Dividend Reliability During A Recession


  • Mutual Fund Observer, Seeking Alpha and Portfolio Visualizer were used to evaluate funds for their total return and dividend performance during the 2007 Bear Market.

  • Criteria used to evaluate funds were Risk Adjusted Dividends, Risk, Risk Adjusted Return, Dividend Growth (Cuts) during 2008 to 2011, closed end fund premium/discount, among others.

  • The October Model Portfolio is based on performance during the 2007 Bear Market intended to have a steady dividend yield of 4% with an acceptable risk of drawdown.


Given the ample historical evidence, this seems to be a classic scenario surrounding a yield curve inversion before a recession. None of the leading indicators are clearly signaling that this time could be different. - Who Wants To Bet Against The Yield Curve: Is This Time Different?, St. Louis Fed, Carlos Garriga, Vice President and Economist, and Matthew Famiglietti, Research Associate

(Seeking Alpha) I have been a total return investor all of my life, but frequently discuss strategies and funds with a dedicated income investor. The primary difference is how we see risk. To me, risk is the permanent loss of capital or not meeting financial objectives. To the income investor, risk is probably best described as a reduction in your income stream. This article is about viewing risk from both sides of the fence.

There are increasing indications about the likelihood of recession occurring next year making dividend cuts a topic of interest to me. For this article, I extracted 173 lower-risk funds from the Mutual Fund Observer database in 46 different categories that were paying dividends prior to the 2007 bear market starting.

I selected the funds based on their risk-free yield divided by the Ulcer Index (Risk), Martin Ratio (Risk-Adjusted Return), Expense Ratios, Yields, and Returns during the 2007 Bear Market. Closed end funds (135) were selected following the guidelines described in "5 Best CEFs To Buy For October 2019" by Financially Free Investor using CEFConnect. The criteria used to select funds to be in the October Model Income Portfolio include dividend performance during the 2007 bear market. Annual dividend growth rates by year are from Seeking Alpha.

Earnings Through The Business Cycle

After a recession, the Operating Margin (Operating Profits/Sales) is low, recovers during the expansion, and peaks in the late stage as shown in Chart #1. The Operating Margin (blue line) is high historically and may fall heavily during the next recession. Earnings per share (red line) peak and decline along with the Operating Margin. Earnings per share, shown as rolling four quarters, can decline over 50% during a recession.

Chart #1: Operating Margin vs Earnings per Share % Off High

S&P 500 dividends have averaged 38% of earnings for the past 25 years as shown in Chart #2.

Chart #2: Dividends vs. Earnings per Share

Chart #3 contains the S&P 500 earnings per share and dividend growth from the peak high. When earnings per share fall, dividends are likely to follow and have fallen 8% to 25% during the past two recessions. This is a risk to the investor relying upon steady income.

Chart #3: Dividend and Earnings Percent Off High

Slowing Growth of Business Sales and Profits

The global outlook remains precarious with a synchronized slowdown and uncertain recovery... In contrast to extremely weak manufacturing and trade, the services sector continues to hold up almost across the globe... There are, however, some initial signs of softening in the services sector in the United States and euro area. - The World Economy: Synchronized Slowdown, Precarious Outlook, International Monetary Fund

Total Business Sales stalled in the third quarter of 2018 and Profits Before Taxes shown in Chart #4 have been on a downward trend for the past several years. These statistics do not include the benefits and distortions of share buybacks.

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