You’ve heard it a million times: When interest rates rise, dividend stocks drop.
It seems to make perfect sense. When rates rise, companies that carry a lot of debt – including classic dividend payers such as utilities, pipelines and telecoms – face higher borrowing costs, so you’d expect their stocks to underperform.
There’s also a valuation element at play. As bond yields rise, yields on dividend stocks would also be expected to rise to remain competitive. That means dividend stock prices – which move in the opposite direction to their yields – must fall.
Well, that’s the theory, anyway.
But Brian Belski, chief investment strategist with BMO Capital Markets, has come to a different conclusion after examining 30 years’ worth of data: Even as some dividend stocks struggle when rates are rising, companies that regularly raise their dividends have historically outperformed the market during such periods.
In a research note this month, Mr. Belski analyzed the seven periods since 1990 when the 10-year U.S. Treasury yield rose for a year or longer. In all but two of those instances, dividend growth stocks posted total returns greater than the S&P 500 index. The average annualized total return for the dividend growers when rates were rising was 20.7 per cent, compared with 17.5 per cent for the index. (Total returns include dividends and share price changes.)
Other types of dividend stocks did not fare nearly as well. The 25 S&P 500 companies with the highest yields – whose dividends were not necessarily growing – posted an average annualized total return of 8.8 per cent during periods when bond yields were rising.
“Rising rates are not a dividend-growth-stock killer,” Mr. Belski concluded. “Companies that are able to continue paying or even increase their dividends during challenging times are the epitome of high quality and stability, in our view.”
His analysis is timely now that government bond yields have surged amid expectations that a strong postpandemic economic recovery could fuel inflation. The yield on 10-year Government of Canada bonds, for instance, has spiked to about 1.5 per cent, up from less than 0.5 per cent last summer, mirroring similar moves in the U.S. Treasury market.
Mr. Belski isn’t the first person to challenge the notion that rising interest rates are uniformly bad news for dividend stocks. In his book, Inevitable Wealth, Robert Cable analyzed 40 years of data from Ned Davis Research and found that dividend growing stocks outperformed non-dividend payers during cycles of rising rates.
Mr. Cable, a retired investment adviser in Mississauga, says declines in dividend stocks triggered by rising interest rates are often temporary. Investors engage in knee-jerk selling because they fear the impact of higher rates, but stocks eventually rebound.
“When the news is all about rising interest rates, dividend-payers will sell off in anticipation of higher rates and rising inflation. Often the worst-case scenario gets cooked into these stocks, a sigh of relief follows and share prices rebound,” Mr. Cable told me.
That’s exactly what happened with the utility company Fortis Inc. (FTS), for example. In October, the shares traded for about $55, but as bond yields started perking up Fortis struggled, briefly dipping below $49 in February. Since then, the shares have bounced back, closing Friday at $54.70. Other utilities have followed a similar pattern.
The lesson here is that selling a solid dividend growth stock because interest rates are rising could come back to bite you. With a company like Fortis – which has raised its dividend for 47 consecutive years and is forecasting continued dividend growth of 6 per cent annually through 2025 – a better approach is to buy and hold. If anything, when the price weakens, it’s a great time to buy more.
“So many people worry about short-term price changes instead of making a solid and relatively low risk investment today that will almost certainly benefit them handsomely a decade from now,” Mr. Cable said.
Looking for dividend growth stock ideas? BMO maintains a model North American Dividend Growth Portfolio that includes the following Canadian names: BCE Inc. (BCE), Telus Corp. (T), Restaurant Brands International Inc. (QSR), Enbridge Inc. (ENB), TC Energy Corp. (TRP), Manulife Financial Corp. (MFC), Power Corp. of Canada (POW), Royal Bank (RY) and Toronto-Dominion Bank (TD).
With the exception of Power Corp., all of these stocks (plus Fortis) are also included in my own model Yield Hog Dividend Growth Portfolio, which Globe Unlimited subscribers can view online at tgam.ca/dividendportfolio. (Full disclosure: I own the stocks personally as well.)
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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