversified portfolio with multiple asset classes and various sector and geographic exposures, you have even less concern regarding a reduction in your income stream. US treasuries, Government of Canada bonds and even most high-quality corporate bonds are in no danger of default. Further, if you have diversification within the equity component of your portfolio, the effect of broader market dividend declines can be further mitigated.

Every portfolio, for instance, should have Canadian bank exposure. Reliable dividends are critical to the reputation of our big banks making it extremely unlikely they will ever cut. Indeed, none of the big five Canadian banks has cut dividends in at least the past 80 years (National Bank, the sixth largest, cut its dividend in 1993) and none cut, of course, during the financial crisis:

S&P/TSX Canadian Bank Index dividends per share (white line) vs S&P500 dividends per share (orange line) – Canadian banks held steady during the financial crisis.

Source: Bloomberg

But if for some reason you have no confidence in the payouts of our Canadian banks, you might find comfort in other sectors such as US health care. Many of the largest US health care companies (Johnson & Johnson, Pfizer, etc.) have actually RAISED dividends this year.

Regardless, the point here is that diversification is always the key to limiting your dividend downside.

So, more dividend cuts are coming. Brace for it. Fortunately, these cuts are likely to be short lived and can be ameliorated through proper portfolio diversification. However, if you’re taking income from your portfolio, you may simply have to temporarily adjust to a more modest lifestyle. One thing this crisis has taught us is that we’re all going to have to make sacrifices.

Think you’re above doing that? Tell that to a frontline worker.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

What matters

The news was enough to freak Amy out. Like she needed more of it.

The economy’s shrunk faster than a dude in a lake – 8% in March (and half of that month was pre-virus). This is Great Depression stuff. Imagine what the April and May numbers will be. Ugh. Also a bank just cut its dividend. So are things starting to unravel?

Here’s her situation, and her fear.

I have been reading your blog for years, and while I was in a relationship, had my money invested jointly.  When the partner parted I moved to a self directed brokerage (TD Waterhouse) and that worked well for me over the past five years.  I have since retired, living on CPP, OAS, GIS and dipping into my TFSA dividends to make ends meet.  I rent an old apartment in Hope BC; after a lifetime in Victoria, I couldn’t afford to retire there.

Before COVID my portfolio (maxed TFSA & RRSP) was at $100k, not much to speak for, but two divorces and 16 yrs of being a single mom, has been devastating financially.  Given the present global situation, my portfolio is down 35%.  I am prepared to ride it out, however a close friend is impressing the “inevitable ” on me, meaning now the banks will fail and I should sell off my investments and buy silver and gold.  I can’t afford to get this wrong.  Your thoughts?

First, Amy, the ‘bank’ cutting its dividend is more like a glorified credit union. The Laurentian Bank has been lackluster for years, forced to pay off staff and close 50 branches in Quebec. Total assets are $35 billion, which sounds like a lot. But the Royal Bank is worth $1.5 trillion, and probably has a few billion lying around for pizzas-&-beer on Fridays.

So, none of the Big Six will be cutting, suspending, trimming or otherwise diddling with their dividends. No bank will fail. Never will there be any bail-in provisions triggered. Your bank-held assets are safe and dry.

Now, this does not mean the bankers aren’t sweating a few bullets, thanks to Covid. These ae testy times on Bay Street, which is why bank stocks shed about 20% of their value since the virus came to town. Eight million Canadians are on the dole and almost a million can’t/won’t pay their mortgages. Tons of small business clients are going paws-up over the next few months. Defaults on home loans are expected to increase, as are consumer bankruptcies. HELOCs, car loans, business LOCs – lots of debt will sour.

In response, the banks have set aside almost $11 billion to cover these anticipated loan losses. Doing so has crashed their profit numbers, but it was the correct action. Says TD’s chief financial officer: ““What we’re living through here is an unprecedented shutdown of large segments of the economy, which is impacting consumers and businesses and customer activity in unprecedented ways. We’ve looked at our provisions and applied a good measure of prudence to make sure that we are prepared to weather this pandemic.”

Amy, babe, worry about something else. Not the banks. They’ve got this handled.

So, about your portfolio. Let’s start there. If it tanked 35% you’re not balanced, not diversified and had way too much equity exposure for a wrinklie (or anyone else). A B&D portfolio shed far less than stock markets  and has steadily crawled back since then. With a hundred grand in two registered accounts, you should have just a few positions – balanced ETFs with exposure to North American and international markets plus some bonds and REITs. If you have no preferred fund, this is the time to get one. Cheap. Six per cent yield.

The worst possible move would be to go to cash, then buy a bunch of rocks. Gold and silver are purely speculative, highly volatile, pay no interest, no dividends, no income. You can’t easily trade this stuff (especially in rural BC), nor can you chew off a hunk to buy groceries with at Save On. Bullion is the emotional crutch of the prepper set, and goes nice with semi-automatics, sheep manure and the Old Testament. But it has no place in the modern portfolio of a retired, single woman who needs dependable cash flow.

Now, will things get worse?

Of course. What happens when the CERB, the mortgage deferrals and the emergency business loans/rent subsidies end? More contraction. Many business failures. Household distress. Forced property sales. Just what you’d expect when the jobless rate stays north of 10% and the free government money ends. This is the scenario the bankers are readying for with their eleven billion in bad-money reserves.

At that point anything can happen. The T2 gang might keep the benefits going, ensuring that your grandchildren’s offspring are taxed mercilessly. Or maybe the virus sneaks back. And what about the US election in November? How does that possibly end well?

All of this you cannot know, Amy. Nor can anyone.

But this is not our first disaster. And pandemics are temporary. You may think it’s different this time. It is not.

Even if it were, fretting over events you cannot control only wastes what matters. Without time, nothing has value. Even in Hope.