Dividend Paying Stocks in Rising Rate Environments

August 23, 2017

Dividend Paying Stocks in Rising Rate Environments

You’ve probably heard the financial press proclaiming that the rally in stocks has to be doomed, given that the gains enjoyed since the end of the Financial Crisis have all been predicated on the “easy-money” monetary policy of the Federal Reserve. Through August 7, 2017, the broad-market S&P 500 index has risen more than 335% since the market low on March 9, 2009. And since the Fed first started raising rates in the most recent cycle on December 16, 2015, the index has risen more than 23%, including dividends.

It’s been almost two years since the Federal Reserve System’s initial rate hike, and it’s apparent that a rising rate environment hasn’t caused the equity markets to stall as many had predicted, like Deutsche Bank in September 2015[1]. It is hard to argue that historically microscopic interest rates have not been positive for stocks. But many have been surprised over the last 12 months when the yield on the 10-Year U.S. Treasury has soared from 1.51% to 2.25% (08.10.16 through 08.07.17), even as the Federal Reserve raised rates. More importantly, equity yields make us optimistic about value stocks in a rising rate environment.

Dividend-Paying Stocks

While past performance is no guarantee of future results, investors with the patience to stick with a diversified portfolio of stocks in times of rising interest rates have historically done well.  One could even argue that we ought to be cheering on Janet Yellen & Co., given that our long-term-oriented value portfolios are loaded with dividend-paying stocks.

Annualized Stock Performance After "Fed Liftoff" - 24 Months After

Annualized Stock Performance After "Fed Liftoff" - 36 Months After

Annualized Stock Performance After "Fed Liftoff" - 60 Months After

The data above show that 24 months following a Fed Liftoff, dividend payers have returned an average of 9.1% versus 3.7% for non-dividend payers and 8.5% for the S&P 500.  60 months following a Fed Liftoff, dividend payers returned an average of 10.4%, with non-dividend payers returning 6.9% and the S&P at 9.6%. Next time you ask yourself what to invest in if you think interest rates will rise, we would argue that dividend-paying stocks are a good place to start.

The Latest from the Federal Reserve

We might have expected a bit more in the way of fireworks, given that the Federal Reserve made a series of announcements in conjunction with the June Federal Open Market Committee meeting on June 14, 2017. Fed Chair Janet Yellen said, “Today, the Federal Open Market Committee decided to raise the target range for the federal funds rate by 1/4 percentage point, bringing it to 1 to 1-1/4 percent. Our decision to make another gradual reduction in the amount of policy accommodation reflects the progress the economy has made, and is expected to make, toward maximum employment and price stability objectives assigned to us by law.”

Of course, the FOMC Statement continued to include the reminder, “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

Using data from Bloomberg on August 8, 2017, the Fed Funds Futures market indicated that the latest interest rate increase is likely to be the last this year, as the odds are less than 50% of another hike happening until the March 2018 FOMC meeting. Even by the first meeting in January 2019, the odds for an interest rate above 2% are less than one in twenty five.

Staying the Course

Rather than pretending to have a market crystal ball that can predict the next few minutes with certainty, we feel much more comfortable investing our diversified portfolios of dividend-paying, undervalued stocks. This offers long-term appreciation potential through rising and falling interest rate environments, taking the good days, weeks, months and years along with the bad. We remain secure in the belief that in the fullness of time, patience eventually will be recognized and rewarded. This philosophy can be applied to investing while interest rates rise, as well as any other season.

The Case for Value Investing

We believe that you pre-pay for expectations in growth stocks, whereas value stocks have already been discounted. This is why over the long-term, growth stocks have trailed value stocks, returning an annualized average of 9.4% while value stocks have returned an annualized average of 13.6% over the same time period.

Download The Case for Value Investing

[1] https://www.cnbc.com/2015/09/15/when-the-fed-raises-rates-heres-what-happens.html

Nothing presented herein is, or is intended to constitute, investment advice, nor sales material, and no investment decision should be made based on any information provided herein. The information provided herein is educational in nature, is not individualized, and is not intended to serve as the primary basis for your retirement, investment, or tax-planning decisions.

No guarantee of investment performance or dividend payment is being provided and no inference to the contrary should be made.

Value stocks are shares of a company with solid fundamentals that are priced below those of its peers, based on analysis of price/earnings ratio, yield, and other factors. Please note that the illustrated depictions are not intended to be representative of any individual product available through AFAM Capital, Inc.

The performance of dividend paying stocks as illustrated is comprised of the returns of the 30% highest dividend payers, 40% mid-range dividend payers, and 30% lowest dividend payers – calculated using dividend yield. The performance of non-dividend paying stocks as illustrated is comprised of the returns of stocks that do not pay a dividend. All as of dates indicated, rebalanced monthly, and derived using data from Professors Eugene F. Fama and Kenneth R. French. http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

The S&P 500 Index is a broad market sample based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. It is not possible to invest directly in an index.

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