The 12m US dividend growth assumptions used in Figure 1 ranged from +2% (very best-case) to -20% (very worst-case). To put that into perspective, year-on-year (y-o-y) US dividend growth has rarely slipped below zero since 1970. The biggest post-WW2 decline was the roughly 20% seen during the GFC. With so many companies postponing dividends, that -20% projection may seem optimistic: the biggest y-o-y decline in the last 150 years was the 40% slump seen in 1933, which followed -13% in 1932 (all calculations based on Robert Shiller data).
The uncertainty extends beyond the current year: for example, will dividends ever return to the path previously imagined? We try to capture this uncertainty through the discount factor that is implicit in our projection for dividend yield in 12 months. In Figure 1, we assumed the US dividend yield in 12 months would range from 2.1% (very best-case) to 3.5% (very worst-case). The latter was roughly where it peaked during the GFC (it was 2.16% on 15 April 2020, having peaked at 2.76% on 23 March 2020, as calculated by Refinitiv Datastream). For more perspective, consider that the US dividend yield reached 13.8% in 1932, rarely went below 3% until the early 1990s and has since only been above that level during the GFC.
For those more comfortable with price-earnings (PE) ratios, the collapse of earnings renders historical PE ratios useless and makes it hard to construct sensible earnings estimates upon which to base forward PEs. Therefore, we prefer to use a PE based upon a moving average of historical earnings, which eliminates a lot of the cyclical volatility. The Shiller PE is one such tool and Figure 2 shows the history since 1881.
Despite its many detractors, the Shiller PE has a reasonable correlation with future returns (future returns have tended to be higher when the ratio is lowest and vice-versa). Importantly for our analysis, the ratio tends to decline during periods of economic recession (though not always), suggesting that the stock market de-rates during recessions (multiples fall and yields rise). This was especially the case during the GD and GFC (and of course in the early 2000s when the dotcom bubble burst).
What all three of those episodes had in common was an elevated starting Shiller PE. That was also the case when the Covid-19 struck. In fact, the Shiller PE had only ever been higher during the dotcom bubble and just prior to the Crash of 1929. In that context, and bearing in mind the dramatic economic backdrop, we think it is fair to ask whether a Shiller PE of 25 (as of 31 March 2020) is low enough (the Shiller PE bottomed at around 7.5 and 5.6, respectively, during the GFC and GD episodes)?
The answer to this conundrum may be the massive central bank asset purchase programmes that have been launched around the world. Based on what they have announced so far, we reckon the y-o-y growth in the aggregate balance sheet of the Fed, ECB, BOE, SNB and BOJ will reach nearly 30% over the next year or so (higher than at any time in the last 10 years). We suspect this is an important factor behind the recovery of stock markets but worry that it will not be enough to prevent another downturn in major indices over the coming months, as economic and corporate reality strikes home.