Our Co-Heads of Investments make the case for dividend-paying stocks and the tax-free feature of Munis as tax hikes are possible, given our government debt levels.
Observations: The Value of Dividends and Munis to Stoke Income
Adam Sparkman
Welcome and thank you for joining us for our quarterly observations in global equities and fixed income series. As always, I’m joined by our co-heads of investment, Ben Kirby and Jeff Klinghoffer. In our previous two videos, we’ve hit on market sentiment following a very strong first quarter. We’ve talked about concentration, risk and where do we go from here, as well as the Fed’s outlook on rates. Today, I want to get into two particular segments within equity and fixed income markets.
So, Ben on the equity side, we really wanted to touch on high dividend paying stocks coming out of a prolonged period of quantitative easing and a near-zero interest rate environment really from the end of the financial crisis up to 2022. I think the markets really de-emphasized the need for income as a component of total return within equities. But now that we are getting higher rates and really a normalized cost of capital, how do you think that the outlook for dividend paying stocks changes?
Ben Kirby
Yeah, it’s a great question. So, look, I think dividend investing is an attractive long term structural investment strategy. It’s tried and true. It tends to generate attractive returns in many cases better returns to the overall market and usually with less volatility than the overall market. So, I think it’s a sound long term approach.
Now, that said, today, it’s also a particularly attractive moment in time for dividend investing because as you’ve alluded to, the growth stocks have outperformed very strongly and dividend paying stocks at a significant valuation discount versus their own history and certainly versus the higher growth companies.
So, if you just look at the overall global dividend paying index, it’s probably about 12 times earnings. It has about a 4% dividend yield. That’s pretty interesting, especially if that grows over time. If you try a little bit harder, you can build an active portfolio that has a 5% yield and is trading at ten times earnings and has the potential for that dividend stream to grow over time. So, when you think about an aging population that needs investment income, having a portion of their income being generated from equities with the potential to grow over time and provide inflation protection is a really important consideration. And again, today we think is an especially auspicious time for that strategy.
Adam Sparkman
Great. Thanks, Ben. Jeff, on the fixed income side, one topic we haven’t hit on in a while is the municipal bond market. Can you touch on that a little bit? Tell us about where you see opportunities for investors and maybe where some of the risks lurk as well?
Jeff Klingelhofer
Yeah, I think it actually dovetails really well into the prior conversation about dividend paying equities, and that’s primarily because many participants in the municipal market come to that market looking for income and specifically looking for tax exempt income. Right? So, as we look through the outlook, we talked about the Fed in previous videos. I think the Fed does continue to pose just an overarching risk to markets as markets are expecting that the Fed is now basically on hold.
It’s not my base case that we see further rate hikes. But again, we’ve seen a previous history where if the Fed is premature in rate cuts, it does reintroduce the potential for higher inflation and higher rates from here. And so that’s really the big overarching risk for the municipal market, is the Fed may have to price out some of those existing rate cuts or potentially even resort to rate hikes in the future. Now, as we look forward to the potential political season that’s coming up here in presidential elections. Right. The biggest benefit to municipal bonds is they continue to be tax exempt. That will continue indefinitely into the future. And there’s a real risk when the US government continues to run massive deficits, that tax rates are only going up from here. So, it’s a way to shield investors from that potential pain. Now, much like you’ve talked about and just broad complacency in a prior video that also exists in municipal market. So when you look at kind of the ratios between tax exempt yields versus taxable yields, that ratio has compressed, but the benefit does continue to accrue towards the municipal market.
You want to take a very cautious approach, just like on all things in fixed income, creating that durability of an income stream. And that’s exactly how we want to be thinking about.
The market is focusing on the higher quality of issuers and really playing for defense, waiting for potentially better opportunities to open up.
Adam Sparkman
Thanks again for joining us. Please check out our other videos where we cover market sentiment following a strong first quarter. The Fed’s outlook on rates, as well as concentration in equity markets.
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The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This document is for informational purposes only and does not constitute a recommendation or investment advice and is not intended to predict the performance of any investment or market. It should not be construed as advice as to the investing in or the buying or selling of securities, or as an activity in furtherance of a trade in securities.
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