Fear of rising rates hits high dividend-paying stocks

Appetite for bond substitute continues to wane but some strategists suggest keeping some exposure

Mar 15, 2014 @ 9:18 am

Shares of high-dividend-yielding companies are trading near the lowest level in almost three years relative to the market, as the prospect of higher interest rates makes these stocks less attractive to investors.

The Dow Jones U.S. Select Dividend Index has lagged behind the Standard & Poor's 500 Total Return Index by 4.5 percentage points since April 30, 2013. During the same period, the yield on 10-year Treasuries has risen to 2.65% from 1.67%.

The dividend index — made up of 100 companies including Lockheed Martin Corp. and Philip Morris International Inc. — attracted investment amid the backdrop of low interest rates because it served as a “bond substitute,” by providing a higher yield, said Jack Ablin, who helps manage $66 billion in assets as chief investment officer at BMO Private Bank in Chicago. This favorable investment backdrop is reversing, he said.

“If the U.S. economy stays on the path it's on, 10-year Treasury rates could hit 4% this year, pushing these stocks further out of favor,” Mr. Ablin said.

Even though the harsh winter could slow U.S. growth during the first quarter, it won't harm the economy enough to prompt “a fundamental change in the outlook” for the Fed's reduction in bond purchases that were aimed at lowering interest rates, William C. Dudley, president of the New York Fed, said March 6 at an event in New York. “The threshold is pretty high to change it.”


The yield on 10-year Treasuries will increase to 3.35% by the end of 2014, according to the median forecast of economists surveyed by Bloomberg. That forecast is down slightly from February's survey of 3.4%. Meanwhile, gross domestic product will expand 1.9% in the first quarter and accelerate to 3% by year-end, according to the median forecast of economists.

Interest rates started to rise in May when the Federal Reserve began bracing investors for a phase-out of its unprecedented monetary stimulus.

That increase was temporarily interrupted in January by concern about a global slowdown caused by emerging market economies, said William O'Donnell, head U.S. government-bond strategist at Royal Bank of Scotland Group's RBS Securities unit. In the past month, rates have drifted “moderately higher” again, driven in part by the prospect of a modestly better U.S. economic backdrop, along with improving corporate and household balance sheets, he said.

Shares of companies that pay high dividends track closely with 10-year Treasuries, so amid a correction in the markets in January, there was some “flight to safety” that favored these types of stocks, according to Jeff Mortimer, director of investment strategy in Boston for BNY Mellon Wealth Management. While such volatility could continue throughout the year, longer-term — the next 12 to 18 months — “stocks that have a bond-like component will be weighed down by rising interest rates,” he said.

In the past year, this group has been trading in a “series of declining peaks” relative to the market as investors allocate a smaller amount of money to them than to other companies in the S&P 500, said Jim Stellakis, founder and director of research at research company Technical Alpha Inc. “These lower highs show investors want progressively less and less exposure to high-dividend paying companies.”


Relative to the benchmark, the dividend index is trading near a “big support level” and if it were to trade below a March 2012 threshold in a “decisive manner,” this would signal the appetite for these stocks has deteriorated a lot more, Mr. Stellakis said. “These stocks are hanging on right now.”

The dividend group also includes General Mills Inc. and Clorox Co.

Not every analyst believes 10-year Treasury rates will rise. They could fall to 2.25% this year because there's no sign of inflation on the horizon, according to Andrew Wilkinson, chief market analyst at Interactive Brokers. “To agree with the consensus forecast, you have to be convinced the economic recovery will be sufficiently strong to withstand a rise in interest rates that won't impact demand, particularly in housing.”

Gross domestic product expanded at a slower-than-projected 2.4% pace in the fourth quarter, down from a prior estimate of 3.2%, Commerce Department data show.

Still, the rotation out of this group already is underway, Mr. Mortimer said. He recommends investors don't forsake all of these companies and instead pair select “high-dividend payers” with high-growth stocks in industries such as technology, health care and biotechnology that don't have as high a payout, he said.

As rates climb higher this year — Mr. O'Donnell forecasts the yield on 10-years will increase to a “more benign” 3.2% — “Treasuries will become a better alternative to riskier assets like high-dividend-paying stocks,” he said. A larger portfolio adjustment probably won't be triggered until interest rates breach at least this level, he said.

“We're in a transition period to higher rates, illustrated by the weakness in high-dividend-paying stocks,” Mr. Mortimer said.

Bloomberg News


What do you think?

View comments

Recommended for you

Sponsored financial news

Upcoming Event

Apr 30


Retirement Income Summit

Join InvestmentNews at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Featured video


The power of data

Your clients have financial news and data at their fingertips, but donít know how to interpret it. Katy Gibson of Envestnet|Yodlee and Blake Kannady of Envestnet discuss the power of leveraging aggregated data.

Recommended Video

Path to growth

Latest news & opinion

Relying on trainees, Merrill Lynch boosts adviser headcount in 2017

Questions remain about long-term effectiveness of wirehouse's move away from recruiting experienced brokers.

Supreme Court review of SEC judges could roil pending cases

But long-term, the agency may get around questions of constitutionality by changing the way it brings on administrative law judges.

Lightyear Capital takes 50% stake in $9 billion HPM Partners

Private equity backing could fuel acquisitions by the large RIA.

Tax reform: 7 essential strategies for financial advisers

While advisers face the difficult task of analyzing the law's impact, they will also have a significant opportunity to prove their value by implementing money-saving strategies for clients as well as their own businesses.

Tax law: Everything advisers need to know about the pass-through provision

The provision is tricky, but could provide advisers and business-owner clients with sizable tax savings.


Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print