As major countries have started to ease restrictions on social and business activities, investors remain rightly concerned about the speed of economic recovery and its impact on corporate dividend payouts. While a quick return to 2019 macro conditions within the next 18 months could leave prospects for future dividend payouts nearly unchanged, a delayed recovery can elevate risks to payouts for a prolonged period of time. The potential for large shocks to trend economic growth and their impact on dividend payouts to persist matters for long-term investors as these shocks drive long-term portfolio risk, returns and decisions.

To grapple with these issues, we find it insightful to frame the current context through historical perspective. Exhibit 1 describes the five major economic crises of the past 100 years - including the Covid-19 induced crisis - in terms of their time to recovery and impact on real economic trend growth and uncertainty. In all cases, the severity and duration of shocks to the real economy were extreme, to say the least, with the Great Depression (1929-1933), the 2008 Global Financial Crisis (GFC), and Covid-19 markedly standing out. Not surprisingly, the Great Depression experienced the deepest economic recession (-12% average annualized decline in real GDP) and the longest recovery time to date (43 months), and in turn, the largest increase in macro uncertainty (84%) (1) Our model derived measure of macro uncertainty captures the long-term variability in real economic growth trend, as implied by bond and equity markets, and macroeconomic fundamentals. .

Exhibit 1 - Past 100 Years Major Economic and Financial Crises

The 2008 Global Financial Crisis (GFC) also experienced persistent declines in annualized growth rates for a prolonged period of time, leading to a large increase in macro uncertainty (77%). By contrast to the Great Depression though, effective monetary and fiscal policies may have contributed to limit the impact and duration of the crisis. What about Covid-19? While the short-term drop in real output could be comparable in magnitude to the 1929 and 2008 experience, it is still too early to assess the longer-term macro impact. Thus our models only indicate a mild increase in macro uncertainty so far, reflecting our baseline scenario of a return to 2019 macro conditions in the next 18 months in the US (2) See our previous note Covid-19 and Global Macro Uncertainty for a detailed description of our baseline and alternative policy driven Covid-19 scenarios. .

Large and persistent shocks to the real economy matter for investors as such shocks are likely to put acute pressures on corporate balance sheets for a prolonged period of time, leading to sharp declines in dividend payouts (3) When their balance sheets become strained for a prolonged period of time, firms are ultimately left with no choice but to cut share buybacks and dividend payouts. In some cases, prudential regulatory requirements could also call for firms to restrict their dividend payouts, to safeguard against potential risks of insolvency. For example, the Federal Reserve announced on June 25th 2020 its plan to cap dividend payments (and ban share buybacks) made by US banks. On March 25th 2020, the EBA (European Banking Authority) urged banks in the European Union to stop all planned dividend payments and share buybacks. - which in turn drive long-term portfolio variability and returns. Exhibit 2 shows this has indeed been the case for all major crises, including Covid-19. More precisely, equity market dividends per share experienced annualized average declines ranging from -26% in the case of the 1970s Oil Crises to as much as -40% in the case of the GFC. And as it happened, during the Great Depression, small cap stocks and value stocks even stopped paying dividends over a 17-month stretch! In addition, shortfalls in dividends per share appeared to increase with the change in macro uncertainty witnessed during crisis.

Exhibit 2 - Portfolio Dividend Payouts Vary in Their Sensitivity to Macro Shocks

Exhibit 2 also shows that portfolios seem to differ in their payout sensitivity to large macro shocks. In all past crises, a growth-sensitive portfolio, with tilts towards small cap and value stocks, and consumer discretionary, industrials, materials, information technology, and financials sectors typically experienced larger declines in dividend per share compared to a growth-defensive portfolio, with tilts towards stocks with robust earnings and profitability, and consumer staples, utilities and healthcare sectors. However, the pandemic crisis seems different in this regard so far. Both growth-sensitive and growth-defensive portfolios experienced losses in dividends per share of similar magnitude. Deeper analyses revealed that in the last 6 months, payout gains experienced by the information technology sector - a major and heavy weight growth-sensitive sector - helped compensate the deep losses from small cap and value stocks and all other growth-sensitive sectors. Again, both the extent of the crisis and its duration remain uncertain to date. According to our models, a longer recovery time relative to our baseline scenario could lead to further severe losses in payouts (4) See our previous note Covid-19 and Macro Uncertainty for a detailed description of our baseline and alternative policy driven Covid-19 scenarios. .

Exhibits 1 and 2 suggest that large, persistent shocks leading to large increases in macro uncertainty are at the source of long-term, systematic return differentials across portfolios - through their impact on dividend payouts. More precisely, our macro-based models show that long-term return premia (5) We define a portfolio's long-term return premium as the long-term expected difference between the portfolio total return and the 10-year US treasury yield. are compensation for the sensitivity of dividend per share to macro uncertainty, or "cash-flow beta". As a result, return premia also increase with macro uncertainty. Moreover, growth-sensitive portfolios, with higher cash-flow betas relative to the market, command higher expected returns in the long run in excess of the market, in compensation for greater payout losses in times of increasing macro uncertainty. Conversely, defensive portfolios, that exhibit lower cash-flow betas relative to market, command lower expected returns in the long run.

Exhibit 3 - Macro Uncertainty Drives Long-Term Returns - Through Its Impact on Dividend Payouts

Exhibit 3 supports this fundamental relationship between macro uncertainty, cash-flow beta and return premia. Indeed, we find that the growth-sensitive portfolio outperformed the cap-weighted equity market on average over long periods (from January 1966 to present), while the defensive portfolio underperformed the market. In addition, the relative performance of growth-sensitive and defensive portfolios depended on changes in macro uncertainty. In our models, the growth-sensitive (defensive) portfolio underperformed (outperformed) on average when macro uncertainty rose, as in the decade that followed the GFC, and outperformed (underperformed) on average when macro uncertainty receded.

Where does this leave long-term investors? Going forward, a delayed economic recovery in the US driven by a resurgence in Covid-19 infections and inadequate policies (health and safety, fiscal, and monetary) could lead to a significant rise in macro uncertainty. In such a scenario, according to our models, corporate balance sheets could deteriorate further, shattering dividend payouts and realized equity returns. Moreover, in this scenario growth-defensive portfolios could outperform the equity market and growth-sensitive portfolios. In this context, long-term investors would be well-advised to re-examine their investment and savings decisions in view of potential changes in policy.