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Is there a case for dividend-paying stocks during interest-rate hikes?

After postponing previous plans to raise interest rates, the Federal Reserve finally embarked on its intended course, with its first hike of the Federal Funds rate in nine years. The prospect of a rising interest-rate environment, however, has caused concern among many equity investors.

That’s because they assume that rate increases are bad news for stocks. These investors further believe that low-risk bonds paying greater yields after the rate hikes make stocks less attractive by comparison. Stocks have to get cheaper to retain their comparative luster, the thinking goes. This is assumed to be true especially for dividend-paying stocks since rising rates supposedly hurt income-paying investments disproportionately.

Yet data historically shows that, on average, rising interest-rate regimes haven’t hurt stocks, in general, or dividend stocks, in particular. One study of dividend stock performance during periods of rising rates analyzed the highest decile of dividend-paying stocks from 1960–2014. The study defined 10 rising interest-rate periods with meaningful increases in the yield of the 10-year U.S. Treasury during that 55-year time frame.

If history is any guide, we believe that current interest-rate conditions bode well again for dividend-paying stocks.

On average, this top decile group of dividend payers generated an average dividend yield of 6.4 percent and posted an annualized return of 12.55 percent in the 10 rising-rate periods. This performance exceeded the S&P 500 index’s 11.78 percent annualized return by 77 basis points annualized through the 10 rising-rate periods.

This outperformance of the high dividend-paying group relative to the S&P 500 occurred in seven out of the 10 rising-rate periods. The three periods when the dividend payers did underperform the index were periods of the most rapidly rising rates. In contrast, our current period of interest-rate increases should be gradual, which historically has proven beneficial for high dividend-paying stocks.

Moreover, the high-dividend payers didn’t just outperform over those 10 rising-rate periods. They also outperformed significantly over the entire 55-year period, posting a 13.76 percent compounded annualized return, versus the S&P 500’s 10.27 percent annualized return. This outperformance of nearly 350 basis points annualized means that a $10,000 investment in the high-dividend stocks would have grown to around $10 million, 1960–2014, while the same investment in the index would have grown to around $2 million.

Over 55 years, then, dividend stocks have suffered only in rising-rate periods where rates have risen dramatically—and then only with modest drawdowns. According to the Fed’s own statements leading up to and accompanying the first increase, it’s unlikely that the current rising interest-rate regime will be a dramatic one and that rates will increase only as growth continues.

Additionally, the Federal Funds rate is still below 1 percent, while the 10-year U.S. Treasury yield is below 2.5 percent.

Data source: Global X Management Company LLC Information expressed herein is strictly the opinion of Kayne Anderson Rudnick and is provided for discussion purposes only. This report should not be considered a recommendation or solicitation to purchase securities. Past performance is no guarantee of future results.

This article was originally published in the February/March 2016 issue of Worth.

Investing and the Economy

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