By all accounts, 2023 ended (and a new year began) with unbridled positivity for financial markets. Perhaps this was the tacit acknowledgement that the Federal Reserve really is threading the needle and orchestrating a soft landing for the economy. It certainly hasn’t hurt that the Fed’s rate-hike cycle appears to be winding down. In fact, according to the fed fund futures, the market is pricing in several rate cuts in the coming year. Naturally, investors have cheered the arrival of the terminal rate, and the S&P 500 clocked in with an impressive bounce-back after a dreadful 2022.

Although all this is good news, the internals within the market tell a slightly different story. The past year was dominated by domestic large caps (once again), and specifically by just a handful of mega caps that have been responsible for the lion’s share of gains. The Magnificent Seven—Nvidia, Apple, Microsoft, Amazon, Alphabet, GOOGL, Meta Platforms, and Tesla—were substantially responsible for the 26% return delivered by the S&P 500® during 2023.

And even though breadth improved late in the year with small- and mid-cap stocks finally joining the fun, there’s no denying that the broad category of dividend-paying stocks had more pedestrian results. Virtually all popular measures of dividend funds—pick any dividend-focused equity index—lagged the broader market for the full year.

The performance of stocks by industry during the past year also illustrates a bifurcated market. Interestingly, the dominant returns generated during 2023 were from the three sectors with the lowest dividend yields—information technology, communications services, and consumer discretionary. By contrast, the eight other sectors—all with higher dividend yields—lagged considerably. In fact, two of the highest dividend-yielding sectors were actually negative during 2023.

Don’t Bail on Dividends

We think it’s far too early to give up on dividend-paying equities, and there are several reasons why patience may be in order when it comes to assessing your dividend strategies. For starters, we don’t necessarily buy into conventional wisdom that higher yields across the curve are bad for dividend-paying equities. It’s true that income-seeking investors may now have more viable options at hand, but that alone does not tell the story of why dividend stocks have lagged during 2023. The reality is that the narrow rally (i.e., investors' ongoing love of tech) largely excluded dividend stocks for the majority of 2023.

However, investors looking to allocate new money to equities may want to step back to consider valuations and the overall risk/reward scenario. As of early February 2024, the S&P 500 was yielding approximately 1.4%, while the forward-looking price-to-earnings ratio—the market price of a security divided by its earnings estimates—was approximately 20x, which is above historical averages. This suggests that stocks have gotten relatively expensive.

By comparison, looking at an index of large-cap domestic dividend payers* —one that selects the highest 100 dividend-yielding stocks that also have had positive earnings across the last 12 months—shows a more attractive 4.2% yield with a forward-looking P/E of approximately 13x. Simply stated, a lower forward P/E means that the dividend-paying stocks appear cheaper than the broader market, and they provide a higher yield. That’s a nice combination.

Fundamentals, not Sentiment

Although the price performance of most dividend-paying stocks has lagged the market, we see many of these underlying businesses continuing to grow their earnings even if the broader market has been slow to reward them. Much of this has to do with momentum and market sentiment. After all, 2023 seemed to be the year of artificial intelligence, and there are not many high-dividend payers in the insanely popular AI space. Yet, if you believe that, over time, share price follows earnings, there is room for the price of many of these dividend payers to catch up to their earnings. And remember, investors presumably will earn an attractive yield while holding these stocks and waiting for the rally to broaden out further, though we all know yields can change and nothing is without risk.

If and when the Magnificent Seven finally take a breather, we believe that investors will again begin to focus on those businesses that are demonstrating an ability to grow earnings. This should include many companies in the cohort of high dividend-yielding, large-cap U.S. stocks. Given that dividend payers are trading at a discount to the broader market and offer an attractive yield, you can see why we’re defending dividend payers as we head deeper into 2024.

*The Nasdaq Victory U.S. Large Cap High Dividend 100 Volatility Weighted Total Return Index.

Index performance includes reinvestment of dividends and other income but does not reflect management fees, transaction costs or expenses. One cannot invest directly in an index. Past performance does not guarantee future results. Nasdaq® and the Nasdaq Victory Indexes are registered trademarks of NASDAQ, Inc. (which with its affiliates is referred to as the "Corporations") and are licensed for use by Victory Capital Management Inc. The Fund(s) have not been passed on by the Corporations as to their legality or suitability. The Fund(s) are not issued endorsed, sold, or promoted by the Corporations. THE CORPORATIONS MAKE NO WARRANTIES AND BEAR NO LIABILITY WITH RESPECT TO THE FUND(S).