by Dimensional
The Coronavirus and Market Declines — A Letter From Dimensional
February 27, 2020
The world is watching with concern the spread of the new coronavirus. The uncertainty is being felt around the globe, and it is unsettling on a human level as well as from the perspective of how markets respond.
At Dimensional, it is a fundamental principle that markets are designed to handle uncertainty, processing information in real-time as it becomes available. We see this happening when markets decline sharply, as they have recently, as well as when they rise. Such declines can be distressing to any investor, but they are also a demonstration that the market is functioning as we would expect.
Market declines can occur when investors are forced to reassess expectations for the future. The expansion of the outbreak is causing worry among governments, companies, and individuals about the impact on the global economy. Apple announced earlier this month that it expected revenue to take a hit from problems making and selling products in China1. Australia’s prime minister has said the virus will likely become a global pandemic2, and other officials there warned of a serious blow to the country’s economy3. Airlines are preparing for the toll it will take on travel4. And these are just a few examples of how the impact of the coronavirus is being assessed.
The market is clearly responding to new information as it becomes known, but the market is pricing in unknowns, too. As risk increases during a time of heightened uncertainty, so do the returns investors demand for bearing that risk, which pushes prices lower. Our investing approach is based on the principle that prices are set to deliver positive future expected returns for holding risky assets.
We can’t tell you when things will turn or by how much, but our expectation is that bearing today’s risk will be compensated with positive expected returns. That’s been a lesson of past health crises, such as the Ebola and swine-flu outbreaks earlier this century, and of market disruptions, such as the global financial crisis of 2008–2009. Additionally, history has shown no reliable way to identify a market peak or bottom. These beliefs argue against making market moves based on fear or speculation, even as difficult and traumatic events transpire.
Dimensional also stands behind the important role financial professionals play in helping investors develop a long-term plan they can stick with in a variety of conditions. Financial professionals are trained to consider a wide range of possible outcomes, both good and bad, when helping an investor establish an asset allocation and plan. Those preparations include the possibility, even the inevitability, of a downturn. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.
FOOTNOTES
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1Apple, February 17 press release. https://www.apple.com/newsroom/2020/02/investor-update-on-quarterly-guidance/
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2Ben Doherty and Katharine Murphy, “Australia Declares Coronavirus Will Become a Pandemic as It Extends China Travel Ban,” The Guardian, February 27, 2020. https://www.theguardian.com/world/2020/feb/27/australia-declares-coronavirus-will-become-a-pandemic-as-it-extends-china-travel-ban
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3Ben Butler, “Coronavirus Threatens Australian Economy Reeling from Drought and Fires,” The Guardian, February 5, 2020. https://www.theguardian.com/business/2020/feb/05/coronavirus-threatens-australian-economy-reeling-from-drought-and-fires; Ed Johnson, “Australia Says Economy to Take ‘Significant’ Hit from Virus,” Bloomberg, February 5, 2020. https://www.bloomberg.com/news/articles/2020-02-05/australia-says-economy-to-take-significant-hit-from-virus
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4Alistair MacDonald and William Boston, “Global Airlines Brace for Coronavirus Impact,” The Wall Street Journal, February 26, 2020. https://www.wsj.com/articles/germanys-lufthansa-makes-cuts-as-it-braces-for-coronavirus-impact-11582712819
Tuning Out The Noise
For investors, it can be easy to feel overwhelmed by the relentless stream of news about markets.
Allowing emotions or opinions about short-term market conditions to impact long-term investment goals can lead to disappointing results. By filtering out the noise to help manage your emotions and biases, you can maintain perspective, remain calm, and look beyond the concerns of today.
10 Attributes of Great Financial Advisors
Not all financial advisors are created equal. “As part of Dimensional’s 30th anniversary of working with advisors…we consider 10 common attributes of advisors who are focused on delivering a great client experience.” —Dave Butler, Co-CEO, Dimensional Fund Advisors
1. Purposeful: They have a clear mission to serve clients and help them reach their goals.
Great advisors want to do great work for their clients. They stake their business on doing the right thing—and know that business success will follow.
2. Empathetic: They know they cannot effectively serve clients without genuinely relating
to them.
To serve well, an advisor must assume a client’s perspective. Empathetic advisors put themselves in their clients’ shoes and work to understand what matters most to them.
3. Authentic: They reveal their true selves to clients.
Effective advisors elevate the connection with clients by revealing their own personal stories. A willingness to be transparent and vulnerable helps build client trust and encourages real communication.
4. Intellectually curious: They continue to search for the most robust solutions for clients.
Great advisors are on a continual path of professional improvement. They are lifelong learners, open to new ideas and committed to honing their technical knowledge and skills.
5. Personally inquisitive: They work hard to uncover what’s truly meaningful to their clients.
Engaged advisors also have mastered the personal side of advice. They ask probing questions to better understand their client’s views on money and life before creating a plan.
6. Quiet: They listen more than they talk.
Active listening encourages clients to reveal their deeper thoughts—and often, an advisor’s best answer is to ask a question that sparks creative analysis and self-discovery.
7. Passionate: Their unwavering desire to do well for others drives constant improvement.
A strong sense of conviction to do right by clients compels great advisors to continue honing their craft and ultimately enhance the value clients receive.
8. Entrepreneurial: They run their practice as a business and plan strategically for the future.
Advisors can better serve clients when they run successful firms. Just as they encourage financial responsibility in their clients, top advisors apply a high standard to managing their own enterprise.
9. Honest: They set realistic expectations about controllable actions and probable outcomes.
While the best advice may not be easy to hear, great advisors communicate essential truths about money and investing so that clients have realistic expectations about their wealth.
10. Disciplined: They don’t let market swings or media messages drive impulsive actions.
Effective advisors know the importance of preparing clients to navigate changing markets and apply discipline at crucial times, which can lead to a more enjoyable and promising financial journey.
Yields of Dreams: A Closer Look at Dividends
Investors often see dividends as a way to generate income. But dividend strategies are not the only way to produce cash, and investors should be aware of the potential tradeoffs that accompany a focus on dividends.
For stockholders who own dividend-paying shares, those payments arrive on a schedule (quarterly, in many cases). The cash to fund a dividend must come from somewhere, however. We know the price of a stock is potentially influenced by all expected future cash flows to shareholders. If cash is paid today in the form of a dividend, the stock price—and total market capitalization—of the issuing company may therefore fall, as the hypothetical Portfolio A in Exhibit 1 shows. That means, all else being equal, an investor who receives a dividend may also be left with a less valuable equity holding.
Exhibit 1
Pay, Your Way
Comparing methods of income generation
For illustrative purposes only. Assumes the stock price will fall by roughly the amount of the dividend and assumes no nondividend-related price movement.
Cash Considerations
An alternative method of raising cash is to simply sell shares. Exhibit 1 compares the two methods of generating income by contrasting Portfolio A with the similarly valued hypothetical Portfolio B. While Portfolio A receives income through a dividend payout, Portfolio B generates it through a stock sale.
The investor in Portfolio A, in which a dividend is issued, ends up holding the same number of shares as were held prior to the dividend payout, but we assume that those shares have declined in value. The investor in Portfolio B holds a reduced number of shares that haven’t seen their value decrease as a result of a dividend payout. The two approaches arrive at the same place—both investors end up with $100 in cash and $1,900 in stock, notwithstanding potential trading costs or tax implications. But there are potential downsides to the dividend approach when contrasted with the stock-sale approach.
First, the average proportion of firms paying dividends in the US was about 52% from 1963 through 2019,1 meaning an investor focusing only on those stocks is missing out on nearly half of investible US companies. A second consideration is that a dividend’s value, while not subject to the same degree of fluctuation as a stock price, isn’t guaranteed. Just 10 years ago, more than half of dividend-paying firms cut or eliminated those payouts following the financial crisis.2 More recently, a company that had consistently paid dividends for more than a century, General Electric, slashed its payout to just one cent a share,3 and the UK’s Vodafone Group cut its full‑year dividend for the first time in two decades.4 Thirdly, investors may give up flexibility in terms of the timing and the size of the payout when they rely on company-issued dividends. With stock sales, an investor determines the amount and schedule of the income.
Total Return
When considering an investment, it is also important to assess total return, which accounts for capital appreciation (or loss) alongside dividend income. High dividend yields may not lead to high total returns. Exhibit 2 plots the trailing 12-month returns of S&P 500 Index constituents as of December 31, 2019, with each dot representing a company. It’s clear that companies with greater dividend yields, the dots located higher up the vertical axis, weren’t consistently those with a higher total return over that period.
Exhibit 2
Income Facts
Dividend yields and 12-month returns for S&P 500 firms as of December 31, 2019
Note: Plotted yield of 18.38% reflects a stock that paid special dividends. Source: Dimensional calculations using Bloomberg data. For constituents with reported returns of less than one year, returns shown since earliest date available. S&P data © 2020 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Dividend yield is calculated as the sum of dividends paid in calendar year t divided by end of year t-1 price.
Income generation may be a priority for some investors, but other important investment considerations, such as diversification and flexibility, needn’t fall victim to that aim. While the use of stock sales instead of dividends to create cash flow may involve trading costs and tax considerations, those concerns may be offset by the benefits of investing in companies that don’t currently pay dividends. An approach focused on income derived through dividends may not be the most desirable choice when weighing broader investment goals.
Footnotes
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1Source: Dimensional, using data from CRSP. Stocks are sorted at the end of each June based on whether a dividend was issued in the preceding 12 months.
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2Stanley Black, “Global Dividend-Paying Stocks: A Recent History” (white paper, Dimensional Fund Advisors, March 2013).
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3Janet Babin, “GE cuts dividend to a penny per share. Why bother keeping it at all?” Marketplace, American Public Media, October 30, 2018.
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4Adrià Calatayud, “Vodafone cuts dividend after swinging to 2019 loss.” MarketWatch, May 14, 2019.
Disclosures
Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision.
Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.
Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Investing risks include loss of principal and fluctuating value.
All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.
