A recent article in Bloomberg by Aaron Brown (former managing director of AQR Capital Management) compares market risk factors today compared to several months ago.

At the bottom of the market in March, Bloomberg published an article outlining the following unknowns faced by investors:

• How long the reduced economic activity resulting from the coronavirus-related lockdown will continue?
• How much money will the government spend, and how will it handle the resulting increase in debt?
• What will the long-term impact be on public health?
• What permanent changes will result?

At the time, Brown used dividend futures to conclude that the market expected a 20% decline in real activity and would bottom in July of 2020. He wrote, “That led me to dismiss diminished payouts as a major worry for stock investors since the present value loss from the missing dividends was less than 3% of stock market value.”

In the more recent article, however, he writes, “Things look quite different today,” noting that dividend futures suggest a 30% decline in cash flows for the S&P 500, with “minimal growth for seven years. Not until after 2027 will cash flows start to expand at the predicted pre-virus rates. Nevertheless, the S&P 500 is up 34% from the March low.”

The article lists three possible explanations for the divergence between stock prices and expected dividends:

• Investors expect companies to generate good profits, but “to use those earnings for reinvestment, cash hoarding, debt reduction and share buybacks, rather than for dividends.”
• Investors expect a growth period exceeding 10 years.
• Investors “have decided to accept lower long-term expected returns than they demanded either pre-virus or at the market lows.”

Brown writes, “the first is probably true to some extent, but nowhere near enough to explain the data. The second is implausible,” and settles on the third as the appropriate explanation.

Brown contends that investors have “begun to forget what they used to consider normal,” and are now asking, “How do I want to live in the future?” adding, “This is a cultural shift that was triggered by the virus, but not caused by it, and the biggest changes are likely to have no direct connection to the virus.”

He concludes that investors appear to be opting for stocks not because they are particularly attractive, but because “everything else is much less attractive.”

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