Rising_Rates_Dont_Have_to_Hurt_High_Dividend_Stock

By David J. Abella, CFA

Key Takeaways:

  • Many factors affect high dividend stocks
  • Rates remain low by historical standards
  • Quality companies perform well long term

City National Rochdale's High Dividend Income strategy focuses on stocks with attractive yields, raising the question: How can these stocks perform in a rising interest rate environment, especially after a difficult first quarter?

QU 1Q18 Abella Chart 1

Our strategy relies on lengthy historical analysis showing that there has not been a strong correlation between the long-term returns of high dividend stocks and periods of rising interest rates. Many other factors affect these stocks, including the growth rates of income and cash flows at the companies, expectations about the operational states of the underlying businesses, the condition of the equity markets, and the strength and growth rate of the overall economy. In some cases, higher rates have corresponded with a negative price performance of high dividend stocks; in other cases, price performance was positive as rates rose. Our data showed no sustainable pattern or high correlation.

In past periods, we have experienced short-term volatility in our dividend stocks when expectations for higher rates were suddenly heightened. Our view is that much of the weakness in dividend stocks in the first quarter was due to outsized expectations regarding higher rates. Although the Fed is expected to increase the fed funds rate three more times this year, with the 10-year Treasury rate being range-bound, it's important to remember that interest rates, both short and long, are currently quite low by historical standards.

QU 1Q18 Abella Chart 2

We conclude that rates are not the main driver of performance for income stocks over the long term if other significant factors are at play, such as solid cash-flow growth. At the same time, we are aware that rising rates (or heightened expectations of increases) can result in short-term price volatility, and our experience tells us that continued caution is in order in the near term. Our focus will remain on identifying undervalued, high-quality companies with solid prospects for dividend growth over time under most conceivable economic environments.

Read the next article in the series: Choices for Opportunistic Income Include More Than High Yield Bonds.

Index Definitions

Bloomberg Barclays U.S. Municipal High Yield Index: measures the non-investment grade and non-rated USD-denominated, fixed-rate, tax-exempt bond market within the 50 United States and four other qualifying regions (Washington DC, Puerto Rico, Guam, and the Virgin Islands). The Index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

The Bloomberg Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year.

Bloomberg Barclays U.S. Corporate High Yield Index: measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.

The Bloomberg Barclays Emerging Markets Hard Currency Aggregate Index is a flagship hard currency Emerging Markets debt benchmark that includes USD-denominated debt from sovereign, quasi-sovereign, and corporate EM issuers.

The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the performance of the largest facilities in the leveraged loan market.

Bloomberg Barclays Intermediate U.S. Corporate Index: measures the performance of U.S. corporate bonds that have a maturity of greater than or equal to 1 year and less than 10 years. The Index is a component of the Barclays U.S. Corporate Index and includes investment grade, fixed-rate, taxable, USD-denominated debt with $250 million or more par outstanding, issued by U.S. and non-U.S. industrial, utility, and financial institutions.

The Bloomberg Barclays US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index.

Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Important Disclosures

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 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.

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.

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 the municipal securities of a particular state or territory may be subject to the risk that changes in the economic conditions of that state or territory will negatively impact performance. These events may include severe financial difficulties and continued budget deficits, economic or political policy changes, tax base erosion, state constitutional limits on tax increases, and changes in the credit ratings.

All investing is subject to risk, including the possible loss of the money you invest.

As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.

Diversification does not ensure a profit or protect against a loss in a declining market.

Past performance is no guarantee of future performance.

Investment management services provided by City National Bank through its wholly owned subsidiary City National Rochdale, LLC, a registered investment advisor.