The Dividend Corner: 2025 2nd Quarter Mid-Market Update

Hi, I’m Nick Puncer, Portfolio Manager and member of Bahl & Gaynor’s Investment Committee. Today is Thursday, May 15, 2025, so we are halfway through the second quarter, and we wanted to provide investors with our thoughts about the year so far and our outlook.

Markets have regained a meaningful portion of what was lost in the volatile drawdown experienced after “Liberation Day.” This advance has come via a combination of the passage of time, reversal of some policy proposals, and contours of trade policy resolution emerging so companies can return to the collective highest and best use of their resources: maximizing profits.

In our interactions with investors during this quarter, several questions are a consistent staple of our discussions. We will answer them here but also provide broader thoughts that we believe may be helpful in positioning for the future.

How are your strategies positioned to navigate the ongoing volatility driven by trade and tariff policy uncertainty and where do Bahl & Gaynor think we go from here?

This is the first question we get, usually before sitting down, and usually asked in a way that exhibits genuine concern, which is understandable.

We think it’s best to divide answering this question into two parts: first-order and then second-order effects of trade policy uncertainty.

The first-order narrative we recount is along the lines of, “Markets ended 2024 with high valuation levels, and therefore greater sensitivity to any potential change in the growth outlook. Tariffs just happened to be the particular domino flicked into this fact pattern.”

It makes sense that the first-order reaction to the growth disruption precipitated by trade policy uncertainty is the compression of the price/earnings (P/E) multiple of a very expensive market. Because Bahl & Gaynor’s strategies came into this market fact pattern with considerably lower portfolio-level valuations, part of our downside protection YTD has simply been the avoidance of an as-significant compression in P/E multiple.

But this is not the complete picture. To complete the picture, we must examine idiosyncrasies present in both the large cap and small/mid (or smid) cap portions of the equity market.

In the large-cap space, concentration in top index constituents, which include many of the Magnificent 7, contributed significantly to the indexes’ nearly 20% peak-to-trough decline. We highlighted in our Investor Letter and quarter-end edition of The Dividend Corner that not only have the top 10 constituents of the S&P 500 grown to represent 35% of the index’s market cap at 3/31/2025 (versus 17% a decade prior), but the average downside capture of these top constituents has risen to 134% versus 92% a decade ago. While the beta of the market will always be one, this does not mean its volatility is constant.

Our work in portfolio construction and fundamental analysis is heavily focused on intentionally building downside protection potential so it is present in volatile periods whenever they arise and independent of proximal cause. For our large-cap strategies, this has involved avoiding the concentration of market indexes, selecting companies with lower-volatility business models and therefore lower-volatility equity, combining portfolio constituents in such a way as to maximize the benefits of diversification, and maintaining valuation discipline. This discipline has contributed to year-to-date downside capture ratios for our large-cap strategies ranging from approximately 60% to 75% versus the S&P 500.

The smid cap portion of the equity market possesses a different form of concentration. Nearly 40% of constituents were not profitable in the last four quarters ended 1Q2025 and this figure has been rising since 1990. A lack of profitability leaves a company dependent on external sources of capital, and capital market access can be unpredictable. Growth disruptions can upend this access and precipitate significant equity volatility or even impairment. In the smid space, Bahl & Gaynor builds in downside protection potential primarily through a focus on profitable companies – a near-universal feature of dividend-paying companies. This discipline minimizes exposure to unpredictable variables like capital market access that can potentially impair a business model. We also maintain our focus on diversification and valuation discipline, the combination of which has allowed our small and smid strategies to deliver downside capture ratios YTD of between approximately 65% and 75% versus their respective benchmarks.

Recall that we view this question as best answered in terms of first-order and second-order effects of tariff policy uncertainty. With the first-order impacts now articulated, the second-order component of this question relates to the impact of trade policy changes on the earnings profile of the market versus the companies we hold in our strategies. We believe tariffs can be viewed as inflationary in the short run in the form of a one-time price increase and disinflationary in the medium-to-longer run via substitution effects and supply chain retooling. This resembles the dynamics present in goods markets during the pandemic. The companies across our strategies demonstrated earnings resilience during this historical period, allowing the strategies to deliver portfolio income growth ahead of inflation. Today, the downside protection our strategies have provided relative to their respective benchmarks amid the trade policy upheaval signals the market’s confidence in resilient earning power despite these challenges.

On an individual company basis, we do believe this and subsequent earnings cycles will provide a clearer picture of how various businesses will be able to manage through any shift in trade regime. Inevitably there will be mis pricings that become evident in our fundamental work that we may act upon across our strategies. It’s important to note that these may be limited for the time being for two reasons:

1. The performance of our strategies in this period of elevated volatility has been peer-leading from a downside protection perspective, and in line with the expectations derived from investment theses across our strategy holdings.
2. Trading in anticipation of what may be, particularly with respect to fluid policy decisions, is not the sort of value we seek to add in delivering outcomes to investors. Allowing investor capital to compound consistently and produce more cash for them over time is our value proposition. These characteristics are fortunately slow to change because they are grounded in business models with wide moats, guided by management teams with experience through many kinds of cycles, and backstopped by balance sheets fortified in good times so they may provide protection in uncertain periods.

All this said, the second-order effects of evolving trade policy will not be known until trade policy itself arrives at a steady state. It’s uncertain how long various bilateral negotiations will take, and, in turn, when companies will be comfortable making investment decisions and individuals making purchase decisions based on these new policy equilibria. What we do know is financial flexibility amid a rapidly changing business and consumer environment is an advantage to companies that possess it. We view a significant component of our work as fundamental investors to be the underwriting of both business model resilience and financial strength for precisely these kinds of situations.

Even though action may be less necessary within the portfolios we manage, we do think now is an important time to re-underwrite overall portfolio positioning and risk exposure, which leads to our second question.

 

How do you think about the positioning of your strategies across other risk assets in investor portfolios, given the current and anticipated landscape?

From a longer-term and general perspective, the reason investors earn a risk premium from investing in equities is rooted in the innate tendency of humans to panic. This is one of those periods – it just so happens that tariffs were the proximal cause this time around and the reaction was made worse by the high starting valuation of the market and the idiosyncrasies we described across certain market cap spectrums in our first question.

Many of our conversations with investors during this period suggest that the volatility they experienced in investment disciplines outside of our own offerings exceeded their expectations and comfort levels. Recent strength, therefore, should be viewed as an opportunity for investors to re-think and re-calibrate their go-forward risk posture.

Across all risk assets, public and private, equity and fixed income, liquid and illiquid, we think it’s a very worthwhile exercise to re-underwrite quality exposure. Quality can be multi-faceted. It can concern valuation – an expensive quality asset can fail to deliver downside protection. It can concern fundamentals – unprofitable companies with great promise can be challenged by tightening financial conditions. It can concern mean reversion – the historically anomalous role price appreciation has played in the last 15 years of equity returns versus dividends may not continue for another 15 years. 

Whatever the vector, quality has mattered in this current environment, and it is likely to continue to matter for some time as the causes of volatility may be partly secular in Nature.

Though we are biased, we believe strongly that dividend growth strategies deserve a place in any investor’s portfolio. Dividends, in our view, provide a convenient signal to investors about the inherent quality of the business underlying the equity. Dividends have not been a central focus of investors for some time, whether because of falling interest rates and tame inflation, globalization, technological innovation, or simply investor zeitgeist. But a reversal or change to any of these reasons for dividends having been de-emphasized in the collective investor psyche is precisely what may make them so attractive as a portfolio component now and going forward. Perhaps in the future, investors will be more focused on durable earnings and the tangibility of dividends in the face of uncertainty.

As with tariffs, we have no special insight as to how this or any other volatility-inducing event may affect economic and market fortunes in the future. What we do know is the world is navigating significant change, and that can be uncomfortable, particularly given the uncertainty around its magnitude and duration. Through these changes, anything that can potentially enhance certainty of outcome will likely command a premium from investors. We know of no better way to increase certainty of outcome, in investment terms, than to own a diverse basket of resilient businesses that trade at reasonable valuations and reliably produce cash for reinvestment and distribution shareholders. Though the next few months and quarters may continue to be a nerve-wracking rollercoaster ride (and we hope it is not), we are confident in our ability to deliver these outcomes to investors in their time of need.

 

We conclude with the final question we have been asked frequently: What would make you more optimistic about the economic and market backdrop?

This question is usually asked in the context of the prior answers being perceived as bearish in nature – which is not our intent. After all, we at Bahl & Gaynor are long-term equity investors and ours is a fundamentally optimistic asset class. We do not view ourselves as bearish, merely cautious, which is an underpinning of our value proposition in the form of downside protection – discussed at length so far today and in our most recent quarterly Investor Letter (link).

Since the trough lows in early April, markets are clearly discounting some level of resolution to the shift in trade policy and other risks as markets have recovered about half their losses from YTD peak in short order. Part of this may be the self-inflicted nature of trade policy revisions and the ongoing adaptation of the approach to resolution. There is a careful balance here because uncertainty is not only what pressures P/E multiples outright, but also future earnings via diminished investment and demand. Conversely, incremental removal of uncertainty allows the market to more clearly discount future value.

We do think some inked trade deals, or at least memoranda of understanding, will go a long way towards helping businesses regain confidence to invest and demand to recover. This has already been reflected in the positive reaction to the announced outcomes of negotiations between the US and the UK and a détente with China. But we also think this overlooks the broader opportunity currently available to investors. Because of the recovery in risk assets, there is currently an uncommon opportunity for investors to reassess their portfolio positioning based on their recent experience amid volatility and potentially adjust this risk profile if it has threatened future goals or caused undue concern.

The incipient market recovery is providing an opportunity for investors to make necessary changes without as much of the behavioral pain of forced selling or “trading under fire.” While the incredibly strong equity returns of the last few years, indeed the last 15 years, have advanced investors closer to their goals, now is the time (and opportunity) to think deeply about the level of risk one is willing to accept on their continuing journey.

We are pleased with the tangible outcomes we have provided to investors through this period of volatility, namely a little-altered dividend income stream that is likely to grow faster than inflation this year, and downside protection amid the market drawdown. We hope to be considered as part of this risk introspection process we believe investors will be undertaking in the coming weeks and months.

 

Disclosure:

Please note that the information provided in this update is for informational purposes only and does not constitute investment advice or a recommendation by Bahl & Gaynor.

The views expressed in this update are those of the speaker and may not reflect the views of Bahl & Gaynor. Market conditions can change rapidly, and past performance is not indicative of future results.

Before making any investment decisions, please consult with a qualified financial professional to ensure the information is appropriate for your individual circumstances. 

Bahl & Gaynor is a registered investment adviser with the Securities and Exchange Commission (SEC), and all discussions in this update are subject to the firm’s disclosure documents, including Form ADV Part 2A and Part 2B, which are available upon request.

This is not an offer to buy or sell any securities or investments. Any examples or information related to specific securities are for educational purposes and should not be considered a solicitation or recommendation. 

Downside capture ratios are supplemental performance measures calculated using gross returns of Bahl & Gaynor representative large-cap strategy composites compared to the S&P 500® Index during down-market periods YTD through May 15, 2025. The S&P 500® Index is an unmanaged index that cannot be invested in directly. For complete net performance information, including 1-, 5-, 10-year and since-inception figures, please refer to the full GIPS-compliant presentation available upon request.

Downside capture ratios represent gross performance for representative Bahl & Gaynor’s mid and small-cap strategies during negative return periods YTD through May 15, 2025. These are supplemental to net performance and benchmark results, which are available in Bahl & Gaynor’s full GIPS compliant presentation upon request.

Past performance is not indicative of future results. Investing involves risk, including the potential loss of principal.