Jonathan Marriott, Chief Investment Officer
The UK equity market has traditionally been supported by high dividend yields. Over the last twenty years, the FTSE 100 Index has returned a total of just 3.8%. However, it is a capital-only index. When dividends are taken into account, it has returned 114%, or an average of 3.7% per annum. By way of comparison, the difference between the annualised return of the US equity S&P 500 Index is just 2%. In 2019, dividends would have added 329 points to the FTSE 100, or 4.8% at the present level (which is at 6,788 as I write). As a result of the pandemic, last year only 214 points of dividends were paid, or a 3.1% dividend yield. Dividends only really started being cut after the first quarter, so the prospective annual pay-out as it stands is lower than this. If dividends were to return to pre-pandemic levels and the FTSE 100 were to yield 3.7%, as it has on average, then the index would be at 8,891, or 30% higher than it is today. So, the question is important to consider, but hard to answer. We must always remember that past performance may not be a guide to the future.
When considering this question, we must first consider why the dividends were cut in the first place. Banks and insurance companies were ordered not to pay dividends by their regulators to bolster their finances and capital position. Oil companies such as Shell and BP, that had been big dividend payers in the index pre-pandemic, cut their dividends in response to the falling oil price. It is also worth remembering that excess supply, falling demand, and a lack of storage capacity drove the oil spot price negative at one point. Others companies cut their dividends as trading conditions deteriorated and demand fell as a result of the pandemic.
In the US, the regulator has already removed some of the restrictions on dividends and share buybacks. So, there is hope that the Bank of England will follow in due course. This does not mean that the level of dividends will return to the same level as they were pre-pandemic. Low interest rates make it harder for banks to be profitable, and we expect interest rates to remain low for a prolonged period. Many companies and individuals have increased borrowing during the pandemic, as has the government. As a result, any rise in rates is likely to have a more significant impact on the economy than it would have done before the pandemic. It will therefore be hard for the Bank of England to raise rates meaningfully any time soon. While many of the debts incurred by companies have government support, default levels may still rise. Finally, the Brexit deal did not cover financial services and those that benefitted from links with Europe may have activity restricted if the UK does not negotiate "equivalence" with EU regulations. While, in the long run, banks may return to profitability, it may take a long time to get to a level of profitability that justifies the level of dividends some of them were making pre-pandemic.
2020 started with a dispute between Saudi Arabia and Russia over the level of oil production, leading to a fall in price even before the pandemic hit. With production cuts and some recovery in demand, the oil price rose during the second half of the year. Over the long term, moves to counter climate change should see demand for oil decline and the oil majors have been looking to diversify their activities and sources of revenue. For now, a sustained higher price for oil will be needed for these companies to justify making dividend payments back at previous levels.
Many companies have cut their dividends to shore up their balance sheets as activity declined during the pandemic. Many of these companies are likely to have incurred higher borrowing to get through the pandemic, and until the damage to their balance sheets is restored, they may not resume dividend payments at pre-pandemic levels. Some companies have not been impacted by the pandemic, and those with strong online activity may have even flourished, enabling those that have been able to maintain dividends over the period, to increase distributions over time.
In conclusion, there is unlikely to be an immediate restoration of dividend levels after the pandemic goes away. Some companies may never resume dividend payments at pre-2020 levels; others may take several years to resume payments at that level. It is too early to say when the economy will recover from the pandemic, and there are many other factors to consider that may restrict future dividend payments. However, even after the dividend cuts, the yield on UK equities is higher than many other developed markets and looks attractive relative to the yield available in the bond market.
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