Markets Brief: What’s wrong with US dividend stocks?

Even as the US stock market has roared back in 2023, many dividend stocks have floundered.

Their struggles reflect the year’s narrow rally, which has been focused on names in artificial intelligence. Sectors with many of the highest-quality durable dividends—healthcare, energy, and financial services—have suffered in comparison.

“The big winners this year haven’t been the dividend champions,” says Dan Lefkovitz, a strategist for Morningstar Indexes.

The Morningstar Dividend Composite Index—a broad measure of dividend stock performance—has risen 7.7% through July. That’s less than half of the wider market’s 20.6% gain as measured by the Morningstar US Market Index.

Meanwhile, the Morningstar High Dividend Yield Index, which focuses on the higher-yielding half of the U.S. dividend-paying market, is up just 3.9% for the period. In addition, the Morningstar Dividend Leaders Index—a collection of the 100 highest-yielding stocks with a consistent history of paying their dividends and a demonstrated ability to sustain their dividends going forward—has mostly flatlined, up only 0.9% for the same period.

“Overall, dividend performance this year has been lackluster,” says Lefkovitz. The returns on dividend stocks this year mark a dramatic reversal from 2022, when dividend payers shined as the broader market fell into bear territory.

Lefkovitz cautions investors against reading too much into the short-term underperformance. “The great thing about dividend investing is that it’s got a great track record. Plus, investors get paid while they wait for performance to turn around,” he says.

Dividend stocks missed out on the (tech) rally

Through the first half of 2023, nearly all the returns in the Morningstar US Market Index came from the very largest technology stocks, including Apple AAPL, Microsoft MSFT, and Nvidia NVDA—none of which are known for their dividend payouts.

“The equity income section of the market has suffered from lack of exposure to artificial-intelligence-related businesses and too much exposure to underperforming banks, biopharma stocks, and the energy sector,” says Lefkovitz.

Among the highest-quality dividend stocks, only 4.8% come from the technology sector. The group is heavily weighted among financial services (21.9% of the index), energy (17.0%), and healthcare (16.0%).

By comparison, the U.S. stock market is made of 28.4% technology stocks by weight as of July 31, as measured by the Morningstar US Market Index. Because of this, when tech stocks do well, the market benefits disproportionately, but dividend stocks may not be along for the ride.

The Morningstar US Dividend Growth Index—a collection of stocks with a history of increasing their dividends steadily over several years, plus a healthy margin to continue growing those dividends—carries 17% technology stocks by weight.
(Lack of) Competition From Bond Yields

Conventional wisdom about the performance of dividend stocks holds that rising bond yields are bad for dividend payers. However, Lefkovitz says the historical connection between dividends and rising rates is not straightforward.

“Interest rates are just one variable out of many for dividend performance,” he explains. “We’ve seen dividend payers both outperform and underperform in rising rate environments.”

Lefkovitz believes it’s not worth putting much emphasis on rates when it comes to income-focused investing. “It’s really more about what has been in and out of favor in the equity market,” he says.

Which dividend stocks underperformed?

Healthcare, utilities, and energy stocks were among the key detractors within the dividend universe as measured by the Morningstar US Dividend Composite Index.

Pharmaceutical giant Pfizer PFE dragged the index down the most, with losses of 27.2% in 2023 through July. Next was the wireless service provider and index heavyweight Verizon Communications VZ, whose 2.1% weighting in the dividend composite index meant its 10.8% loss in 2023 had a sizable impact on the index’s overall performance. Oil and gas companies Chevron CVX and Devon Energy DVN, as well as utilities company NextEra Energy NEE, also made the list of the 10 most impactful detractors.

Which dividend leaders fell furthest?

Stocks from the communication services, healthcare, and consumer cyclical sectors dragged the Morningstar Dividend Leaders Index down furthest.

Alongside Verizon and Devon Energy, North Carolina-based regional bank Truist Financial TFC (down 20.4% in 2023) and pharmaceutical firm AbbVie ABBV (which only lost 4.7% but carries 7.4% of the index’s weight) were the leading detractors.

Ford Motor F, developer of infectious disease treatments Gilead Sciences GILD, and retail pharmacy chain Walgreens Boots Alliance WBA were also key detractors.
Dividend Stocks Look Cheap

“The good news is that a lot of dividend-rich areas of the market are attractively valued right now—financial services and healthcare among them,” Lefkovitz says.

The weighted-average valuation of the Morningstar US Financial Services Index stood at 0.87 on July 31, well below its fair value of 1.00 and discounted compared to the Morningstar US Market Index, which carried a weighted-average valuation of 0.94 as of July 31. Several large dividend-paying healthcare stocks are currently in deep discount territory, including CVS Health CVS, Pfizer, Medtronic MDT, and Gilead.