- Dividend growth has outpaced stock returns in several sectors
- Ongoing economic expansion is positive for yield-oriented equities
- Strong operating earnings driving dividends toward our growth targets
After a good performance in 2016, the challenge for dividend stocks this year was to continue to deliver attractive total returns, particularly in light of a rising interest rate environment. As 2017 progressed, we have seen a strong rally in the S&P 500 index, with particular benefit to large-cap growth stocks. This has left some investors in dividend-oriented equities wondering if there are still opportunities in these stocks.
We remain optimistic about our dividend-paying companies in light of their strong operating performance and solid dividend growth. We are aware that our High Dividend & Income (HDI) buy universe stocks have not moved up at nearly the same pace as large-cap growth stocks. We also note that some of our sectors, notably Real Estate Investment Trusts (REITs) and Consumer Staples, have had relative underperformance over the past six months despite a steadily rising rate of dividend growth (see chart). However, in our view, this muted performance relative to dividend growth has enabled our HDI buy universe stocks to accrue value and makes them more attractive over the long haul.
With two interest rate hikes already enacted by the Federal Reserve and one more possible this year, investors continue to wonder about the potential effects of rising interest rates on income-oriented equities.
As part of our equity analysis work, we seek to invest in companies that can grow their earnings and dividends consistently. We have found that these stocks have performed well over longer periods of time. In the second chart, we see how the iShares Select Dividend ETF has performed over the past 13 years. Overall, the total return has been independent of the level and move in rates, as represented by the 10-year Treasury. We target dividend growth of 3-8%, which we feel can offset some of the effect of rising rates and help drive our longer-term total returns.
Going forward, we feel that modest return expectations in the 5-7% range, driven by solid dividend yields and their projected growth, continue to be realistic.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.
There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.
Concentrating assets in the real estate sector or REITs may disproportionately subject a portfolio to the risks of that industry, including the loss of value because of adverse developments affecting the real estate industry and real property values. Investments in REITs may be subject to increased price volatility and liquidity risk; concentration risk is high.
Investments in Master Limited Partnerships (MLP) are susceptible to concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy, and market risk. Investors in MLPs are subject to increased tax reporting requirements. MLP investors typically receive a complicated schedule K-1 form rather than Form 1099. MLPs may not be appropriate investments for tax-advantaged accounts because of potential negative tax consequences (Unrelated Business Income Tax).
There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.
Investments in emerging market bonds may be substantially more volatile, and substantially less liquid, than the bonds of governments, government agencies, and government-owned corporations located in more developed foreign markets. Emerging market bonds can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.
As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Returns include the reinvestment of interest and dividends. Investing involves risk, including the loss of principal. Diversification may not protect against market loss or risk. Past performance is no guarantee of future performance.
The Conference Board Leading Economic Index is an American economic leading indicator intended to forecast future economic activity. It is calculated by The Conference Board, a nongovernmental organization, which determines the value of the index from the values of ten key variables.
The Goldman Sachs Financial Conditions Index (GSFCI) is a weighted sum of a short-term bond yield, a long-term corporate yield, the exchange rate, and a stock market variable.
The Standard & Poor’s (S&P) 500 Index represents 500 large U.S. companies. The comparative market index is not directly investable and is not adjusted to reflect expenses that the SEC requires to be reflected in the fund’s performance.
Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.