The Search For Yield Continues: Aristocrats Or High Yield?

Dividend stocks appear set to outperform high-yield bonds in the U.S. in all economic scenarios other than a recession.

O ur U.S. Investment Strategy service performed a scenario analysis comparing the prospective return performance of dividend stocks and high-yield bonds. While the total return to dividend stocks shows a wider range of outcomes, they manage to outperform high-yield bonds in three of the four scenarios. It is only in the “mild recession” case that the S&P Dividend Aristocrats (DA) index underperforms. This is consistent with the historical tendency for relative returns to be directional with the overall market.

Two main factors are behind the DA index outperformance in most scenarios.

• First, the starting point for valuation favors dividend stocks over speculative-grade bonds. The junk index outperformed the DA index in the early 1990s, during a sluggish economic recovery, but the high-yield index began the period with a yield of 17.5%. With a yield of 7% today, there is obviously much less room for capital gains.
• Second, the relative performance trend is generally directional, with sizeable declines in the DA index usually required for junk to outperform. The DA index is made up of companies that have lower leverage, higher returns on capital and stronger cash flows, and these higher quality firms are better suited to weather the business cycle.

Bottom Line: Dividend stocks should outperform high-yield corporate bonds as long as the economy is growing, even if very slowly.