At some point this year, interest rates should go up. What will happen then to dividend-paying stocks? Because they benefited when fixed-income rates were low, they will dip – and some already have, in anticipation. Over the long pull, however, dividend payers do well.
In an era of low interest rates, the dividend stock trade was a good place to be. Getting a higher yield on a good-quality stock than you can on a 10-year Treasury bond seems like a no-brainer. The Federal Reserve will eventually start raising short-term interest rates, and this likely will lead to higher yields on longer-term bonds like the 10-year Treasury.
The January and February jobs reports were relatively strong and stoked fears of an earlier-than-expected Fed tightening. Around both of those reports, dividend stocks sold off quite a bit. While the March employment report was disappointing, the especially cold winter in the Midwest and Northeast, and the West Coast port strike, likely made it an aberration. Year to date, dividend stocks still are not doing that well.
Below is the return of three popular dividend-stock exchange-traded funds, as compared with that of the Standard & Poor’s 500. All three ETFs are in negative territory, lagging behind the (barely) positive S&P:
iShares Select Dividend (DVY) – minus 1.08%
Schwab US Dividend Equity (SCHD) – minus 0.44%
Vanguard Dividend Appreciation (VIG) – minus 0.29%
S&P 500 – plus 1.05%
So what does history tell us about dividend stocks during rising rate environments? That dividend stocks suffer, certainly, although just how and why are nuanced.
The highest payers get hurt the most during rate hikes, a report and chart from financial research firm Morningstar shows, covering 1927 through 2013. Performance-wise, the one-third paying the highest dividends were in the red, while the bottom fifth of payers were ahead almost 5%.
Non-payers, however, did the best then, returning around 7%. Over all periods, the situation was the reverse, with the most generous payers outdoing everyone else. The same was largely true when rates fell.
A research paper from O'Shaughnessy Asset Management found that, when rates rose, the very highest-yielding dividend-paying stocks (top one-tenth) beat the market only half the time. During the 16 rising-rate periods it measured, from 1927 through 2012, this group outpaced the general stock market just eight times, although most of those occurred in the distant past.
Only three of those market-beating performances came after 1982, when a long bond market rally began. Before then, as the study notes, rate rises were more gradual and lasted longer, thus giving financial markets more years to adjust.
Note that Fed Chair Janet Yellen says that the central bank will raise rates slowly, because of the economy’s fragile state.
Obviously, high stock payouts are most appealing when bond interest rates are dropping. The Dividend Ladder newsletter points out that the biggest payers tend to be real estate investment trusts (or REITs, collections of properties, which pass the bulk of their rental income to investors) and business development corporations (they invest in small companies, often start-ups). REIT payouts, for instance, are just over 4%, with the highest paying sector, financial trusts, exceeding 7%.
By contrast, the S&P 500’s average yield is around 2%. Only 79 of those companies don’t pay dividends.
All that said, history indicates that dividend stocks do the best in the long run. According to Ned Davis Research, from 1927 through 2013, dividend payers returned 9.3% annually, on average, versus 2.3% for non-payers. And companies that increased their dividends or started paying them were up 10%. During stock bear markets, payers got hurt the least, down 17.9%, versus negative 31.1% for non-payers.
Bottom line: dividend stocks mostly perform well, regardless of the rate climate. They pay you to own them.
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Matthew Tuttle, CFP, is chief executive of Tuttle Tactical Management in Stamford, Conn., and the author of How Harvard & Yale Beat the Market. He can be reached at 347-852-0548 or mtuttle@tuttletactical.com.
Nothing in this article should be interpreted to state or imply that past results are an indication of future performance. Please consult your tax or investment advisor before making any investment decisions.
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