The last few years have been tough on income investors. Many income-oriented portfolios use the 10-year treasury has the foundation and then build around that with other income producing investments. The yield on the 10-year treasury has been trending lower for the last 20 years, but it has really plunged in the last two years.
We see on this chart from Macrotrends.net just how sharp the decline from the last two years has been compared to the last 20 years. We saw a decent move to the upside from July ’16 through October ’18 and that move took the yield from 1.37% to 3.23%. Even that peak was half of what the yield was in 2000.
Now the 10-year yield has plunged below 1.0% and is currently at 0.62% as I write this. Think about that, the yield now is 1/1oth of what it was 20 years ago. How do you build an income-oriented portfolio when one of the main tools to create income is 10% of what it used to be?
Now income investors have to look for other areas to generate income – municipal bonds, corporate bonds, dividend paying stocks. But these investment vehicles have also seen dramatic declines in their yields. The following chart from Tradingeconomics.com shows how the Moody’s Seasoned Aaa Corporate Bond yield has fallen over the last 20 years. The index was up near 8% in 2000 and as of this writing, it is all the way down to 2.3%. The chart only shows through the end of February.
So investment grade yields are only down to 25% of what they used to be, where 10-year Treasury yields are 10% of what they used to be. That isn’t very helpful now is it?
Junk bond, or high yield, corporate bonds are currently yielding around 8.5%, but they come with considerably more risk than what investors get with investment grade bonds. Even junk bond yields are down from their 2000 levels. In April 2000, yields on the BofAML US High Yield Index were hovering around 12.5%.
This leaves dividend paying stocks, but the risk profile for stocks is considerably different than that of 10-treasury notes or even investment grade corporate bonds. We saw the huge plunge in stocks in the first quarter and that is enough to spook any investor, but especially a retiree that is looking for income. From a historical perspective, dividend paying stocks have not been as volatile as non-dividend paying stocks, but if we look at a couple of ETFs that are focused on dividend stocks, they didn’t fare well during the market swoon.
I looked at three different dividend-focused ETFs and compared them to the S&P 500 SPDRs. I looked at the iShares Select Dividend fund (Nasdaq: DVY), the Vanguard High Dividend Yield fund (NYSE: VYM), and the SPDR S&P Dividend fund (NYSE: SDY). Looking at the performance of these four ETFs since the beginning of the year, the dividend ETFs have underperformed the overall market and they dropped lower in March than the S&P 500 did.
All three of the dividend-focused ETFs dropped over 34% at their lows and the DVY was down over 40%. The Spyders were down just over 30% at their low.
What’s even worse is that we are seeing record cuts to dividends at this point. The Wall Street Journal posted an article on Tuesday that discussed all of the companies that have cut dividends. According to the article, 81 companies had cut their dividend as of April 27. That is the most since 2001 and we are only in April. Another 135 companies have reduced their dividends this year and that puts 2020 on pace to be the worst year for dividend reductions since 2009. There were 316 dividend cuts that year.
There are also underlying problems with two areas that usually have high-paying dividends—energy and REITs. The energy sector is getting crushed because of record low oil prices and a glut of supply. Now consider REITs that have commercial real estate portfolios. How bad is the commercial real estate market going to be now and in the future? With everyone working from home, the demand for office space is going to drop considerably, at least in my opinion. Many companies are learning that they can operate with people working from home and may continue to do so even after the pandemic is over. Sure there will be some companies that return to normal, but will they keep the same amount of square footage, or will they reduce their spaces? Instead of leasing 5,000 square feet, maybe they cut it in half after the health crisis is over.
I normally have some sort of recommendation at the end of articles like this, but I really don’t know what income investors are supposed to do right now. There are the dividend aristocrats like Johnson & Johnson (NYSE: JNJ) and Procter & Gamble (NYSE: PG) that have increased dividends year after year for over 50 years, but even those stocks were down over 20% at the March low. That is a considerable downside risk for a yield in the 2.6% to 2.7% range.