US Dividend growers hedge against Trump bump to inflation

Key takeaways

• The combination of healthy economic data and Trump’s election win have resulted in meaningful changes to interest rate expectations.
• As investors move beyond the first-order effects of Trump’s victory—pro crypto, pro fossil fuels, etc.—they will need to position for the second-order effects of the new world order: higher costs, lower margins, higher rates and higher inflation.
• Dividend growers are well-positioned to navigate the evolving landscape but are under-represented in the broad market indexes, creating an opportunity for active management.

There will be second-order effects to Trump 2.0

Since the election, investors have piled into sectors expected to benefit from the second Trump administration. As we turn the page on 2024 and the joy of these quick gains subsides, equity investors will have to think through the second-order effects of Trump’s presidency and position accordingly.

A second Trump presidency should be good for domestic energy production, but is higher production good for energy prices and thereby producer profits? Robust tariffs should raise import prices and thereby encourage reshoring. But, if corporations moved those jobs overseas to cut costs and save money, doesn’t bringing them back invariably mean rising costs and lower profits? Deporting millions of undocumented immigrants may prove politically popular, but won’t removing millions of workers from a labor market that is already tight inevitably lead to higher employment costs and inflation?

One thing seems clear; to the extent that Trump is successful in bringing manufacturing jobs home and sending undocumented immigrants packing, inflation will be permanently higher. There is no way around it: globalization benefited investors at the expense of workers. Companies substituted higher-paid US workers with lower-paid, foreign replacements, reducing wages and hurting US workers, while expanding profits and benefiting shareholders.

Deglobalization will certainly have some benefits. Bringing manufacturing jobs back to the United States will be good for US workers; by some measures the middle class has seen little real wage growth in several decades. Increasing labor costs will reduce margins and come directly out of shareholders’ pockets, but it will benefit society as it reduces inequality. Reshoring manufacturing and unwinding globalization could also result in structurally higher US gross domestic product (GDP) growth. The middle class has a far higher propensity to consume than the wealthy. So, as money is shifted to the working class from the rich (via higher wages and lower profits), more of that money should end up being spent, propelling economic activity.

At the same time that the market has been processing the implications of Trump’s victory, economic data has come in better than expected. While it previously seemed a slowing economy would give the Fed space to significantly cut interest rates, recent data suggests the economy remains robust. The combination of healthy economic data and Trump’s election win have resulted in meaningful changes to interest rate expectations (Exhibit 1).

With the market at all-time highs, valuations on the fuller side (Exhibit 2) and interest rate expectations becoming less dovish, investor positioning must become more nuanced. The economy is healthy, Republicans should provide help on taxes and several sectors should benefit from regulatory changes under the incoming Trump administration. Consequently, corporate earnings in 2025 should also be healthy. But security analysis requires more than just forecasting earnings; investors must also decide how to value that stream of earnings.

Parsing the net impact of a Trump presidency is complicated. Trump’s economy should entail higher wages, higher consumer spending and higher US growth, but also lower margins, higher inflation and higher interest rates. Higher growth, higher wages and reduced inequality are invariably good for the top line and good for society. But lower margins, higher inflation and higher interest rates all augur for lower multiples on investments.

As we look to 2025 and position for this brave new world, the case for high-quality dividend payers—companies that are typically leaders in their sectors, with strong balance sheets, low debt, recurrent predictable revenues and economic moats—has almost never seemed stronger.

Current income: In big bull markets people tend to overlook dividends. When a handful of mega cap growth stocks drive the preponderance of equity market performance, people predictably focus on capital appreciation. But bear markets remind us that dividends—albeit prosaic—are responsible for 40% of total return over the long term. In flat-to-down markets, meanwhile, dividends provide a cash flow return to investors that offsets share price stagnation or depreciation.

Growth: While strong upfront yield is attractive, the real power of equity is in its long-term compounding and growth. Unlike bonds, which typically offer fixed coupons, dividends have the potential to offer rising cash flow streams over time. Dividend growth is great in regular periods, but absolutely critical during inflationary periods. As inflation erodes the value of a dollar, growing dividends could help to maintain purchasing power despite the increasing cost of living.

Dividend growers have a history of being rewarded by the market over time (Exhibit 3). A look at the returns of S&P 500 Index stocks sorted by dividend policy over the past 50 years shows that dividend payers outperformed the broad market.

Actively targeting dividend growers in a skewed market

In a market myopically focused on a few technology stocks, active investors may find opportunities to target dividend growers in more value-oriented sectors. Cyclical sector representation is near a 100-year low (Exhibit 4), and we may be at the tail end of a trend that started 40 years ago when interest rates peaked.

There is plenty of room to actively diversify exposure away from higher-multiple stocks to dividend-friendly sectors underweighted in the broad market (Exhibit 5).

Energy: With energy production poised to benefit from a supportive regulatory regime, midstream operators of pipelines and related infrastructure, which offer a combination of strong upfront yields and a tendency toward contracts with built-in inflation escalators, are poised to benefit.

Financials: The financials sector should benefit from reduced regulatory pressure and positive leverage to rising interest rates. Banks, for example, directly benefit from higher interest rates as they raise the rates they charge to borrowers.

Consumer staples: Consumer staples have significantly underperformed as they lapped comparisons from the Covid era when people stayed home and prices soared. A robust business cycle and healthier long-term wage growth should result in better long-term demand and earnings growth.