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Financial pundits have been telling two stories about how rising interest rates affect dividend stocks. Both stories have some merit, but they say opposite things.

The first story says dividend stocks are the place to be during times like today.

According to this story, steady dividend payers are positioned to hold up well in the current turmoil because they put an immediate, steady stream of money into your pocket. In contrast, tech stocks and similar growth investments are likely to suffer because the prospect of reaping rewards years from now becomes less tantalizing when interest rates go up and reduce the present value of future payouts.

The second story is pretty much the reverse of the first. It argues that rising rates inevitably hurt dividend stocks. The logic here is that dividends become less compelling as the yield grows on competing investments, such as bonds and savings accounts. A stock that pays you a 4 per cent dividend looks like a great deal when bonds are yielding close to zero. Its attraction dwindles, though, if high-quality bonds start paying very similar rates.

Both stories sound reasonable. But which one is actually true?

The market can’t make up its mind.

Just as the first story would have predicted, tech stocks have taken a beating since interest rates began to rise. The tech-heavy Nasdaq index has slumped more than 20 per cent since the start of the year. Canada’s own Shopify Inc. has lost two thirds of its value.

Meanwhile, some dividend stocks have done just fine. Utilities and telecommunication companies, in particular, have performed admirably during challenging times.

But the second story is also proving true, at least in patches. Just as this story would have predicted, some of the most reliable dividend payers – banks and real estate investment trusts – have taken their lumps as rates have gone up. Canadian bank stocks have struggled since early February, while Canadian REIT indexes have lost more than 10 per cent since the start of the year.

This pattern in which some dividend stocks gain during a period of rising rates and others lose is confusing. It’s also unusual.

As Ian de Verteuil of CIBC pointed out in a report this week, utilities and telecom stocks usually lag behind the market when rates are rising. Their current popularity is an anomaly.

He suggests that this unusual pattern reflects broader economic jitters. In the past, rising interest rates often went hand-in-hand with growing optimism about the North American economy. The opposite is true now. Many people are worried about a potential slowdown ahead. Today’s rising interest rates aren’t the result of growing optimism. They are the result of the need to bring inflation to heel.

Given the cloudy economic outlook, it makes sense for investors to look for defensive stocks that can offer shelter against a possible storm. Utilities and telecom companies stand out in that regard. No matter how rough the economic weather might get, people will still pay their electricity and phone bills.

In contrast, other dividend stocks are exposed to the full force of the interest-rate headwind because they are more economically sensitive. Banks and REITs, in particular, are likely to feel the drag of any economic slowdown (although this may be partially offset in banks’ case by higher net interest income). So perhaps it is no great surprise that their stocks aren’t thriving as rates ratchet upward.

This explanation makes a lot of sense. However, it also raises questions about what happens next.

Mr. de Verteuil argues that so long as the yield on 10-year government bonds, now around 3 per cent, remains below 4 per cent, utilities and telecom stocks should hold up well. He particularly likes Hydro One Ltd. and Atco Ltd. among the utilities and Rogers Communications Inc., Quebecor Inc. and Cogeco Inc. among the telcos.

Stepping away from his report, investors might also want to consider the basic logic of the situation. History suggests dividend stocks of most varieties usually lag behind the market during periods of rising interest rates. This is more in keeping with the second story than the first.

If history is any guide, investors shouldn’t lose sight of the broader market. In particular they may want to pay attention to defensive stocks that can keep on plugging ahead during economic slowdowns, but aren’t primarily bought for their dividend yields.

Transportation stalwarts such as Canadian Pacific Railway Ltd. and Canadian National Railway Co. fit into this category. So does a retailer such as Walmart Inc., which has fallen as a result of recent snafus but usually fares well during downturns in the broader economy. No matter which story about higher rates you buy, or what outlook you have for the economy, stocks like this are likely to hold up well.

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