Dividend Growers Could Be Well Positioned for the New Rate Regime

Download the PDF version of this insight

Quality companies with an established history of growing their dividends tend to be profitable and generate strong free cash flow. That last point is important, because it enables these companies to become self-funding—able to finance their future growth internally without tapping capital markets. As we shall see, that is something investors may wish to focus on in today’s higher interest-rate environment.

But first, some historical context.

The Days of Easy Policy and Easy Money Are Over

In a period of ultra-low interest rates—like the one seen from the onset of the Global Financial Crisis (GFC) in 2008–09 through early 2022—most companies can borrow at attractive rates, reducing the competitive advantage for self-funding quality businesses.

In addition, lower long-term interest rates can have an impact on equity valuations. Low rates increase the impact of farther-out future cash flows in a discounted cash flow analysis (put differently, a lower discount rate raises the present value of a company that generates most of its profits in the future). In essence, amid low rates, businesses that are not profitable have an easier ability to borrow, can obtain such funding at relatively low cost, and are afforded valuations that are less penalized for the lack of near-term cash flow.

But the ground has shifted since the U.S. Federal Reserve (Fed) began to normalize rates in early 2022; in our view, this new environment bodes well for Dividend Growth and Quality investing strategies.

An Interest-Rate Regime Change

We believe that global capital markets are experiencing a structural regime change from ultra-low rates to a more historically average level of inflation and interest rate policies. That change will have significant consequences to where investors allocate equity capital.

The combination of moderately higher inflation expectations over the next five years, combined with higher deficit spending by the U.S. government, likely will lead to higher long-term interest rates. And elevated U.S. budget deficits (see Figure 1) imply higher potential risk for investors in government debt, leading those investors to seek higher returns (i.e., yields) to compensate for that increased risk. As a result, higher borrowing costs will persist across the economy.

Figure 1. Large U.S. Budget Deficit at Full Employment Signals Higher Borrowing Costs

Data for the calendar years 1949–2023

Source: US Treasury, National Bureau of Economic Research, U.S. Bureau of Labor Statistics, Congressional Budget Office, Lord Abbett. GDP= gross domestic product. For illustrative purposes only.

While we are not forecasting the timing of Fed policy changes, we do observe a U.S. economy at full employment (i.e., an unemployment rate at or below 4%) and demand drivers that are greater than those seen in the prior decade. Interest rates and yields were depressed after the GFC due largely to exogenous factors and widespread deleveraging among households and governments. Going forward, we anticipate a higher sustainable rate level that can be attributed to the end of deleveraging, as government policy has turned away from fiscal stringency post-GFC, and household balance sheets have been rebuilt due to higher savings (see Figure 2) and rising asset prices, including house prices. All these demand drivers, along with full employment, are likely to help keep interest rates higher than in the prior regime.

Figure 2. The “Wealth Effect” in Action: Consumers Save Less, Spend More

U.S. household wealth-to-income ratio and personal savings rate, 1953–2023

Source: Federal Reserve, Bureau of Economic Analysis, Lord Abbett. LHS=Left-hand side. RHS=Right-hand side. For illustrative purposes only.

Quality Stocks and Dividend Growers in a World of Higher Rates

To illustrate our earlier point about how low rates can influence equity performance and valuations, the period after the GFC and prior to COVID-19 (2012–20) saw profitable companies (those reporting profits in the prior 12 months) outperform unprofitable companies (those with negative profits) by “only” 440 basis points (see Figure 3). It is not unusual for profitable companies to outperform, but the narrowness of this difference was notable during this era of ultra-low rates. Even with this narrower performance gap, non-earners experienced significant volatility during this eight-year period (standard deviation of unprofitable companies was 25% versus just 18% for earners).

Figure 3. The Performance Gap Between Earners and Non-Earners Has Widened

Equal weighted average return and standard deviation for the indicated periods

Source: FactSet, Russell 3000 Index. Earners represent all companies in the Russell 3000 Index who reported positive earnings, and their forward 12-month performance. Non-Earners represent all companies in the Russell 3000 Index who reported negative earnings and their forward 12-month performance. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Past performance is not a reliable indicator or guarantee of future results.

Fast forward to the 2021-2023 period, and the impact of higher rates becomes clear: profitable, high-quality companies outperformed their unprofitable counterparts by 21%.

We believe that as the cost of capital remains at higher levels, investors will continue to prefer quality companies with durable business models as well as those businesses that can self-fund. We see these characteristics of durability and sustainable, growing free cash flow as emblematic of companies that consistently grow their dividend payments to shareholders. These attributes, along with the rising income stream that a dividend growth portfolio can provide, are likely to become more appealing to equity investors in the months and years ahead.

LAMAX

Class A

Dividend Growth Fund

The Dividend Growth Fund invests primarily in stocks of large U.S. companies that have a history of increasing their dividends. Learn more.

Learn More

About the Contributors

Darnell Azeez, CFA

Partner, Portfolio Manager

Subrata Ghose, CFA

Portfolio Manager

Jeffrey Rabinowitz, CFA

Portfolio Manager

Important Information

Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.

References to fund yields are for informational purposes only and are not meant to represent any specific Lord Abbett bond fund or portfolio.

Asset allocation or diversification does not guarantee a profit or protect against loss in declining markets.

No investing strategy can overcome all market volatility or guarantee future results.

The value of investments and any income from them is not guaranteed and may fall as well as rise, and an investor may not get back the amount originally invested. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.

Market forecasts and projections are based on current market conditions and are subject to change without notice.

Projections should not be considered a guarantee.

Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

Dividend policy: A stock is classified as a dividend payer if it paid a cash dividend any time during the previous 12 months; a dividend grower if it initiated or raised its cash dividend at any time during the previous 12 months; and a non-dividend payer if it did not pay a cash dividend at any time during the previous 12 months.

Equity Investing Risks

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies.

Glossary & Index Definitions

Downside/Upside capture: These ratios measure a manager’s performance in down or up markets relative to a particular benchmark. A down market is one in which the market’s quarterly (or monthly) return is less than zero; an up market is greater than zero. For example, a downside capture ratio of 50% means that the portfolio’s value fell half as much as its benchmark index during down markets.

Standard deviation is a statistic that measures the dispersion of a data set relative to its mean. The higher the standard deviation, the further the observed data are from the mean.

The Russell 3000^® Index measures the performance of the largest 3000 U.S. companies representing approximately 98% of the investable U.S. equity market.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

This material may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The views and opinions expressed are as of the date of publication, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions, and Lord Abbett disclaims any responsibility to update such views. Lord Abbett cannot be responsible for any direct or incidental loss incurred by applying any of the information offered.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

Please consult your investment professional for additional information concerning your specific situation.

Important Information for U.S. Investors

Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.

FOR MORE INFORMATION ON ANY LORD ABBETT FUNDS, CONTACT YOUR INVESTMENT PROFESSIONAL OR LORD ABBETT DISTRIBUTOR LLC AT 888-522-2388, OR VISIT US AT LORDABBETT.COM FOR A PROSPECTUS, WHICH CONTAINS IMPORTANT INFORMATION ABOUT A FUND'S INVESTMENT GOALS, SALES CHARGES, EXPENSES AND RISKS THAT AN INVESTOR SHOULD CONSIDER AND READ CAREFULLY BEFORE INVESTING.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Important Information for non-U.S. Investors

Note to Switzerland Investors: In Switzerland, the Representative is ACOLIN Fund Services AG, Leutschenbachstrasse 50, CH-8050 Zurich, whilst the Paying Agent is Bank Vontobel Ltd., Gotthardstrasse 43, CH- 8022 Zurich. The prospectus, the key information documents or the key investor information documents, the instrument of incorporation, as well as the annual and semi-annual reports may be obtained free of charge from the representative. In respect of the units offered in Switzerland, the place of performance is at the registered office of the representative. The place of jurisdiction shall be at the registered office of the representative or at the registered office or domicile of the investor.

Note to European Investors: This communication is issued in the United Kingdom and distributed throughout the European Union by Lord Abbett (Ireland) Limited, UK Branch and throughout the United Kingdom by Lord Abbett (UK) Ltd. Both Lord Abbett (Ireland) Limited, UK Branch and Lord Abbett (UK) Ltd are authorized and regulated by the Financial Conduct Authority.

A decision may be taken at any time to terminate the arrangements made for the marketing of the Fund in any EEA Member State in which it is currently marketed. In such circumstances, Shareholders in the affected EEA Member State will be notified of this decision and will be provided with the opportunity to redeem their shareholding in the Fund free of any charges or deductions for at least 30 working days from the date of such notification.

Lord Abbett (Middle East) Limited is authorised and regulated by the Dubai Financial Services Authority (“DFSA”). The entire content of this document is subject to copyright with all rights reserved. This research and the information contained herein may not be reproduced, distributed or transmitted in any jurisdiction or to any other person or incorporated in any way into another document or other material without our prior written consent. This document is directed at Professional Clients and not Retail Clients. Any other persons in receipt of this document must not rely upon or otherwise act upon it. This document is provided for informational purposes only. Nothing in this document should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction. Nothing contained in this document constitutes an investment, an offer to invest, legal, tax or other advice or guidance and should be disregarded when considering or making investment decisions.

Note to Singapore Investors: Lord Abbett Global Funds I plc (the “Company”) and the offer of shares of each sub-fund of the Company do not relate to a collective investment scheme which is authorized under Section 286 of the Securities and Futures Act, Ch. 289 of Singapore (“SFA”) or recognized under Section 287 of the SFA, and shares in each sub-fund of the Company are not allowed to be offered to the retail public. Pursuant to Section 305 of the SFA, read in conjunction with Regulation 32 of and the Sixth Schedule to the Securities and Futures (Offers of Investments) (Collective Investment Schemes) Regulations 2005 (the “Regulations”), the Lord Abbett Global Multi-Sector Bond Fund, the Lord Abbett High Yield Fund, the Lord Abbett Short Duration Income Fund, the Lord Abbett Ultra Short Bond Fund, the Lord Abbett Climate Focused Bond Fund, the Lord Abbett Emerging Markets Corporate Debt Fund and the Lord Abbett Multi Sector Income Fund have been entered into the list of restricted schemes maintained by the Monetary Authority of Singapore for the purposes of the offer of shares in such sub-funds made or intended to be made to relevant persons (as defined in section 305(5) of the SFA), or, the offer of shares in such sub-funds made or intended to be made in accordance with the conditions of section 305(2) of the SFA. These materials do not constitute an offer or solicitation by anyone in Singapore or any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation.

Note to Hong Kong Investors: The contents of this material have not been reviewed nor endorsed by any regulatory authority in Hong Kong. An investment in the Fund may not be suitable for everyone. If you are in any doubt about the contents of this material, you should consult your stockbroker, bank manager, solicitor, accountant or other financial adviser for independent professional advice. The Fund is not authorised by the Securities and Futures Commission ("SFC") in Hong Kong pursuant to Section 104 of the Securities and Futures Ordinance (Cap 571, Laws of Hong Kong) ("SFO"). This material has not been approved by the SFC in Hong Kong, nor has a copy of it been registered with the Registrar of Companies in Hong Kong and, must not, therefore, be issued, or possessed for the purpose of issue, to persons in Hong Kong other than (1) professional investors within the meaning of the SFO (including professional investors as defined by the Securities and Futures (Professional Investors) Rules); or (2) in circumstances which do not constitute an offer to the public for the purposes of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32, Laws of Hong Kong) or the SFO. This material is distributed on a confidential basis and may not be reproduced in any form or transmitted to any person other than the person to whom it is addressed.