Today’s decision by the Federal Reserve to raise rates wasn’t a surprise. The markets had been pricing in the move for weeks. What may be unexpected, is how the hike could play out for dividend payers.
Average Relative Performance of S&P 500 Highest Dividend Growers/Highest Dividend Yielders
Source: Ned Davis Research, Inc. and Standard & Poor's, 10/26/1976 to 8/10/2005.
Interest rate increase dates included are 10/26/1977, 11/17/1980, 8/9/1988, 3/22/1994, 8/24/1999, and 8/10/2004. A tightening cycle is defined as three consecutive rate hikes without a cut and is only known retrospectively. Indices used are equal-weighted indices based on total returns, with the constituents of each index reconstituted quarterly. The dividend growth rate is measured as the year/year percentage change in a company's indicated annual dividend. The dividend yield is calculated using indicated annual dividends. The largest dividend growing stocks are defined as the top quartile of dividend paying stocks by dividend growth rate. The highest dividend yielding stocks are defined as the top quartile or fourth of dividend paying stocks by dividend yield. © Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/. Past performance does not guarantee future results.
As the chart shows, performance strength following a second rate hike has been tied to dividend payout growth, not the level of yield at the time of the hike. This may come as unwelcome news to investors that have been bidding up high yielding names and sectors in a scramble for income lost from treasuries. Signs of trouble for bond-like sectors began to emerge as anticipation of a rate hike grew. In the past two months (as of November 30), Utilities and Real Estate Investment Trusts in the S&P 500 fell 4.58% and 8.39%, respectively. As the yield on treasuries begins to climb, we expect investors will turn to equities that can grow dividends or are reinvesting cash flow to drive revenue higher.
Dividends have long been viewed favorably by us because they enforce financial discipline on management, but we have refused to pay up for high yielding names. As rates climb, that approach may be particularly rewarding.