Jeremy Warner: The dividend gusher is over

Click to follow

Outlook: One of the reasons why stock markets are still crashing is the outlook for dividends, which has turned truly dire. Over time, most of the return on equities comes from dividends, so the virtual cessation of these payments is as much if not more of a concern to long-term equity investors as the present loss of value.

As Kevin Gardiner, head of equity strategy at HSBC, pointed out in a circular published yesterday, nominal dividends are falling faster in the US than at any time since the 1930s. I'm not sure what the equivalent statistic is for the UK, but it is hard to find a finance director remotely interested in paying a dividend. Mr Gardiner's own employer, HSBC, has just slashed its dividend. Nor is this just an affliction of the distress sectors of finance, property, retail and media. With few exceptions, it's pretty much across the board. Nor too is it driven only by the outlook for corporate earnings, which is plainly deteriorating with frightening speed.

In a mirror image of what's been happening among banks, the credit crunch is causing even the most solvent of companies to conserve whatever cash they can. Companies are worried about whether they will ever be able to borrow again. We seem to be moving back to a world in which businesses must fund themselves from their own cash flows. The process of deleveraging is shifting from the banking to the rest of the corporate sector. The upshot is smaller or non-existent dividends. In the present squeeze on corporate spending, dividends come a long way down the list of priorities.

How long this process lasts is anyone's guess. One of the things that made everyone feel safe about equity valuations when the stock market peaked in June 2007 was that by historic standards they didn't seem at all stretched. Both in terms of the earnings multiple and dividend yield, shares looked reasonably valued. One of the key signals of the top of the market – extreme valuations – seemed to be missing.

In fact, it was there all along, but well hidden. The massive profits being generated by the banking sector turned out to be largely an illusion. As it transpired, quite a bit of the rest of corporate profitability too was little more than another creation of the credit bubble. Now that the credit has gone, so have the profits. As the boom times roll, companies also find ways of inflating their profits through clever accounting to unrealised levels. In each cycle, about 10 per cent of reported corporate profits turn out to be completely non-existent. In the downturn, the process goes into reverse. Companies have a tendency to over-exaggerate their losses.

In any case, we are left with a truly appalling outlook for corporate earnings. Unfortunately for equity holders, they have the last call on anything that survives the cull. Bondholders, bankers, the Revenue, employees, creditors and pensioners all come first. Whatever your view of the length and depths of the recession, it is plainly going to be an awfully long time before corporate earnings recover to anything like normalised levels. Once the private debt has been worked off, the public debt now being taken on to replace it needs to be addressed too. That's going to crimp growth through higher taxes and lower public spending for years to come.

Over time, equities have historically always delivered a better rate of return than almost any other asset class. Yet there are long periods when they don't. Regrettably, we are right bang in the middle of one of them and no one can say quite how long it will last.