Dividend hikes in the air

Funds that focus on dividends were laggards last year. Will they return to investor favor this year? Quite possibly, given a boost from tax reform and investor worries about an overheated market.

First, let’s clarify. Most dividend funds didn’t beat the Standard & Poor’s 500 stock index last year, which gained 22.2%, including reinvested dividends. But most dividend funds did beat 10%, which is the average annual return from large-cap stocks since 1926, according to Morningstar. So dividend funds and ETFs were only laggards on a relative basis.

Dividend increases in 2017 were strong on an absolute basis, despite a massive cut by General Electric. The average dividend increase for 2017 was 11.6%, up from 10.5% in 2016, according to Howard Silverblatt, senior index analyst for S&P Dow Jones Indexes. U.S. companies reported 801 dividend increases for the fourth quarter of 2017, compared to 784 increases during the fourth quarter in 2016, a 2.2% year-over-year increase.

The 417 companies in the S&P 500 currently pay an average dividend yield of 2.24%.

“At this point I am looking for a record year, aided by lower income taxes and repatriation, which should finally put the S&P 500 over the $1 trillion mark for shareholder dividend and buyback return,” Mr. Silverblatt wrote in a note to clients.

“We see a continuation of mid single-digit to high single-digit dividend increases for better companies, which is about as good as it gets,” said Phil Davidson, chief investment officer for U.S. value equity at American Century Investments. “I think dividend stocks will outperform over time, and feel pretty good about what we own.”

One favorite is UPS, currently yielding 2.63% and up 6.2% the past week, partly on President Donald J. Trump’s tweet that the U.S. postal service should charge Amazon more for shipping.

WisdomTree U.S. Quality Dividend Growth Fund (DGRW) was the top-performing U.S. dividend ETF last year, rising 27%, according to Morningstar.

Close behind was iShares Core Dividend Growth ETF (DGRO), up 22.8%. The top U.S. dividend mutual fund was Horizon Active Dividend Fund Investor (HNDDX), up 24.1%.

But some international dividend ETFs, aided by a declining dollar, fared better. WisdomTree Europe SmallCap Dividend Fund (DFE) jumped 32.2% last year, while WisdomTree Japan SmallCap Dividend Fund (DFJ) gained 31.6%.

The top mutual fund was Matthews China Dividend Fund Investor (MCDFX), which returned 37.7%.

Declared dividends are expected to increase 10% globally this year to approximately $1.65 trillion, representing the highest level of annual growth since 2014, according to IHS Markit.

“Our positive global forecast is based on a bottom-up analysis of more than 7,500 companies, which collectively show an encouraging economic outlook,” said Thomas Matheson, head of dividend research at IHS Markit. “In 2018, we expect to see stronger performance across sectors, coupled with resurgent growth in Europe and a notable decrease in dividend cuts.”

The company expects emerging markets to outperform developed markets in dividend growth.

A sharp rise in inflation and concurrent jump in the 10-year Treasury note yield could take some of the wind out of dividend stocks, Mr. Davidson said.

He’s not terribly concerned, however.

“The situation with economic outlook is reasonable, corporate profitability is high, and they will get a lift from the tax bill. It should be a reasonable year for real returns in dividend growth,” he said.