Dividend Futures Imply Slow Growth in 2020s

S&P 500® Annual Dividend Index (ADI) futures offer a window into equity investors’ perceptions about the future. Those views can currently be summed up in two words: slow growth, at least when dividends are concerned.  In 2019, S&P 500® dividends amounted to 58.21 index points.  By 2030, futures markets are projecting dividends at 69.9 index points, or 20% growth in total dividend payments over the course of the 2020s, amounting to just 1.7% per year – or basically zero growth after anticipated inflation, which the bond market prices at 1.65% per year over the next 10 years. 

Moreover, most of the expected growth is front-weighted.  S&P 500® ADI futures project dividends to grow to 61.5 index points in 2020 – a solid growth rate of 5.64% over 2019, and by 2.6% in 2021.  After 2021, further growth is expected to flatline at around 1% per year.

Figure 1: Heading into a Decade of Dividend Growth Stagnation?

To be clear, dividend futures don’t always price such weak growth.  As recently as the fall of 2018, S&P 500® ADI futures priced much more robust growth over the coming decade: sometimes with increases as much as 50% (Figure 2).

Figure 2: Spread between current year and expected future dividends has narrowed since 2017

Why are investors so gloomy about future dividend growth and what does it imply about the economy?  Over the past 30 years, the S&P 500® has had a weak correlation with GDP growth of 0.1.  Equities themselves try to anticipate what will happen in the future. By contrast, ADI futures had a much stronger correlation with GDP of 0.55 (Figures 3 & 4).

Figure 3: The S&P 500® has had a weak correlation to economic growth of 0.1 since 1990

Figure 4: S&P 500® dividends have a much stronger correlation with GDP Growth of 0.55

Does low expected dividend growth in the 2020s imply that investors also anticipate slow economic growth?  One could make the case that the exceptionally flat US yield curve is sending a signal that growth is likely to slow in coming years (Figure 5).  But in the past, yield-curve shapes have only led economic growth by one to two years (Figure 6).

Figure 5: The US private sector yield curve is still inverted, possibly heralding slow growth in 2021

Figure 6: Yield curves are often a useful indicator of growth 1-2 years in the future

While yield curves are often a useful indicator of economic growth one to two years in the future, they cannot be used to forecast growth over an entire decade.  For example, a flat yield curve in 1989 and 1990 correctly anticipated the 1990-91 recession but that recession didn’t stop dividends from growing from 11.7 to 16.78 S&P 500® index points by 1999.  Likewise, flat yield curves in 1999 and 2000 and again in 2006 and early 2007 accurately warned of the 2001 and 2008 recessions.  Even so, dividends still grew from 16.78 to 22.81 S&P 500® index points between 1999 and 2009.

What will be especially hard to sustain in the 2020s is this past decade’s pace of dividend growth.  In the 1990s, S&P 500 dividends grew by 42.5%.  In the 2000s, they rose by 36.7% despite the tech wreck and global financial crisis.  However, during the 2010s, S&P 500® dividends grew by an explosive 155% -- a high hurdle to cross in this decade, hence investors’ modest expectation of 20% growth between now and 2030. 

Aggregate dividends should be equal to nominal GDP multiplied by corporate earnings as a percentage of GDP multiplied by the pay-out ratio (the percentage of earnings paid out in dividends).

Aggregate dividends = (Nominal GDP) x (Corp. Earnings as a % of GDP) x (Dividend Pay-Out Ratio)

Examining the components of this equation also give us some insight into why the market is pricing such modest growth for dividends.  Let’s start with nominal GDP’s inflation component.  Break-even spreads between nominal 10-year US Treasuries and 10-year Treasury Inflation Protected Securities (TIPS) anticipate an inflation rate over the next decade of only 1.65%.  So, the markets don’t expect much of a boost for dividends from higher rates of inflation.

When it comes to the real growth component of nominal GDP, things don’t look a lot better.  Even setting aside the possible implications of a flat yield curve for growth in 2021 and 2022, economic prospects don’t look too promising for the 2020s, unless the economy experiences a substantial improvement in productivity growth.  For starters, unemployment fell from 10% at the end of 2009 to 3.5% at end of 2019.  Labor force participation has improved slightly, so it is possible for more workers to come off the sidelines and into the labor force, but in the 2020s the economy can’t grow quickly simply because of more people working.  This not a phenomenon unique to the US.  Australian, Canadian, European and Japanese labor markets have tightened as well and all of these countries have slow population growth, as does China.  As such, this leaves improved productivity growth as the main hope for higher dividend payments. 

Next, there is the issue of corporate earnings as a percentage of GDP.  As of Q3 2019, corporate earnings were 9.6% of GDP, a relatively high number by historical standards. Earnings peaked at 12.5% of GDP in 2012.  So, while pre-tax corporate earnings have risen in nominal terms since 2012 as the economic expansion goes on, they are slowly but steadily underperforming GDP.  The combination of a tight labor market and relatively tight US monetary policy (as evidenced by the flat yield curve) could put further downward pressure on earnings going forward.

During the 2010s, pre-tax corporate earnings ranged from 10-12.5% of GDP.  This was much higher than in previous decades.  During the 1990s, corporate earnings accounted for between 7% and 10% of GDP and during the 2000s they ranged from 7% to 12% of GDP.  Dividend payments did get a big boost from the corporate tax cut from 35% to 21% that took effect at the beginning of 2018.  This tax cut, however, was a one-time deal and corporate taxes are unlikely to go lower and could possibly go higher in the 2020s, depending on Presidential election outcomes.

Furthermore, the fact of earnings underperforming GDP growth hasn’t prevented the stock market from soaring relative to the size of the economy (Figure 7).  But then, the stock market also ignored falling earnings at the end of the 1990s, in 2006 and in 2007 before catching up on the downside later.

Figure 7: In the 2020s it will be difficult to keep corporate earning at 2010s levels

Finally, there is the issue of the pay-out ratio. The ratio of earnings paid out to investors as dividends has remained largely stable at around 1/3 during periods of economic expansion. That ratio tends to soar during economic downturns, like in 2001 and 2008, only to return to normal levels as the economy and corporate earnings recover (Figure 8). There is no particular reason to think that corporations will pay out a greater percentage of earnings during the 2020s than they have in the recent past.

Figure 8: Dividend pay-out ratios are usually around one third during expansions

Lastly, dividend futures highlight one other potentially troubling aspect of equity markets: their dependence on low long-term rates.  If one compares the level of the S&P 500® index to expected dividends calculated five years continuously forward using S&P 500® ADI futures, one sees that expected dividends largely led the market higher in 2017.  However, beginning in 2018, expected dividends five years forward began to stagnate: as of January 31, 2020, five years forward expected dividends are only 1% higher than they were two years prior on January 31, 2018.  In the meantime, the equity market has soared by 17% (Figure 9). 

However, if one looks at the net present value (NPV) of the dividends anticipated by S&P 500® ADI futures over the next 10 years, discounted back to the value of today’s money, the picture looks very different.  Comparing NPV of future dividends to equity prices, stocks and NPV dividends have grown at roughly the same pace (Figure 10).  This has been made possible by long-term interest rates, which are used to discount future dividends, falling in line with expectations for future dividend growth (Figure 11).  The stock market has been able to sustain its rally not because economic growth prospects have become rosier but because long-term rates are discounting future dividend payments at a much slower pace than in the recent past, increasing the NPV of those anticipated future dividend payments. 

With the S&P 500® now trading at a post-World War II high in terms of market capitalization as a percentage of GDP, equities look far from cheap.  That is until one compares them to the primary alternative: long-term interest rates (Figure 12).  So long as long-term rates remain low, equities may be able to sustain high levels of valuation but if long-term rates rise for whatever reason – higher inflation or exploding budget deficits—all bets are off.

Figure 9: Expected future dividends led stocks higher in 2017 but have stagnated since

Figure 10: The net present value of future dividends has risen even as long-term rates have fallen

Figure 11: Falling long-term rates “saved” equities from slowing growth prospects

Figure 12: The equity market could maintain high levels of valuation if long-term rates remain low


 

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

About the Author

Erik Norland is Executive Director and Senior Economist of CME Group. He is responsible for generating economic analysis on global financial markets by identifying emerging trends, evaluating economic factors and forecasting their impact on CME Group and the company’s business strategy, and upon those who trade in its various markets. He is also one of CME Group’s spokespeople on global economic, financial and geopolitical conditions.

View more reports from Erik Norland, Executive Director and Senior Economist of CME Group.

Equity Index Options

Our Equity Index options offer around-the-clock liquidity, market depth, and extensive product choice on the world's benchmark indices to suit a variety of trading strategies.

Start Trading