Fashions in investments change with time. For most of history, income was the major rationale of investing. Some observers of the economic scene suggest we may be entering a period where the recent fascination with capital gains, inflation hedges, and leveraged speculations will give way to a renewed interest in instruments which generate reliable and substantial income. No economic logic is foolproof, and even the most persuasive argument can be negated by tomorrow's change in tax policy or next week's stock market crash, but the possibility of a general change in the valuation of income is worth considering. How might this happen?
First, the general trend in interest rates has been down ever since they hit historic highs in 1980. If rates continue to fall, as many believe they will, rates on debt instruments may approach and possibly fall below, yields on dividend-bearing stocks (as they have been for most of economic history). If dividend paying stocks become the highest yielding investments, they will become the focus of those seeking income.
Second, tax reform has eliminated the preferential treatment accorded capital gains (in other words, appreciation of stock) compared to income earned from interest or dividends. Investors who previously sought ways to avoid income and realise deferred capital gains to reduce the tax bite no longer have any reason to do so. (Of course, this may change, and proposals to restore the preferential treatment of capital gains are in the air at this writing.)
Third, ours is the age of debt. Debt is growing exponentially, and takeovers are in many cases eliminating equity and replacing it with debt. As the debt market further dwarfs the equity market, debt--income producing investments--becomes the centrepiece of the investment world.
Fourth, there are many reasons to believe that a severe recession is in the offing. A recession and the bear market for equities which usually attends it causes severe depreciation in the value of equities. In such a period, secure and stable income assumes greater value than capital gains, since most capital assets are falling in value.
To the extent that these factors are significant, and the assertion they will increase the relative value of income is valid, the argument for paying dividends is strengthened. Confirmation of these trends would be indicated by a relative increase in value of dividend-paying stocks over comparable stocks which retain earnings.
Editor: John Walker