Royal Dutch Shell Group .com Rotating Header Image

Investors are left to chase increasingly rare dividends

FT Home

By David Oakley

Published: November 29 2008 02:00 | Last updated: November 29 2008 02:00

We got another reminder this week that we are living in extraordinary times. The yield on the benchmark 10-year gilt fell below 4 per cent for the first time since 1961 amid increasing investor concerns about the prospect of a UK and global recession and worries about deflation.

Yields this low change the dynamic between the bond and equity markets. That is because government debt sets the risk-free rate for markets generally. A lower risk-free rate tends to reduce investors’ required rate of return more generally, including the return they seek from shares.

On September 18, yields on 10-year gilts fell below the dividend yield on the FTSE All-Share index for the first time since March 2003 – the nadir of the last bear market. Historically, this inversion has been a sign that share prices are close to finding their floor and a signal to buy.

But since that point, far from rallying, UK equities have fallen a further 21 per cent, pushing the dividend yield even higher. Gilt yields are much lower than they were then. Now gilt yields trade at 3.75 per cent, while the FTSE All-Share dividend yield stands at 5.5 per cent. Rarely can the gap have been wider. It is not surprising that investors have shunned equities, as they have had to contend with extraordinary turmoil in markets since the collapse of Lehman Brothers in mid-September. It is only since then that deep fears about the prospect of global recession and a collapse of corporate earnings have taken hold.

A key question for stock market investors now is not just how far earnings are going to fall, but also how many companies are going to cut or scrap their dividends as part of a desperate attempt to conserve cash. This week DSG International, owner of the Currys and PC World chains, and Mitchells & Butlers, the pubs group, both scrapped their dividends.

Gareth Evans, UK strategist for UBS, warns that we could have reached a turning point, where dividends fall as fast as earnings for the first time. This has never happened before. “We are living in unusual times. The need for cash is so great that these companies are left with little choice,” he says.

In Mr Evans’ worst-case scenario, dividends will fall 15 per cent next year, the same as his forecast for the drop in earnings of UK companies. This is much higher than the 5 per cent fall in dividends seen during the recession of the 1990s. In past recessions, companies have always been highly reluctant to cut dividends because investors generally hate it. But there are signs of a change in attitude. Given the difficulty and cost of raising money in the credit markets, companies may take the view that it is more sensible to cut their dividend pay-outs than tap bond markets.

When an investment-grade company of the stature of Vodafone has to pay 400 basis points over gilts for a 10-year bond, as it did last week, then you know things are bad. This was a company that was paying about 50bp over gilts before the credit crunch. Moreover, companies that do cut their dividends are not being punished. Mitchells & Butler’s decision to scrap its final dividend on Wednesday was met with a rise in its share price. Investors seem to be taking the view that the ability of the companies to refinance their debts when they come due is now more important than paying dividends. This is a big contrast to only two months ago, when Punch Taverns was punished for cutting its dividend.

Dividend cuts are not going to be a welcome development for the many pension funds and retail investors who rely on a steady stream of income. They are already having to live with the fact that many of the UK’s biggest banks will not be making pay-outs for the foreseeable future after being forced to turn to the government to shore up their balance sheets.

Things could get even worse, however. Many investors have switched out of the banks and bought into the oil companies in the belief that their dividends at least are safe. But what if they aren’t?

Some analysts believe that if oil prices fall further from their current levels, then even the dividends of BP and Shell could be vulnerable. If either of these giants cut their pay-out, the market really would be shocked.

[email protected]

This website and sisters,,,, and, are owned by John Donovan. There is also a Wikipedia segment.

Comments are closed.